The economic disruption associated with COVID-19 will present challenges to the financial system. Banks have good capital and liquidity buffers and need to use these to support customers and contribute to the economic recovery.
Global economic activity has been severely disrupted as countries have taken public health measures to contain the COVID-19 pandemic. In New Zealand, border closures and economic lockdowns have led to an unprecedented decline in economic activity.
Economic activity has now restarted domestically as we have moved to Alert Level 2 and a number of other countries have made moves to open up their economies. However, economies are operating well below capacity and general economic conditions will remain weak as losses of income in directly affected sectors flow into a decline in overall demand. Unemployment will rise significantly.
The Government and the Reserve Bank have worked together to cushion the losses of income associated with the economic lockdown. The Government’s Wage Subsidy Scheme has provided short-term support to firms that have lost income, and has allowed them to retain staff.
The Reserve Bank has acted in a number of ways to lower borrowing rates in the economy, helping to reduce debt servicing costs for borrowers. We cut the Official Cash Rate to a record low, and began purchasing central and local government bonds in large scales to reduce interest rates. We also provided funding to banks when markets were volatile to ensure banks remained able to support customers.
Despite the broad range of support measures, some households and firms will face a significant loss of income. Firms in the tourism, accommodation and hospitality sectors are particularly affected, and will face longer recoveries as border restrictions and social distancing measures affect sales and operating models. Household incomes will also come under pressure as staff cutbacks and firm failures lead to rising unemployment.
Loss of income will mean that some borrowers have difficulty repaying their loans. As a result, banks are likely to experience more loan defaults and losses.
Banks have strong buffers of capital and liquidity. These have increased substantially in the past ten years in response to increased regulatory requirements. Bank resilience will be tested in the coming months as loan losses rise materially from current low levels.
The Reserve Bank undertakes stress tests to understand banks’ ability to absorb losses. While there remains considerable uncertainty about the economic outlook, stress tests suggest that banks can withstand a broad range of adverse economic scenarios while retaining sufficient capital to continue lending.
Maintaining access to credit is crucial to ensure that households and businesses that are facing temporary losses of income are able to meet their financial obligations. The Reserve Bank has worked alongside the banking industry and the Government to ensure credit markets remain open.
To enable this, the Reserve Bank has delayed increasing capital requirements, relaxed rules on how much of banks’ funding needs to come from long-term sources, and temporarily removed restrictions on low deposit loans. This helps to free up banks to continue supporting customers.
Banks will also have to play their part in supporting their customers. Banks have offered household and small business customers loan deferrals, to help them manage short-term financial stress. They have also offered business customers working capital facilities to help them manage cashflow while incomes have been low.
Maintaining the flow of credit to sound borrowers will contribute to the long-term stability of the banking system by reducing borrower defaults and preventing large falls in property prices and other asset values. Maintaining credit will also play a strong role in supporting the upcoming economic recovery.