Stress testing New Zealand banks’ resilience to COVID-19

This page contains information on Stress testing New Zealand banks’ resilience to COVID-19 from the May 2020 Financial Stability Report.

The Reserve Bank is currently undertaking stress test exercises to assess the banking system’s resilience if the economic downturn becomes very prolonged. The two scenarios developed to test the banking system have similar economic projections to the Treasury’s COVID-19 scenarios 2 and 5 during the peak of the recession in the first 18 months (table A.1).3 In the subsequent recovery phase, as the virus world-wide is brought under control, the bank stress test scenarios assume a protracted global slowdown and a slower recovery for the New Zealand economy than the Treasury’s scenarios. Both scenarios are significantly more adverse than the scenarios published in the May 2020 Monetary Policy Statement.

The Reserve Bank is assessing the impacts of these scenarios in two stages. In the first, the Reserve Bank is modelling the scenarios using the prudential data that banks are required to regularly report. In the second the Reserve Bank will collaborate with stress testing staff at the five largest banks in the coming weeks.

Results from the Reserve Bank’s modelling indicate that banks can maintain capital above their minimum capital ratios in the Baseline Stress scenario. Banks are projected to fall into their capital conservation buffers, meaning they would be meeting their regulatory requirements but also required to develop plans to repair their capital positions over time.

Preliminary results from the Very Severe scenario illustrate that there are limits to the economic shocks that New Zealand’s banks would be able to withstand with their current capital positions. In this scenario, the Reserve Bank’s modelling shows that banks would likely fall below several of their minimum regulatory capital requirements. In this situation, banks would have to undertake significant recovery responses such as raising new capital from shareholders to avoid resolution options.

Some of the economic scenarios produced by the Treasury in April are significantly more severe than the scenarios the Reserve Bank is assessing, in terms of the level of unemployment and decrease in economic activity. Under these more extreme (and less likely) scenarios, additional capital and other mitigating actions would be required to avoid widespread failure in the banking system.

This conclusion is in line with those of previous Reserve Bank stress tests, which indicate that New Zealand’s banks are resilient to a broad spectrum of downturn events, although not all tail scenarios. Results from these exercises will be further refined as the Reserve Bank works with banks’ staff to understand and model how these scenarios would affect their institutions.

Table A.1
Scenario parameters for Reserve Bank COVID-19 stress test
Stress parameter Baseline stress scenario Very Severe scenario Baseline scenario (May MPS)
Peak unemployment rate (%) 13.4 17.7 9.0
Unemployment rate in December 2022 (%) 9.2 11.8 5.5
Cumulative house price decline (%) 36 48 9
Recovery of real GDP to its December 2019 level June 2023 June 2024 March 2022

3 See treasury.govt.nz/publications/tr/treasury-report-t2020-973-economic-scenarios-13-april-2020 for the set of economic scenarios the Treasury developed and published in April.