Moody's expects New Zealand's banking system to remain stable over the next 12 to 18 months despite bad dairy loans and highly leveraged households.The ratings agency said in a report its confidence reflected the system's high capital levels and strong structural profitability, "factors which will provide a solid buffer for the banks to withstand a potentially more challenging operating environment over the same period, as well as higher credit costs."New Zealand's economy would be supported by strong net migration, heavy construction spending in Auckland and high tourism inflows, as well as the Reserve Bank's accommodative monetary policy.But low dairy prices and rising leverage represented two key risks to the banks' operating environment. Moody's said the outlook for dairy farmers was challenging, which meant dairy loan quality would weaken because the dairy industry produced 23 per cent of New Zealand exports and made up ten per cent of bank loan books.It also said the elevated level of household borrowing weakened the ability of borrowers to withstand negative shocks, but that home loan quality would be supported by low interest rates and stable employment conditions.Moody's said it expected credit growth of over seven per cent to be sustained, which would limit further improvements in funding positions. "Nevertheless, tighter regulatory requirements will limit the banks' reliance on less stable funding sources and ensure that their funding positions will not deteriorate significantly," the agency's report stated, adding that a reliance on wholesale funding remained a key sensitivity and that profitability would come under pressure from higher credit costs and margin compression.