House price inflation in Auckland has softened in recent months but the market is still at risk of a "significant" correction, the Reserve Bank says in its six-monthly financial stability report.
The central bank said it was uncertain whether softer house price inflation would be sustained and noted that in the Auckland region house price-to-income ratios "remain among the highest in the world" and prices are continuing to rise rapidly in the rest of the country.
"There is a significant risk of further upward pressure on house prices so long as the imbalance between housing demand and supply remains," the bank said in its statement.
Deputy governor Grant Spencer confirmed the bank has requested Finance Minister Bill English approve the addition of a debt-to-income (DTI) tool to its suite of restrictions on lending to the property market.
It says while it has no immediate plans to impose the measure, "financial stability risks can build up quickly and restrictions on high-DTI lending could be warranted if housing market imbalances were to deteriorate further".
He said restrictions on lending to property investors with high loan to value ratios that were introduced in October, along with other restrictions, were increasing the resilience of bank balance sheets to a downturn in the housing market.
"However, the share of bank mortgage lending to customers with high DTI ratios has been increasing and this could increase the rate of loan defaults during a housing downturn," Mr Spencer said.
New Zealand would join Ireland, the UK, Canada and Hong Kong in adopting a DTI limit.
It would enable the Reserve Bank to limit the degree to which banks can reduce mortgage lending standards during periods of rising housing market risks, in order to protect financial system soundness, it said.
The stability report concluded that New Zealand's financial system is sound but said there were risks from dairy debt levels and it was still assessing the impact of the Kaikoura earthquake.