Housing, dairy prices weak links in New Zealand financial stability

New Zealand's financial stability is facing growing risks from the global downturn in dairy prices and soaring house prices in the biggest city of Auckland, the central bank warned on Wednesday.

The six-monthly Financial Stability Report from the Reserve Bank of New Zealand highlighted these two dangers alongside an increased risk of disruption to global funding markets as the "three key risks" to the banking sector.

Global prices for New Zealand's biggest export commodity remained low due to strong global supply, sanctions on imports of dairy products by Russia, and slower Chinese demand, said the report.

There was also an elevated risk that a drought associated with the El Nino weather pattern this year and next could add to farm financial stress in some regions.

Dairy sector debt had risen by about 10 percent in the last year.

"There is an increased risk that loans to some highly indebted farmers will become non-performing in coming seasons, especially if the payout is slow to recover," it warned.

Meanwhile, house prices in Auckland - home to a third of New Zealand's population - had risen 27 percent over the past year, supported by strong immigration, constraints on new housing supply, and falling mortgage interest rates.

"With prices becoming increasingly stretched relative to household incomes and rents, there is increasing potential for a sharp price correction in Auckland," said the report.

"Falling house prices could in turn weaken economic activity if indebted borrowers attempted to restore balance sheets by reducing consumption."

However, New Zealand's financial system continued to perform well despite a deterioration in the outlook for global financial stability and the increased risks, central bank governor Graeme Wheeler and deputy governor Grant Spencer said on releasing the report.

"Banks hold strong capital and liquidity buffers and have maintained their profitability with further reductions in cost-to- income ratios. Lending growth to households and businesses has picked up and is being funded mainly through higher domestic deposits," Spencer said in a statement.