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Financial stability implications of recent North Island weather events

An article from the May 2023 Financial Stability Report.

Reserve Bank of New Zealand

Financial stability implications of recent North Island weather events
Financial stability implications of recent North Island weather events

An article from the May 2023 Financial Stability Report.

Introduction

The extreme weather events earlier this year caused significant damage to a large part of the North Island. In late January, Auckland experienced very heavy rainfall, which led to extensive flooding across the city. This was followed in mid-February by Cyclone Gabrielle, which caused more widespread severe damage to parts of the North Island. In this special topic we examine the impacts of the weather events on financial system stability.

As noted in the February 2023 Monetary Policy Statement (MPS), the weather events resulted in significant economic disruption. The size of the economic impacts is still uncertain, and we continue to monitor the situation and reassess our estimates. These weather events occurred at a time when labour and other resources in the economy were already scarce. Existing capacity constraints may mean these storms are more inflationary than previous natural disasters and it may take longer for recovery work to take place. Our analysis has suggested that the near-term inflationary impact of these events is likely to be larger than the additional 0.3 percentage points on Consumers Price Index headline inflation in each of the March and June 2023 quarters assumed at the time of the February MPS.

Read the February 2023 Monetary Policy Statement

Over the medium term, rebuild activity is likely to provide upside risks to inflation and employment when we would otherwise expect an easing in capacity pressures. It is likely that the total additional activity from the severe weather events will be above our 1% annual GDP (gross domestic product) assumption at the time of the February MPS.

In addition to their economic impacts, the weather events affected several parts of the financial system, notably by:

  • causing payments systems disruption
  • triggering insurance claims for damage, and
  • creating difficulties for borrowers’ ability to service debts in affected regions.

While the weather events caused significant economic disruption and hardship for the households and businesses affected, they do not appear to have created substantial risks to financial system stability.


Payment systems disruption

Cyclone Gabrielle caused extensive damage to payments-enabling infrastructure in affected areas, which meant that electronic payment systems such as EFTPOS were unavailable for several days. As a result, there were localised increases in demand for cash as the only viable means of payment. However, ATMs were generally inaccessible, offline or empty. Many bank branches in the affected areas were unable to open. The physical movement of cash into and out of the areas by road was impractical or impossible, resulting in added pressure on the local cash system and its users (including retailers).

The Reserve Bank collaborated with cash industry participants and other government agencies, including the National Emergency Management Agency, New Zealand Police and the New Zealand Defence Force to facilitate the movement of cash into and out of the affected regions. We also provided daily public updates on ATM availability, advice on accessing banking services and information on the safe handling of contaminated cash (including with geographically-targeted social media messaging).

Banking services and independent ATM operators are now mostly back to offering regular services in the affected regions, with the exception of Tairāwhiti, where coastal settlements still have road access problems. The cash-in-transit industry is still working hard and at extra cost to maintain services due to the damaged road network.

The disruptions to the cash industry caused by Cyclone Gabrielle have highlighted the lack of resilience in the cash system and its vulnerability to power, data, and road network outages, particularly due to banks reducing branch and ATM networks and retreating from offering in-branch cash services for retailers. Given the increased likelihood of extreme weather events in the future as a result of climate change, this lack of resilience in the cash sector will need to be addressed. This will be an increased focus in our prudential supervisory engagement, as well as a consideration in cash system redesign work under our Future of Money — Te Moni Anamata programme.


Insurance impacts

Insurance companies play an important role in helping households and businesses deal with natural disasters by pooling risks. We estimate that the total claims cost for private insurance (i.e. excluding Toka Tū Ake EQC) will be around $1.6 to $2.1 billion from the Auckland Anniversary flooding and a further $1.4 to $2.1 billion from the effects of Cyclone Gabrielle. In addition there will be considerable claims for Toka Tū Ake EQC. Most infrastructure has no or limited insurance cover, and costs to repair infrastructure damage will largely fall to central and local government, and ultimately taxpayers and ratepayers.

Even in exposure-adjusted terms (that is, adjusting for growth in sums insured),1 the recent floods and cyclone have higher insurance claim costs than any previous New Zealand weather events (figure 2.6). Furthermore, having two very expensive weather events in quick succession was unprecedented in New Zealand. The combined total claims cost of the Auckland floods and Cyclone Gabrielle are slightly higher than that of the Kaikōura earthquake, but are still much lower than that of the Canterbury earthquakes of around $27 billion (excluding Toka Tū Ake EQC).2

Download the graph showing total value of weather event insurance claims (jpg, 386 KB)

Property insurers will in aggregate record a loss in the current financial year. Claim costs net of reinsurance for the 2 recent weather events, plus additional reinsurance premiums, have exceeded normal profits. In addition, insurers have recorded material investment losses from rising interest rates.

While these losses have depressed solvency for the relevant insurers to varying degrees, they are not seen as risks to financial stability.3

Some insurers have injected additional capital from their parents in response. With weaker solvency, some property insurers are at risk of breaching regulatory solvency requirements if there is a further large event in the next few months.

The weather events will lead to higher reinsurance premiums and in turn higher premium costs for policyholders. This is on top of general existing inflationary pressures on premiums (for example, due to the rising costs of construction) and other expenses. Insurers are considering reducing existing cross-subsidies for flood and landslide risks, and properties in particularly high risk locations could soon become uninsurable. The increased likelihood of extreme weather events as a result of climate change will likely lead to a need for ‘managed retreats’ from vulnerable areas. Addressing the impacts of managed retreat on the availability of insurance in these areas will require extensive collaboration across central and local government, regulators, the insurance industry, and other affected stakeholders.


Debt servicing impact

Some households and businesses in affected regions will struggle to continue servicing their debt. In many cases their sources of income have been severely disrupted. Some will also face high costs to rebuild and repair damage to their properties as they were under or uninsured. For example, many horticultural growers in Hawke’s Bay are unlikely to have insurance for lost crops and damaged land, so will likely face significant costs to re-establish their businesses.

We have discussed the impacts of the weather events on loan portfolios with the large banks. The banks have not reported any significant increases so far in the number of their borrowers in the affected regions requesting support. As a result, to date the banks have not identified a worsening in their asset quality or the need for additional provisioning for increasing loan defaults. However, banks do expect to see increased losses on mortgage lending and business loans as a result of the weather events in the near future. The scale of these losses is hard to measure at this stage as banks and customers are still evaluating the extent and the cost of damage. Several banks noted that the impacts of the flooding and cyclone on business customers has come at a time when they are already facing pressures from other factors, such as labour shortages and supply chain disruption, which have increased their vulnerability to the weather events. Similarly, mortgage borrowers are facing the impacts of the weather events while debt servicing pressures are increasing as many mortgages are being re-priced onto higher rates.

Large institutions that have diversified customer bases across the country will be able to absorb the impacts of the weather events on asset quality. However, some smaller lenders with lending concentrated in regions affected by the flooding and cyclone may face more challenges in meeting their prudential requirements.

Flooding risk as a result of climate change is likely to be an increasing focus for banks in the future. We recently published the results of flooding risk assessments of the largest banks as part of our stress testing programme.4

Only a relatively small proportion of banks’ value of residential mortgages is exposed to significant sea level rise, albeit with potential areas of geographic concentration risk. In addition, nearly a quarter of the banks’ residential mortgage exposures in Auckland would be ‘at risk’ to a 1-in-100-year rainfall flood event in a 2.1 degree warming scenario. Overall, banks’ capital ratios were resilient to the most severe sensitivities in the stress test exercise. However, more work is required on data and modelling across industry and government if we are to better understand and manage these risks.

Table 2.1

Summary of financial sector impacts from the weather events

Near-term impacts Long-term impacts / issues
Payments system Localised temporary increase for cash demand. Need to increase / restore resilience in the cash system.
Disruption to cash / EFTPOS access and banking
Insurance sector High number of insurance claims in response to property damage. Further increased premiums in locations with high flood or landslide risks.
Financial losses and weakened solvency.
Particularly high risk locations becoming uninsurable.
Higher reinsurance premiums leading to higher insurance premiums.
 
Debt servicing Little reported impact so far on customers’ ability to service loans. Banks expect increased losses on loans, but the magnitude is hard to forecast.

Footnotes

1 The value of the housing stock is used as a proxy.

2 The total insurance claims of flooding and cyclone weather events are also higher and closer together than events used for the ‘severe weather scenario’ in the General Insurance Industry Stress Test in 2021.

3 Solvency is having sufficient capital to absorb losses before affecting insurers’ obligations to policyholders. The Reserve Bank sets conservative minimum requirements for solvency.

4 2022 Flood risk assessment for residential mortgages, RBNZ Bulletin, March 2023