The Reserve Bank says the country's financial system remains in good shape, but there are emerging signs of stress as households spend more on mortgage repayments.
In its half-yearly financial stability report, the central bank said as households face higher debt servicing costs due to rising interest rates, mortgage arrears have increased from a "very low starting point", and there have been limited signs of increased mortgagee sales.
"The rapid rise in debt servicing costs is testing the cash flows of some households, particularly those that borrowed at high debt-to-income multiples during the period of low interest rates," the report said.
Many of those borrowers were repricing to interest rates above the servicing capacity that was assessed by lenders, it said.
But as a whole, households have been adapting to higher interest rates and have been helped by strong income growth.
It also said while the pace of rate rises has slowed, the full extent of the previous increases is yet to be felt.
The report said rising interest rates exposed fragilities in the global financial system, referencing the failure of three banks in the United States and the forced takeover of Credit Suisse.
But it said New Zealand banks took on little interest rate risk.
"Overall, New Zealand's banking system remains resilient to a wide range of downturn scenarios, as demonstrated in our regular stress tests of their solvency and liquidity positions.
"New Zealand banks have well developed approaches to managing and mitigating interest rate risk, and are therefore not generally exposed to the problems that have emerged in some overseas banking systems in recent months."
The RBNZ said the financial system has also been resilient following the recent flooding and cyclone.
It estimated the Auckland Anniversary Floods and Cyclone Gabrielle to result in insurance claims costs of $1.6 billion to $2.1b and $1.4b to $2.1b respectively.
House prices remain overvalued
The RBNZ said house prices have fallen about 16 percent from their peak, taking pricing back to levels seen around the start of 2021.
It said in the near term prices may continue to fall due to high interest rates, ongoing completion of houses under construction and weak market activity and sentiment.
"Our current assessment is that, given recent falls, New Zealand house prices are closer to being at sustainable levels than has been the case in recent years.
"But the overall balance across indicators suggests prices remain somewhat overvalued."
But the report warned there remained the risk of house prices declining well below what it deemed sustainable, especially if the number of distressed sales picked up.
The central bank recently proposed to ease loan-to-value ratio limits.
Businesses adjusting to higher interest rates
Businesses continued to face a "challenging operating environment", the RBNZ said.
It said global supply chain pressures have eased substantially and the economy was being helped by a recovery in tourism, international education and migration.
But businesses faced ongoing cost pressures and employment remained "above its maximum sustainable level", leading to higher labour costs.
Debt servicing costs have also jumped for businesses more quickly than those for households, but it has not led to a big jump in lending arrears so far, the report said.
"Agriculture and commercial property stand out as business sectors where rising interest rates could lead to financial stresses, given these sectors' reliance on debt-financed physical assets such as property."
The bank said the key risk factor for the business sector was the outlook for economic activity and the potential for a large drop in demand as households cut spending.