Investment and borrowing risks higher than realised

Reserve Bank Governor Alan Bollard this evening warned that too many New Zealanders are taking higher risks than they realise in the way they borrow and invest.

That's come in an address prepared for an Auckland Club and MBA business meeting in Auckland.

Dr Bollard said that the Reserve Bank was concerned because of potential downsides for households, the financial system and the economy. New Zealanders, he said, were taking these risks "… because they don't understand that investing in a low inflation environment may be quite different from investing in the high inflation environment of earlier decades."

"I suspect that too many households may be over-exposed to real estate investment, and that too many are becoming increasingly exposed to relatively high risk financial investments, without fully appreciating the risks involved. Also, there are some risks relating to the extent of borrowing being undertaken by households.

"Unsound investment and borrowing decisions can have severe consequences for individuals and families. Households with high levels of debt and exposure to investments that are riskier than they appreciate could potentially face painful problems. Some may find that the rate of return on their investments is considerably less than they had thought it might be, or even that their investments make a severe loss."

"In a world of low inflation, fluctuations in house prices can result not only in falls in real terms, but also falls in nominal terms. The risk for investors who borrow almost all of a house's sale price is that the value of the house could fall below the debt they owe."

Dr Bollard also warned that some people were investing in higher yield securities in the belief that lower nominal interest rates necessarily meant lower real returns and "In this drive to achieve higher rates of return, some investors may be taking higher risks than they appreciate."

Dr Bollard concluded by saying that investors should get professional advice and "It is important that investors take all the steps they can to better understand the nature of the risks attached to their investment and borrowing decisions. This includes thinking in terms of real rates of return, rather than nominal rates."

To view the speech on the Bank's website go to http://www.rbnz.govt.nz/speeches/0140982.html

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