And farmers under stress are unlikely to experience any cut in finance costs despite the significant fall in interest rates this year with the official cash rate falling from 1.75% to 1%.
While non-performing dairy loans have risen significantly during the past five years and particularly more recently, the RBNZ said it understands the latest rise is driven largely by the reclassification by some banks rather than a deterioration in underlying loan performance.
Nevertheless, the trend warrants ongoing monitoring because the loans reflect significant pockets of financial stress.
The dairy sector has a high debt-to-income ratio of 350% with the debt highly concentrated. About 30% of it is held by farms with debt of more than $35 a kilo of milksolids.
Bank lending to the dairy sector shrank 0.9% in the year ended September, reflecting both banks’ reduced appetite to lend to the sector and a decline in demand for new loans.
Banks expect to tighten credit availability further over the next six months, reflecting a desire to diversify their agricultural exposures and a re-evaluation of lending portfolios to manage the transition to higher capital levels, the regulator said.
RBNZ will announce its final decision on bank capital on Thursday but has proposed lifting the minimum equity level for the four major Australian-owned banks from 8.5% to 16% and to 15% for the smaller banks.
“In particular, banks may seek to reduce the availability of standby facilities that carry ongoing capital requirements irrespective of any drawdowns and raise interest rates on riskier loans,” it said.
While low interest rates should help dairy farmers to pay down debt a number of banks want to increase their margins by imposing fees for the provision of various facilities to farmers and by repricing higher-risk borrowers.
“This means the most financially vulnerable farms are unlikely to see significant relief in their financing costs.”
RBNZ notes the historically low level of farm sales, meaning farmers can’t easily sell land to repay debt.
The central bank is encouraging banks to work constructively with farmers wherever possible but acknowledges the profile of dairy debt reflects a degree of poor decision-making by borrowers and lenders.
Nevertheless, banks shouldn’t be overly cautious in implementing new lending policies.
“Lending always entails a degree of risk but excessive risk aversion by financial institutions when risks crystallise can introduce unnecessary pro-cyclicality into the system and, despite the challenges in the sector, most operations will continue to be viable investments unless payouts decrease significantly.”
RBNZ singled out lending to horticulture as something to monitor carefully because of its 18% increase in the year ended September.
While diversification will reduce bank exposure to shocks in a particular sector, rapid growth can be a sign of overly fast expansion.
Agriculture accounts for about 14% of bank lending.
RBNZ highlights lending to the commercial property sector, accounting for about 9% of the financial system, saying bank lending has been relatively conservative to the sector and is unlikely to threaten financial stability.
Banks have nevertheless tightened credit availability to the sector, particularly for development loans.
It notes the price of retail commercial properties has dropped about 3% and the vacancy rate increased to 7% in the year ended June.
“The retail sector is facing increasing competition from online shopping and there is a significant new supply of retail properties nearing completion in some regions.” That might put pressure on prices, particularly in a broader economic downturn.
RBNZ concentrated most on the housing sector, with lending to households accounting for about 60% of bank lending, though it acknowledged risks have reduced as house price inflation has moderated.
It also noted the increasing number of revelations that a number of banks have been miscalculating their capital requirements.
While RBNZ has publicly named ANZ Bank, Westpac and BNZ, it says the government-owned Kiwibank and NZX-listed Heartland Bank have also identified incorrect calculations relating to both capital and liquidity. – BusinessDesk