As part of its prudential supervision, the Reserve Bank undertakes supervisory stress tests. These exercises involve subjecting several financial institutions to a common stress scenario, with oversight from regulators. The Reserve Bank uses supervisory tests to:
- Investigate and understand the implications of current and emerging risks to financial stability;
- Assess the resilience of participating banks when subject to severe stress;
- Support improvements in the use of stress tests by individual banks to identify and manage the risks facing their business.
The Reserve Bank’s stress test framework
Developing a comprehensive stress testing framework for the New Zealand banking system has been a strategic priority for the Reserve Bank in recent years. In July 2018, the Reserve Bank published a Bulletin article outlining its approach to stress testing banks, and how it interprets test results when assessing the stability of the financial system.
The Reserve Bank’s framework involves a significant role for participant banks to assess the impact of stress scenarios. Banks are expected to invest in stress testing models and infrastructure, and to conduct their own internal stress tests as part of their Internal Capital Adequacy Assessment Process (ICAAP). In May 2016, the Reserve Bank issued a discussion document on stress testing methodology for New Zealand incorporated banks.
Results of recent stress tests
The Reserve Bank reports on the implications of stress tests for the financial system in its Financial Stability Report, and occasionally provides more detailed analysis in Bulletin articles:
- 2017 stress test of major banks (including datapack)
- 2015 common scenario ICAAP stress test
- 2015 stress test of key dairy lenders
- 2014 stress tests of the major banks and selected smaller banks
Reserve Bank modelling of credit risk
The Reserve Bank develops its own models to assess vulnerabilities in key credit portfolios. These models are used to understand and monitor credit risk, and to cross-check the loss rates reported by banks as part of supervisory stress tests. The following publications discuss the findings from this research:
- Analysis of household sector vulnerabilities to higher mortgage rates (2017 Financial Stability Report analytical box)
- Assessment of dairy sector vulnerabilities using DairyNZ data (2015 Bulletin article)
- Assessment of dairy sector vulnerabilities using granular data from banks (2011 Bulletin article)
- Project TUI: A structural approach to the understanding and measurement of residential mortgage lending risk (2008 research paper)
Stress testing is a tool to assess how banks might cope with a severe economic downturn. This video explains how stress tests work and why the Reserve Bank of New Zealand uses them in its role as prudential regulator.