New Zealand’s financial system is sound but housing market vulnerabilities remain a key risk and the central bank still wants to curb high debt-to-income lending if necessary, it said in its twice-yearly financial stability report.
House price inflation has moderated since the last report and banks are more resilient to a market downturn, but houses remain overvalued in many parts of the country and some home owners are vulnerable, the Reserve Bank said.
"A further resurgence in house prices would be of real concern, given existing affordability constraint," it said.
New Zealand's housing market has been running hot, spurred by record-high immigration and record-low interest rates.
Over the past several years, the central bank has introduced loan-to-valuation ratios on borrowing for housing in a bid to curb lending.
The central bank said the LVRs have had an impact, with annual national house price inflation, as measured by the Real Estate Institute's house price index, at eight per cent in April from around 14 per cent in October.
However, while they have helped insulate the banking system from a housing downturn, low mortgage interest rates have encouraged an increase in high debt-to-income (DTI) lending.
"Borrowers with high DTI ratios are typically more exposed to a rise in interest rates or a decline in income," it said.
In Wednesday's financial stability report, the central bank said it will shortly release a consultation paper proposing that DTI ratio restrictions be added to the Reserve Bank's macroprudential toolkit.
It said, however, if a DTI tool was available, the Reserve Bank would not apply it at this stage, given that LVR restrictions appear to be mitigating housing risks.
However, "should high house price growth return and the proportion of housing lending at high DTI ratios remains high, a DTI restriction could be warranted".
The central bank also signalled bank funding pressures and dairy sector indebtedness as other key risks.
While these risks had also moderated, it said New Zealand banks had become more reliant on offshore funding to support new lending, exposing them to international risks that could disrupt global markets.
It said that global political and policy uncertainty "remains elevated" and debt burdens are high in a number of countries.