Increased dairy farm foreclosures look likely if product prices remain weak, the Reserve Bank said in its latest financial stability report.
The central bank said the New Zealand dairy sector was an "area of risk" for the financial system.
Its report said the Auckland property market had become "very elevated" and the country's financial stability could be tested if prices were to fall sharply.
"The second area of risk for the financial system relates to the dairy sector, which is experiencing a sharp fall in incomes in the current season due to lower international prices," the bank said.
Banks continued to have a largely positive view of the long-term outlook for the sector, and have been easing credit conditions for working capital borrowing, it said.
However, the availability of additional borrowing could be limited for some farms that already have elevated loan-to-value ratios.
Around 11 per cent of dairy debt is owed by such farms, while farms with relatively high loan to value ratios account for 27 per cent of sectoral debt.
"It is likely that the number of foreclosures among these indebted farms will eventually increase if weak cash flow persists for multiple seasons," the report said.
"Bank losses associated with these foreclosures would be exacerbated if land values fall alongside weaker farm incomes," the report said.
Fonterra will late this month release its milk price forecast for 2015/16 and indications are that it will be towards $5.00 a kg of milk solids, down from last season's record price of $8.40 a kg. The current season's forecast is for a milk price of $4.50 a kg.
The cooperative is expected to release its 2015/16 forecast after its next board meeting on May 27 amid increased uncertainty around oversupply, Russia's dairy import ban, increased production from the European Union, and slack demand from China.
By Jamie Gray, of the NZME. News Service