Banks need to brace themselves for a series of mini financial crises in Europe which could lead to another freeze of money markets, Reserve Bank governor Alan Bollard said yesterday.
Bollard told Parliament's finance and expenditure select committee that international stresses were continuing, "but we feel that the New Zealand financial system is coping reasonably well with them".
At the release of the Reserve Bank's latest Financial Stability Report earlier in the day, Bollard said the situation in Europe remained "fragile".
The soundness of New Zealand's banks was getting better, despite international volatility.
Bank profits had recovered this year but they were likely to be "quite restrained in the future". Bad and doubtful loans had declined and lending growth was modest despite banks easing their credit conditions.
Bank funding looked firmer than six months ago, but a significant proportion of core wholesale funding was due to mature over the next few months and that was something the banks would be focused on, Bollard said.
But global economic and financial conditions still posed risks for New Zealand's financial system. "Financial market sentiment has improved since the start of 2012, largely reflecting policy measures in Europe which have helped to mitigate the effects of softening economic growth, stretched sovereign debt positions and weak bank balance sheets.
"However, the situation remains fragile given limited progress in addressing Europe's underlying issues."
Further instability would also undermine the fragile global economic recovery and could have significant economic and financial implications.
While the hundreds of billions of euros injected into the financial system by the European Central Bank late last year and early this year meant the continent's banks were "quite liquid and their governments now look quite funded" it was just a "holding operation".
"Their banks haven't raised more capital and their governments haven't, in many cases, done reforms.
Therefore, the European problems "had not been solved", Bollard said.
Elections in France and Greece this week had added a political dimension to the austerity budgets previously agreed to.
"We think we are going to continue to see some mini European crises of the sort that we have seen over the last few days with French and Greek elections, and that we saw a couple of weeks ago with the Spanish banks."
Bank of New Zealand senior economist Craig Ebert said Bollard's comments that the housing market was still over valued and "rents were increasing sharply" suggested the official cash rate would not be cut.Fairfax NZ
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