Are NZ banks strong enough to survive a major economic downturn?

Reserve Bank applies stress tests to test the country’s resilience against a global crash

By Ksenia Stepanova

09 Jul 2018

The Reserve Bank of New Zealand (RBNZ) has emphasised the importance of stress testing, stating that it improves understanding of current and emerging risks to financial stability and helps assess the country’s resilience to a severe global downturn.

In a statement to New Zealand’s biggest four banks, the Reserve Bank asked what would happen to the banking system if a downturn in the Chinese economy resulted in a fall in exports, rising unemployment, falling house prices and three years of low payment to dairy farmers.

Its stress tests are designed to assess whether country is resilient enough to pull through a period of depression, and to oversee improvements to any identified risks.

RBNZ posed several scenarios to New Zealand’s major banks, and this latest test includes a previously unexplored setting where losses related to mortgage misconduct coincide with a macroeconomic downturn. The latest stress tests showed that the banks would be able to absorb significant losses while remaining solvent under the various scenarios tested.

Despite the positive outlook, the Reserve Bank views stress tests as “one lens on capital adequacy rather than a final conclusion.” Stress testing is a relatively new field, and the framework is expected to continue to evolve in the coming years. Potential improvements include exploring a broader range of risks, assessing the resilience of individual banks in greater depth, expanding the scope of the tests to smaller banks and capturing how bank actions might impact on the wider system.

“A stress test models the effect of a severe but plausible scenario – such as a major economic downturn – on the balance sheets of a financial institution,” says RBNZ deputy governor Geoff Bascand. “Since the Global Financial Crisis, stress tests have become a widely used tool by banking supervisors in most countries.”