Reserve Bank stress tests show banks are strong even as house prices fall 47%

Households could struggle, but banks may face a 47% drop in house prices, even if unemployment exceeds 9%, according to Reserve Bank Te Pūtea Matua stress tests.

The Reserve Bank requires banks to run stress test scenarios as part of its mandate to ensure the stability of the country’s financial system.

Reserve Bank Deputy Governor Christian Hawkesby said the 2022 stress tests indicated the banking sector was well positioned to withstand a “stagflation” scenario, where high inflation was associated with a recession.

The stress tests were designed to give the Reserve Bank insight into how banks would deal with “severe but plausible scenarios”.

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The Reserve Bank's 2022 stress test for banks indicates that the banking system remains solid.

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The Reserve Bank’s 2022 stress test for banks indicates that the banking system remains solid.

In its 2022 stress test scenario, the Reserve Bank asked banks to model the impact on their finances of a 47% fall in house prices from the peak in November 2021, a fall in stock prices of 38%​, an unemployment rate reaching 9.3%​, and gross domestic product (GDP) contracting by 5%.

The scenario called for the Reserve Bank’s official cash rate (OCR) to peak at 5.5% and two-year fixed-rate mortgage rates to peak at 8.4% on average.

The current OCR is 3.5%.

ROBERT KITCHIN/STUFF

Reserve Bank Governor Adrian Orr speaks with Stuff a day after raising the official exchange rate in August. (Video first published on August 18, 2022)

ANZ Bank economists currently expect the OCR to peak at 5% in February, and some economists think the OCR could go even higher. The interest rate on ANZ’s two-year fixed rate home loans is currently 6.19% for borrowers with at least 20% of the equity in their home.

Hawkesby said: “Although banks’ capital buffers would be reduced in such a scenario, they would still remain well above our regulatory minimum, thanks in part to capital accumulation since the 2008 global financial crisis, enabling them to continue to support their customers and the economy.

However, this would not be comfortable for many households or bank shareholders.

If the Reserve Bank’s 2022 scenario were to materialize in real life, banks’ profits would turn negative as they forecast sharp increases in bad loans as households and businesses struggled to make repayments.

Households are expected to face rising unemployment and persistently high levels of inflation.

Many households would struggle to repay their home loans due to high levels of unemployment, but also the effect of two-year home loan rates topping 6% and topping 7%, the Reserve Bank said.

The document showed an 11.2% spike in all bank home loans in default under the stress test scenario.

This compared to 18.1% of small and medium enterprises with bank loans in default on one or more repayments.

Dairy demand falls in the Reserve Bank's 2022

VANESSA LAURIE / Stuff

Dairy demand falls in the Reserve Bank’s 2022 “stress tests” for banks, driving down the price of Fonterra milk.

The Reserve Bank’s scenario predicted a renewed sovereign debt crisis in Europe and an increase in the number of companies going bankrupt in New Zealand and abroad.

The European debt crisis would result in lower prices for dairy products.

Commercial real estate prices would fall almost as much as real estate prices in the scenario.

In order to give the banks a real stress test workout, the Reserve Bank included a large computer security breach in the banking system in its scenario.

Hawkesby said more details on the stress tests would be included in the Reserve Bank’s November 2022 financial stability report., which will be published on Wednesday, November 2.

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