It is disappointing that banks have not dropped mortgage rates further as more people face loan defaults in the coming year, Deputy Reserve Bank Governor Grant Spencer said today.
Appearing before Parliament's finance select committee after the release of its six-monthly financial stability report, Mr Spencer said while rates had been coming down, the most recent cut to the Official Cash Rate (OCR) had not flowed through more.
The Reserve Bank considered margins being paid on floating rate mortgages were unusually high, and also thought the bottom of the housing market had yet to be reached.
The report said reduced loan growth was likely to depress bank profits, but the impact would be partly offset by increased interest margins.
Banks were reflecting higher credit risks in the lending rates charged to borrowers and also the cost of borrowing.
Mr Spencer told MPs that the Reserve Bank was expecting the number of people defaulting on mortgages and other lending to increase in the coming year.
"Non performing loans will increase from here," Mr Spencer said.
Banks had taken a hit in the form of reduced profits but Mr Spencer said he was not willing to make a judgment on whether it was sufficient or not.
Asked whether it was right that a private company should insulate its profits margins at the expense of the real economy, Mr Spencer said banks should take their share of the pain.
Despite this, it was essential the banks remained profitable in order to maintain the stability of the system.
"It is a balancing act," Mr Spencer said.
Today's report also noted house prices were around 9 percent lower in the final quarter of 2008 compared to their peak a year earlier.
That was the largest annual drop in property values since comprehensive records started in the 1960s.
While indicators suggested the downward momentum had continued in the early part of 2009, the correction in the New Zealand market so far had been relatively modest compared with the experience internationally.
Despite the recent declines, house prices still appeared to be somewhat overvalued relative to fundamentals, although there were some tentative signs the price declines may start to moderate in the next few months.
Mr Spencer told MPs that he still expected the housing market to decline, it was just a matter of how by much.
People who were buying properties could no longer assume automatic capital gains like they used to be able to.
The report said the economic and financial environment presented significant challenges for the banking sector.
With the domestic economy expected to remain weak in coming quarters, asset impairments would continue to rise.
Banks should ensure they made adequate provisions and maintained capital levels sufficient to absorb unexpected losses.
"Exposures to the agricultural and commercial property sectors warrant particular attention," the report said.
The stability of the financial system was being challenged by continuing strains in financial markets.
But unlike many other developed countries, New Zealand had not experienced significant distress in its banking sector, nor had the availability of credit to households and businesses tightened to the same degree.
NZPA