Financial Stability Report May 2026

Summary

The Financial Stability Report outlines our assessment of risks to financial stability. Financial stability is critical for ensuring that New Zealanders can safely save, borrow, and manage financial risk.

A significant focus of this Report is on the financial stability impacts of the conflict in the Middle East. Global events of this nature affect the New Zealand financial system through several key channels, including trade, financial markets and cyber risk.

• Trade: Higher oil prices and broader economic impacts, partly driven by elevated uncertainty, can affect the ability of households and businesses to service debt. The sectors most immediately impacted are transport, parts of the primary sector and chemical manufacturing. If fuel shortages were to occur domestically, they would intensify the economic impacts.
• Financial markets: Volatility has increased in global financial markets, raising the risk of a sharp fall in equity prices and higher borrowing costs for banks. New Zealand banks source around a fifth of their funding from offshore funding markets. The conflict has added to existing concerns about stretched equity valuations for technology firms and private credit markets.
• Cyber risk: As the financial sector becomes more digital, geopolitical events increase the risk of cyberattacks and system outages. The adoption of artificial intelligence (AI) could add to these risks. To date, no material cyber impacts have been observed.

Economic growth in New Zealand had begun to recover prior to the conflict. Lower interest rates were supporting demand. Indebted households and businesses were finding it easier to make loan repayments, resulting in fewer missed payments. However, recent events suggest a slower recovery is now more likely. This could affect job opportunities and lead to renewed debt-servicing stress.

The New Zealand financial system is resilient amid heightened global risk. The impact on financial stability will depend on the economic impacts of the conflict, which in turn depend on its severity and duration. We will continue to closely monitor developments.

The banking sector remains well placed to support customers and maintain lending, even if economic conditions get worse. Banks are well funded with a high level of deposits, providing flexibility to manage increased volatility in offshore funding markets. Banks also have strong capital buffers. While the changes announced in December to the minimum capital requirements will result in banks needing less shareholder equity, which is the first line of defence for absorbing losses, results from our recent stress tests suggest banks will remain capable of managing even severe scenarios.

Conditions for insurers have been mixed. Profitability in the general insurance sector has remained favourable recently. Most insurance policies exclude war or conflict risks, limiting direct impacts from the Middle East conflict. In contrast, health insurers have needed to raise premiums to restore profitability after two years of claims costs increasing rapidly. We are progressing a stress test of the life and health insurance sectors.

In addition to monitoring the current shocks, it remains important that we continue to enhance our understanding of other risks, issues and vulnerabilities in relation to Financial Stability. In this Report, we examine a couple of longer-run issues in detail.

• Access to credit for smaller businesses: New Zealand small businesses rely mainly on banks for the bulk of their borrowing. Lending conditions vary widely by sector, collateral, and firm size, with smaller firms more likely to face higher costs or less acceptable terms. We highlight opportunities to improve our monitoring of the cost and availability of bank lending, to support clearer reporting on the sector.
• Global fiscal sustainability: Rising government debt in several major economies is an emerging risk. It could affect financial stability through higher borrowing costs for governments, rating downgrades, and market instability, with potential spillovers to bank funding costs and asset prices.

This Report also includes boxes on several topical issues:

• Establishment of the RBNZ’s Financial Policy Committee
• Residential property insurance and financial stability
• Early impacts from the Depositor Compensation Scheme

The business sectors with the largest share of directly affected input costs (excluding labour) are chemical and plastic manufacturers, the transport sector, and parts of the primary sector like horticulture, fishing and forestry (figure 1.3). While other primary industries like dairy use fewer of these inputs (around 19 percent), and this is mainly fertiliser, agriculture as a whole accounts for nearly one third of banks’ business lending. Banks have reported to us that they have seen an increase in requests for increased credit limits for working capital.

In addition to increasing production costs for firms, higher oil prices reduce consumers’ spending power. Higher near-term CPI inflation due to the conflict will reduce real wages. While it seems unlikely at this stage that the impact on real wages will be as large as it was over 2021/22, even a small decline in spending power could create financial hardship for some households given the existing cost-of-living pressures.

The economic recovery is now likely to be slower

These impacts on households and businesses, along with reduced confidence, could cause businesses to hold back on investing and households to save more as a precaution. This could slow the expected recovery in economic activity, prolonging financial pressure on borrowers and potentially leading to higher losses for banks.

Low profitability in recent years has left businesses in a more vulnerable position. Business deposits were elevated after the pandemic, given fiscal support and the strong economic recovery. However, over the past 3 years business deposits, particularly for smaller firms, have declined as a share of GDP (figure 1.4). This suggests businesses do not have the same cash buffers now.

Prior to the conflict in the Middle East there were signs of economic growth picking up. Lower interest rates and strength in the rural sector from elevated commodity prices had supported the recovery. As a result, fewer bank loans are being closely monitored or graded as high risk (figure 1.5). Banks’ assessment of commercial property loans has particularly improved with lower interest rates. However, the share of business lending that is non-performing remains higher than recent years. This tends to lag behind other indicators and has been expected to fall.

Credit growth also picked up as economic conditions improved and interest rates declined. Competition amongst lenders has supported credit growth. Banks are well funded with deposit growth remaining strong relative to credit growth (see Chapter 4). They are well positioned to provide credit through the current challenges and as the economic recovery continues.

Strong export prices mean farmers are well placed to manage the current shock

Elevated commodity prices have supported incomes across the rural sector. The milk payout for the current season is expected to be around $9.70 per kilogram of milk solids (kgMS). With breakeven costs averaging around $8.50 per kgMS, dairy farmers are generally profitable.

Increased fertiliser and fuel costs due to conflict in the Middle East could reduce farm profits. Fertiliser expenses were around $0.6 per kgMS prior to the conflict. It is normally applied in spring and autumn. For 2026 autumn, budgets are unlikely to be affected given the price was already locked in. The biggest impact could be in spring later this year.

Fonterra has completed the sale of its consumer brands to Lactalis and returned $3.2 billon to shareholders on 14 April. This is a significant cash injection for most dairy farmers. We anticipate farmers will use a portion of the money to repay debt.

This debt repayment would strengthen their balance sheets further, with debt levels having already reduced over the past decade (figure 1.6). Farmers may also spend some or invest it in equipment, stock or land, which could boost demand in other parts of the rural sector and increase farm sales.

Financial markets have become more volatile due to the Middle East conflict

Another channel through which geopolitical shocks impact financial stability in New Zealand is financial markets. Increased financial market volatility is likely to continue while the conflict persists. This increases the risk of a disorderly fall in asset prices or a disruption to offshore funding markets. While New Zealand banks are well funded and have plenty of flexibility to manage disruptions in the short term, this volatility could interact with other vulnerabilities and result in a more significant tightening in financial conditions internationally.

AI-related investment has supported global growth and equity prices, but could create risks if returns are lower than expected

Before the Middle East conflict began, global economic growth had been supported by AI-related activity, which helped offset the impact of higher tariffs. Rising investment in AI data centres has contributed to growth in the US and driven strong demand for specialised equipment, electricity and key inputs such as natural gas, copper and memory chips. This surge in demand has, in turn, lifted export demand for many of our Asian trading partners.

Equity prices for technology firms increased considerably up until the end of 2025 (figure 1.7). These stretched prices rely on firms being able to achieve strong earnings growth from their AI-related investments. If investors’ expectations prove to be too optimistic, and actual earnings growth is not as large as expected, this could potentially result in a fall in equity prices and a sudden decline in economic activity in our trading partners.

Equity prices in the technology sector fell over the first few months of this year as investors became more concerned about the returns firms will be able to generate from the large amount of investment currently being planned. Equity prices fell more broadly in March following the Middle East conflict, but have since recovered.

Concerns have also increased around private credit markets, particularly in the US. Private credit is when a business borrows money from a private investment firm instead of a bank or by issuing public bonds. Private credit has funded some of the recent investment in AI infrastructure. Declining investor sentiment has contributed to an increase in withdrawals from private credit firms. Rapid growth in private credit over the past decade means any strains in the sector could reduce credit availability for firms and amplify economic downturns. Limited transparency and oversight makes it hard for regulators to determine the level of risk and to respond accordingly.

While private credit appears to play a relatively modest role in New Zealand, there is a risk of contagion, given the opacity of the sector and the potential for indirect effects via tighter financial conditions abroad. Our earlier work found that lending by New Zealand banks to private credit and private equity firms was limited.³  Private credit primarily supports larger-scale projects, such as commercial property. Responses to our Managed Funds survey indicate that New Zealand fund managers (including KiwiSaver providers, life insurers, and other superannuation funds) hold only a small share of their portfolios in private credit and private equity.⁴  Instead, they maintain much larger exposures to public equity and fixed-income markets.

Geopolitical tensions also increase the risk of cyberattacks and technology outages

Over time, the financial sector has become increasingly reliant on digital systems, including customer-facing applications. The development and maintenance of these systems now represent a significant operating cost for firms. At the same time, cyberattacks are becoming more frequent and more severe, a trend further exacerbated by geopolitical tensions. While no material cyber impacts have been observed to date during the Middle East conflict, the sector’s reliance on cloud service providers was highlighted when infrastructure supporting these services was targeted. Cyberattacks consistently feature among the most prominent systemic risks identified in international surveys.⁵

The adoption of AI could amplify risks in the financial sector.⁶  For example, relying on only a small number of third party AI providers could create dependencies and increase the risk that models produce biased, misleading, or fraudulent outputs. From a credit perspective, if AI leads to job losses in some sectors, more borrowers may struggle to pay their mortgages. From an operational resilience perspective, emerging frontier models, such as Anthropic’s Mythos, highlight how increasingly capable AI systems could materially amplify cyber risks from malicious actors.

We expect our regulated entities to maintain cyber-security strategies and frameworks that adequately address the cyber threats they face. We have issued Cyber Resilience Guidance to support this. We are actively monitoring the risks that Anthropic’s Mythos model may pose to the New Zealand financial sector and to our regulated entities, and are engaging with other domestic agencies and Trans-Tasman counterparts to ensure continued alignment on risk assessments and policy responses.

Deposit takers

Recent stress tests suggest banks are resilient and well placed with strong capital and liquidity buffers to weather severe, but plausible, geopolitical shocks (see our 2025 Geopolitical Bank Solvency Stress Test).⁷

Capital requirements are being adjusted, reducing funding costs

The review of key capital settings that we undertook last year was a key step as we prepare for issuing standards under the Deposit Takers Act (DTA). We announced the decisions from the review in December. The changes included a reduction in requirements for common equity, more granular risk weights, simplification of capital instruments, and greater alignment of instruments for the 4 largest banks with Australian settings.

Common equity is a key buffer for managing losses while continuing to operate. Reducing our requirements for this partly reflects our work towards a stronger resolution regime and more trust in other forms of capital. Loss Absorbing Capacity (LAC) requirements will increase the amount of capital overall. The new instruments for Group 1 deposit takers will be required to be issued to their parent. This will support our preferred ‘single point of entry’ approach to recapitalising a distressed Group 1 deposit taker. We intend to consult on the detailed design of LAC requirements in 2026 and 2027.

The new capital settings should reduce funding costs for deposit takers, for example by shifting the mix of capital toward cheaper forms of funding. We expect to see lower funding costs passed on to households and businesses through slightly lower lending rates than would have otherwise been the case. Any impact on lending rates is likely to happen gradually, as banks transition to the new settings. Impacts may vary by sector, proportionately to the risk weights applied in the sector. We will continue to monitor impacts.

Changes to capital requirements will have different impacts across deposit takers

The new capital requirements should both reduce the overall cost of deposit takers’ funding and, for capital-constrained entities, allow more lending to occur. We expect the reduction in required capital for Group 2 deposit takers (mid-sized banks) to be more material than it is for the 4 largest banks (figure 1.8). The mid-sized banks that are currently capital constrained may begin to compete more actively to grow their lending in the near term. In addition, lower risk weights could boost competition from these banks for certain types of lending, such as low-LVR mortgages.

The risk weight changes from the review will reduce required capital for Group 3 deposit takers (mostly non-banks) by around 16 percent on average, although this will vary by deposit taker. This results in a minimum amount of capital we think necessary to promote the safety and soundness of the smallest deposit takers.

Banks are expected to remain resilient to a range of severe, but plausible, scenarios

Stress tests are very useful for assessing the impact of severe scenarios and preparing for shocks like the conflict in the Middle East. We have taken the results from our 2025 bank stress test and adjusted them to assess the impact of the changes to capital settings on the 4 largest banks. The results are based on a hypothetical scenario that includes a worsening of geopolitical tensions, which causes a severe slowdown in global economic activity and a recession in New Zealand.⁸

The aggregate common equity tier 1 (CET1) ratio across the 4 banks falls to 8.7 percent in the adjusted stress test results (figure 1.9).

While this trough in the CET1 ratio is well into the prudential buffer, it remains above the 6 percent minimum that will come into effect in 2028. It is also materially above the level of capital before 2008/09. This suggests banks would maintain capital buffers even in this severe scenario.

Deposit-taker preparedness is a core part of maintaining financial stability

We will be releasing a crisis preparedness consultation package in June. Part of the consultation will be on the additional LAC requirements. When a distressed deposit taker’s going concern capital is depleted, Tier 2 instruments will be able to be written down to help them recapitalise. This reduces the cost of crises if, and when, they occur. This would provide a key source of resilience if a scenario worse than the 2025 stress test eventuated.

Another part of our efforts to build preparedness is stress testing. Our 2026 bank solvency stress test is being carried out with the Australian Prudential Regulation Authority (APRA). We are again assessing the potential impacts of adverse geopolitically driven economic scenarios. Further details will be published shortly, with scenarios expected to reflect aspects of the current environment, including high oil prices. More detail on the upcoming crisis-preparedness consultation and our stress-testing work is available in Chapter 3.

Introducing the Depositor Compensation Scheme has boosted deposit growth for finance companies

The Depositor Compensation Scheme (DCS) became operational on 1 July 2025. It provides a government-backed guarantee for deposits up to $100,000 if a deposit taker fails. Giving people confidence that their money is protected reduces the likelihood they will withdraw their deposits in periods of heightened uncertainty and therefore adds to the resilience of deposit takers.

Introducing the scheme last year has mainly affected smaller deposit takers. Finance companies experienced a notable increase in deposit growth (see Box C). As a result, finance companies have been able to reduce their term deposit rates to only slightly above what banks are offering.

A risk for these finance companies is that they drop their lending standards to promote lending growth. Finance companies have seen considerable growth in their mortgage lending recently. While mostly low-LVR lending, attracting borrowers in the current competitive lending market suggests they may be taking more risks in other aspects of the lending. We will continue to monitor these risks through our supervisory activities.

Easier deposit requirements will support some mortgage borrowers

In December 2025, we increased the share of new mortgage lending that banks could make to borrowers with high loan-to-value ratios (LVRs), for both owner occupiers and investors. These looser settings are expected to be in place most of the time to give banks more flexibility when making lending decisions, except for when risks are elevated. Currently, less than 15 percent of new lending to owner occupiers has an LVR over 80 percent, which is well below the 25 percent limit.

Looser LVR restrictions are allowed for by the introduction of debt-to-income (DTI) restrictions in 2024. DTI restrictions are set so that they constrain high-risk lending when interest rates are low and the housing market is strong. We are updating our Macroprudential Policy Framework document to capture changes in our approach, including from introducing DTI restrictions (see Chapter 3 for more details).

Housing risks are contained overall

The housing market generally remains soft. National house prices are below their November 2021 peak and have been broadly flat over the past 3 years. Elevated housing inventories are weighing on house prices, particularly in Auckland and Wellington. House prices remain around the top of our estimated sustainable range.⁹  While this suggests the risk of a correction is not particularly elevated, rising mortgage rates could reduce house prices further. Growth in mortgage lending has also been subdued.

Mortgage refinancing between banks was elevated for a short period late last year. This coincided with mortgage rates being near their lowest point and a larger-than-normal share of mortgages rolling off fixed-rate terms. During this period, banks offered new customers up to 1.5 percent of their mortgage balance as an upfront payment to attract new mortgage business, compared with typical levels of around 0.9 percent. As a result, nearly three times the usual amount of mortgage debt switched banks in December (figure 1.10), while market shares remained largely unchanged afterwards. The offer benefited a small share of borrowers at the expense of banks, although it may be offset by generally higher lending margins. Assuming no offset from higher margins, we estimate the higher cashback offer cost banks around $100 million, which is a small share of their annual profits before tax of around $10 billion.

Chapter 2: Special topics

This chapter covers topical issues relevant to financial stability in New Zealand.

In this Report, we cover the following topics:

1. Trends in lending to small and medium-sized businesses
2. Global fiscal sustainability and implications for financial stability

Selected special topics and boxes from the past 12 months

Access to finance supports SME growth and economic activity

SMEs play an important role in New Zealand’s economy. They make up 99.7 percent of firms, and account for around 64 percent of salaries and wages paid and 68 percent of operating profits among all businesses (table 2.1). SMEs’ access to finance is an important indicator of financial inclusion and the financial system’s efficiency in allocating credit.¹⁰

The ability of SMEs to secure financing provides an indicator of the extent to which the financial system supports productive investment, innovation, and economic resilience.¹¹  In line with our Financial Policy Remit and the secondary purpose of the Deposit Takers Act 2023, we have an interest in whether New Zealanders have reasonable access to financial products and services provided by the deposit-taking sector.¹²

Small firms tend to make up a disproportionately low share of banks’ business lending, relative to their overall contribution to economic activity and employment.

Within the other business category, banks’ SME lending was more stable than lending to larger businesses during the COVID-19 period, in part due to support from the government’s Business Finance Guarantee Scheme.¹⁶  However, SME lending growth slowed after the pandemic in the period of higher interest rates (figure 2.2).

At the smaller end of the spectrum of SME businesses, owners often borrow against their personal house to fund their business. Residential mortgage-secured business lending is a common product offered by banks, amounting to $5 billion or around 11 percent of total bank lending to SMEs (excluding agriculture and commercial property). In some instances, lending to smaller businesses (e.g. sole traders) is treated by banks as residential lending rather than business lending, which may not be included in this amount. For example, a mortgage revolving credit facility may be used to fund a small business on a day-to-day basis.

This means that housing market dynamics, including house prices and mortgage lending criteria (e.g. loan-to-value ratio requirements) can influence SME lending conditions.

SME lending has been subdued in recent years due to weak economic conditions

Many SMEs, particularly in hospitality and construction, have experienced margin pressures and have run down cash buffers since 2020 to manage cashflow challenges.

The credit quality of SME lending has deteriorated as economic conditions have worsened over the past 3 years, though remains better than during the GFC (figure 2.3).¹⁷  Non-performing loan (NPL) rates have risen somewhat from their post-pandemic lows, when strong economic conditions and government assistance supported businesses’ cash flows.

A comparison across sectors highlights the important role of loan collateral in mitigating the credit risk banks face, by providing recourse for the lender to recover their loan value in the event of a default. In turn, this influences the interest rate they charge.

• Lending for commercial property investment tends to have the lowest spread to wholesale interest rates, reflecting generally high levels of security (typical loan-to-value ratios are below 65 percent) and diversified cash flows across multiple tenants.
• Lending for agriculture is also well secured, though slightly more expensive, reflecting higher cashflow risks associated with commodity prices and resulting sensitivity of farmers’ profit margins.
• Lending for other businesses tends to be most expensive, reflecting a diverse range of business types and less security coverage for lenders on average.

Across all sectors, medium-sized firms tend to have lower lending spreads, which may reflect more mature and diversified operations, which mitigates cash-flow risks.

Loan rejection rates tend to be low, though firms may not accept the terms being offered

Loan application and rejection rates provide insight into SME credit supply and overall financing conditions. Higher proportions of firms seeking but not obtaining finance can suggest that demand for loans is not being met because either the terms and conditions of the loan offers are not acceptable for SMEs, the average creditworthiness of loan applications has deteriorated, or banks are rationing credit. Rejection and approval rates can also depend on self-selection by applicants. For example, riskier borrowers may be less likely to apply for loans if they expect they will be declined.

Stats NZ’s Business Operations Survey asks firms whether they have sought additional debt finance over the prior year, and if so, whether it was available on terms acceptable to the firm (figure 2.6). This data indicates that a small proportion of firms have their applications rejected outright, averaging less than 5 percent over the past decade. A higher proportion of firms report that debt finance was available, but not on acceptable terms to the firm (for example, the interest rate or the collateral the lender demanded to progress the loan).

Consistent with the interest rate data discussed above, smaller firms tend to report higher rejection rates and being offered loan terms they find unacceptable. The overall availability of debt finance deteriorated in the years following the GFC, as lenders tightened their credit criteria. Availability of debt on acceptable terms has also reduced in recent years, likely reflecting higher interest rates.

Comparing SME lending costs internationally is challenging

International datasets suggest that SME interest rates in New Zealand are relatively high compared with some advanced economies.¹⁸  However, such comparisons are complicated by differences in how SME lending rates are defined and measured across jurisdictions. Differences in inflation rates, loan structures, regulatory requirements and reporting practices mean that interest rate comparisons across countries may not reflect like-for-like borrowing costs. Moreover, banking industry structures and loan portfolio compositions, profitability, and intensity of competition, can influence the relative cost of SME lending over time.

With these caveats in mind, and given data availability constraints, we have limited our analysis to comparing SME interest rates to those in Australia, given the similarities of banking industry structures in both countries. We compare the average contracted rate on new credit to SMEs in New Zealand and Australia relative to the country’s respective 90-day benchmark wholesale interest rate, as an approximation of banks’ wholesale funding costs (figure 2.7).

This comparison shows that, on average, SME firms in New Zealand tend to face higher lending spreads than equivalent firms in Australia. In both countries, lenders offer lower interest rates for larger-sized firms. Over the past 3 years New Zealand small- and medium-sized firms have been charged spreads of 390 basis points (bps) and 280 bps above the 90-day rate respectively, compared to 294 bps and 192 bps in Australia.

Financial inclusion and distributional factors

Some SMEs face acute barriers to access lending

The way banks price and allocate loans can impact segments of the SME sector in different ways. For example, the Ministry of Business, Innovation and Employment highlighted financing gaps for establishing high-growth businesses in the $3 million to $30 million turnover bracket.

The barriers for these firms include demand-side factors (such as challenges presenting a strong track record to banks) and structural barriers that relate to commercial incentives to service this part of the market (such as disproportionate costs of assessing a loan, and administering a loan relative to profit margins).

Last year we published an article on market failures relating to Māori access to capital, building on the findings from the 2022 Māori Access to Capital issues paper.¹⁹  This highlighted structural and legal barriers that disproportionately impact lending among Māori landowners.

An important strand of financial inclusion research internationally has focused on gender financing, and the extent to which women-owned SMEs are able to access affordable lending products that meet their needs. In the New Zealand context there is limited detailed evidence about the number of women-owned SMEs accessing lending, and about barriers that can impact their ability to access lending on acceptable terms.²⁰  Domestic research suggests there may be disparities in accessing credit for women-owned businesses.²¹

While this research suggests that some SME segments are underserved by lending markets, a lack of detailed data has limited our ability to assess such distributional outcomes over time.

Increased transparency about pricing of SME lending is needed

Assessing SMEs’ access to competitive lending is difficult due to current data limitations. Product pricing is well understood in the residential mortgage market, but less is known about the pricing of SME lending products and the effective rate of borrowing across the range of different SME characteristics. This limits the ability of SMEs to understand whether they are being offered a good deal from their bank. Improved transparency could be achieved through benchmarking SME lending costs by firm size, industry, and security types. Information on the average interest rate, prime rate, and risk premium for SME lines of credit would help to improve pricing transparency.²²

Looking ahead, we will monitor SME access to lending through the annual Financial Inclusion Indicators Report.²³  Our loan-level data collection will also provide richer information on lending conditions.²⁴  Improving data quality and monitoring distributional outcomes will support better understanding of financial system efficiency and SME access to finance. There are also opportunities to continue to monitor the role that non-bank lenders play in SME financing, and the distribution of lending across regions, sectors and business demographics.

Investors’ focus on government debt levels has increased in recent years

Government debt levels in advanced economies increased significantly through the pandemic, reflecting large-scale fiscal support to households and businesses and the effects of weaker economic activity. Since then, the global interest rate environment has shifted significantly, with policy rates rising to levels not seen for more than a decade as central banks responded to elevated inflation.

Higher borrowing costs have increased the fiscal burden associated with existing debt, while many governments continue to run persistent deficits. Recent publications by the International Monetary Fund (IMF) and the Bank for International Settlements (BIS) have highlighted that fiscal vulnerabilities remain elevated in several major economies.²⁵

Over the coming years fiscal pressures are expected to remain substantial. Ageing populations are projected to increase spending on pensions and healthcare, while additional spending associated with reducing carbon emissions, defence, and industrial policy is also placing increased pressure on public finances. In an environment where interest rates on government debt may exceed the rate of economic growth, persistent deficits can lead to rising debt-to-GDP ratios unless offset by fiscal consolidation.

Fiscal sustainability refers to a government’s capacity to finance its spending and service its debt over time without resorting to disruptive policy changes and placing undue strain on the economy. It matters for financial stability because government bond markets play an important role in the financial system. Government bond yields are widely used as benchmarks for pricing credit and collateral, and changes in perceived sovereign risk can affect funding costs for banks and other intermediaries.

These issues are relevant for New Zealand’s financial system. While public debt levels in New Zealand remain moderate by international standards, our financial system is closely integrated with global funding markets and therefore sensitive to changes in international interest rates, investor risk appetite and asset valuations.²⁶

Drivers of global fiscal sustainability concerns

Fiscal sustainability is influenced by interacting drivers:

• The level of debt and fiscal balance (i.e. the difference between the government’s revenue and its expenditure) relative to GDP, which determine the starting position for public finances and their trajectory, based on spending and tax settings; and
• The relationship between interest rates and the economic growth rate, which shapes debt dynamics by determining how quickly existing debt burdens grow relative to the size of the economy.

Bond markets look at the combination of these factors to form a view on overall fiscal sustainability, shaping investor confidence, borrowing costs, and how the market responds to shocks.

Debt levels are elevated and countries face structural deficits

Public debt ratios in advanced economies rose sharply during the pandemic and remain high relative to historical norms (figure 2.8). At the same time, many governments continue to run structural deficits, reflecting spending commitments that are not expected to decline as economic conditions normalise. The IMF has noted in recent Fiscal Monitor publications that fiscal balances in many advanced economies are projected to remain in deficit over the medium term, even under baseline scenarios for fiscal revenue and expenditure that assume no adverse economic shocks.

Over the longer term, demographic trends are an important contributor to fiscal pressures.²⁷ In many advanced economies, population ageing is increasing spending on pensions, healthcare and aged care as a share of GDP. These expenditures tend to grow automatically and can be difficult to reduce in the short term.

In addition, governments are facing new spending demands related to defence, climate change mitigation and adaptation, and industrial policy. Recent policy initiatives illustrate these pressures. In the United States, legislation such as the CHIPS Act and the Inflation Reduction Act has increased public spending through subsidies, tax incentives and industrial support programs, aimed at ‘on-shoring’ certain sensitive supply chains. In Europe, fiscal commitments such as the European Green Deal are expected to support investment in the green transition and energy security. Higher defence spending in the wake of the war in Ukraine has also added to these challenges.

As a result, fiscal projections in several jurisdictions point to rising debt ratios in the absence of policy changes. This is particularly evident in the United States, where projections from the Congressional Budget Office show persistent deficits and a steady increase in federal debt over the coming decade (figure 2.9).

Conditions are changing in sovereign bond markets

The structure of sovereign bond markets has changed in recent years. During the periods of quantitative easing responding to the GFC and the pandemic, central banks purchased large quantities of government bonds. These purchases lowered yields, compressed term premia (the additional compensation investors demand for the risk of holding long-term debt) and provided a stable source of demand for governments’ bond issuances.

As inflation has risen, many central banks have begun to reduce the size of their balance sheets through quantitative tightening (selling bonds in the market) or by allowing bonds to mature without reinvestment. At the same time, government borrowing needs remain elevated, both in terms of refinancing existing borrowing, and for ongoing deficits (figure 2.12). This means that a larger share of sovereign debt must be absorbed by private investors, who may be more sensitive to price and risk, contributing to increased term premia.

Recently, non-bank financial institutions (NBFIs) have become increasingly important participants in government bond markets, including pension funds, insurance companies, hedge funds and investment funds. The BIS has noted that the growing role of leveraged and liquidity-sensitive investors may increase the risk of market volatility during periods of stress. Episodes such as the disruption in the UK gilt market following the 2022 mini budget demonstrated how leveraged positions and margin calls can amplify interest rate movements.

Geopolitical considerations may also affect global capital flows. Shifts in international investment patterns, such as changes in reserve management policies to mitigate sanctions risks, could alter demand for certain sovereign bonds by some countries. These developments may contribute to greater volatility in some markets, particularly where fiscal positions are perceived to be weaker.

How fiscal risks could crystallise

Concerns about fiscal sustainability do not necessarily imply that a sovereign faces an immediate risk of default. In most advanced economies, the risk is better characterised as a gradual erosion of the flexibility governments have available in their fiscal policy, rather than an imminent solvency crisis. Moreover, there are no clear-cut thresholds to indicate when fiscal sustainability risks will be triggered. A country’s fiscal sustainability depends on institutional factors and the particular circumstances at the time. However, in broad terms, elevated debt levels can increase the sensitivity of bond markets to shocks, and in some circumstances, liquidity stress can emerge even when long-term solvency is not in doubt.

Credit rating agencies play an important role in this process. Sovereign ratings influence the investment mandates of many institutional investors and often act as a ceiling for the ratings assigned to domestic banks and corporations. A downgrade of a sovereign can, therefore, have broader effects on funding costs across that country’s financial system, even if entities themselves have relatively strong fundamentals.

Market functioning can also be stressed if demand for new issuance weakens. Government bond auctions that attract limited participation, or that clear at unexpectedly high yields, may signal reduced investor confidence. In the current environment of large sovereign financing needs, such episodes could result in a rapid increase in borrowing costs.

Political and institutional factors can amplify these risks. Fiscal consolidation may be difficult to implement if there is limited political consensus, particularly when ageing populations increase pressure for public spending. In the US, regular disputes over budget legislation and the debt ceiling have repeatedly raised uncertainty about fiscal policy (figure 2.13).

There may also be concerns that fiscal pressures could influence monetary policy decisions. The BIS has highlighted that high public debt can increase the risk of fiscal dominance, which is where pressure to limit debt servicing costs constrains the ability of central banks to maintain price stability. Any perception that inflation targets could be compromised may lead to higher inflation expectations and higher bond yields.

Financial stability risks may also arise through some market structures. A sharp rise in yields can generate losses for leveraged investors, prompting margin calls and forced sales of government bonds. Because government bonds are widely used as collateral in financial markets, disruptions can affect market liquidity more broadly.

In some jurisdictions, banks hold significant quantities of domestic government bonds, creating a sovereign-bank interaction in which declines in government bond values and associated financial-market functioning reflect back on the financial health of banks. The experience of the euro area crisis in the early 2010s illustrated how quickly such solvency and liquidity feedback loops can emerge.

Implications for New Zealand’s financial system

As discussed in previous sections, government bond markets have repriced significantly over recent years, with higher yields and rising term premia reflecting tighter global monetary conditions and increased debt issuance. This shift in the global interest rate environment provides an important backdrop for assessing the implications for New Zealand’s financial system.

New Zealand has lower public debt levels than many advanced economies and operates under a well-established fiscal framework that emphasises transparency, medium-term sustainability and prudent debt management. Nevertheless, our vulnerability to natural disasters creates a risk to the Crown’s debt levels, both from funding the Natural Hazards Commission for insured property losses and from funding recovery costs for damage to uninsured property, such as public assets.²⁹  In addition, our financial system is closely connected to global capital markets, and developments in major sovereign bond markets can affect domestic financial conditions through several channels.

Movements in global interest rates affect domestic interest rates through benchmark pricing and portfolio allocation. Increases in yields in major sovereign markets can place upward pressure on yields in New Zealand, even if domestic conditions are unchanged, as shown in the high correlation between long-term interest rates over recent decades (figure 2.14).

Chapter 3: Regulatory developments

This chapter provides details on recent policy and supervisory developments in the deposit-taking and insurance sectors. It includes a round-up of the 2025 review of key capital settings for deposit takers, gives an update on the consultation on deposit taker standards, and highlights work on an update of our macroprudential policy framework. We also discuss the licensing of deposit takers, recent enforcement action, the deposit taker risk management thematic and ongoing efforts to enhance regulatory coordination.

Round-up of the 2025 review of key capital settings for deposit takers

Between August and October 2025, we consulted on proposals for revised capital settings.³⁴ After carefully analysing the feedback, we announced our decisions in December 2025. In February, we concluded the review by releasing a summary of submissions and a cost-benefit analysis.

Key decisions

• Reduce common equity requirements for all deposit takers, relative to the 2028 settings that were decided on in the 2019 Capital Review.
• Introduce loss absorbing capacity (LAC) requirements for Group 1 deposit takers, which help support our preferred approach to recapitalising them in distress, if needed.
• Introduce more granular, lower, standardised risk weights for many categories that more accurately reflect the level of risk associated with exposures.
• Remove AT1 instruments as a form of regulatory capital to simplify and enhance the effectiveness of deposit takers’ capital to absorb losses.

The overall easing in capital requirements will continue to support financial stability while also reducing deposit takers’ funding costs and supporting access to credit. They reflect a revised risk appetite within our legislative framework – we have placed a slighter greater emphasis on our tools and ability to resolve an entity in distress, rather than reducing the risk of crises occurring.

Implementation timeline

Some of the decisions from the Review are being implemented on an accelerated timeline through amendments to the Banking Prudential Requirements (BPRs) for banks and changes to conditions of licence for non-bank deposit takers (NBDTs). These changes will take place later in 2026.

The decisions around common equity and LAC requirements will be incorporated into the Capital Standard under the Deposit Takers Act 2023 (DTA). We intend to consult on some key additional topics raised in feedback, including further changes to risk weights and the detailed design of LAC requirements in 2026 and 2027. The Capital Standard is due to be issued in 2027 and come into force in December 2028.³⁵

Deposit taker standards consultation

The Deposit Taker Standards (the standards) will replace our existing prudential requirements. Importantly, the standards will be secondary legislation unlike most of our existing non-legislative prudential requirements. The standards will set the rules that deposit takers must meet to be sound enough to take deposits from the public.

We consulted on the policy for our standards in 2024 (excluding crisis preparedness, which is on a different track). Since then, we have enlisted professional drafters to convert our policy proposals into legally robust standards that align with New Zealand’s legislative framework. This means that the standards will look different to our existing prudential requirements. We have also developed guidance documents to support deposit takers’ understanding of requirements. We are consulting on the exposure draft standards and accompanying guidance in three tranches. In October 2025 we released Tranche 1 of the standards and are currently considering feedback provided. We will provide a response to feedback later in 2026.

Currently, we are consulting on Tranche 2 of the standards, which includes exposure drafts and guidance of the 5 standards outlined below (figure 3.1).

The DTA introduces an individual accountability regime by establishing a positive duty on directors to exercise due diligence to ensure that the deposit taker complies with its prudential obligations. As part of Tranche 2, consultation on the exposure draft of the due diligence guidance is open until 15 May 2026.

Consulting on the exposure drafts ensures the accurate translation of policy into workable law. As the end users of the standards, stakeholder feedback is important to help us refine the drafting.

Deposit Takers Crisis Preparedness Consultation – June 2026

The DTA makes the Reserve Bank the designated ‘resolution authority’ for New Zealand. As resolution authority we have a duty to ensure that resolution is carried out in a way that furthers the crisis management purposes set out in Part 7 of the DTA. The RBNZ is now engaged in a multi-year process of capacity building for resolution to enhance our ability to deliver our resolution authority mandate.

A well-developed recovery and resolution framework can deliver significantly better outcomes in the event of deposit taker distress than would be achieved through liquidation. These outcomes can only be achieved if deposit takers have also developed the necessary capabilities to deliver recovery and resolution strategies. It is particularly important to focus on resolvability preparation because there is potential for private incentives to diverge from the social good in resolvability – deposit takers’ shareholders are unlikely to derive significant economic value from effective resolution, while there are significant social benefits.

In June 2026 we will publish a consultation on a range of standards designed to ensure deposit takers have carried out the necessary preparations. This material includes consultation on the detailed implementation of the decision to introduce Loss Absorbing Capacity (LAC) instruments, made as part of the review of key capital settings.

Table 3.1: An indicative timeline for the DTA crisis management framework

2026

June to September 2026:

• Policy consultation on Crisis Preparedness standard, including policy for a revised Open Bank Resolution standard and LAC requirements alongside the publication of indicative approach to resolution.
• Consultation on the Tranche 3 DTA Standards exposure draft and guidance (including Outsourcing).

2027

• February to April 2027: Consultation on an exposure draft of LAC requirements.
• May 2027: Consultation on exposure draft of Crisis Preparedness Standard.

2028

• 1 December 2028: All DTA standards (including LAC requirements in the Capital Standard and the Outsourcing Standard) commence with phased-implementation.
• Late 2028: Crisis Preparedness Standard issued.

2029 and beyond

• Transition to new capital ratios and LAC requirements.
• Crisis Preparedness Standard commences.
• Mid-2029: Publish the Statement of Approach to Resolution (separate DTA requirement).