RBNZ published the financial stability report for May 2020. This review of the financial system in the country highlights that the economic disruption associated with COVID-19 will present challenges to the financial system. The financial system in a good position to support recovery. Banks have good capital and liquidity buffers and need to use these to support customers and contribute to the economic recovery. However, outside of the banking system, some parts of the financial system entered this downturn in a vulnerable position. Some non-bank deposit-takers have low profitability and are operating with low buffers. There has been consolidation in this sector in recent years and this is expected to continue. Resilience could also be boosted by seeking operational efficiencies, asset sales, and additional capital.
Although RBNZ has eased some prudential requirements, the profitability of banks will be affected by rising non-performing loans in the downturn. Appendix 1 to the report outlines economic and financial policy responses to the challenges posed by COVID-19 pandemic. While there remains considerable uncertainty about the economic outlook, stress tests conducted by RBNZ suggest that banks can withstand a broad range of adverse economic scenarios while retaining sufficient capital to continue lending. RBNZ is undertaking stress test exercises to assess resilience of the banking system 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. In the subsequent recovery phase, as the virus worldwide 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.
Results from the RBNZ modeling 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 banks in New Zealand would be able to withstand with their current capital positions. In this scenario, the RBNZ modeling 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 RBNZ 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.
Keywords: Asia Pacific, Banking, Insurance, COVID-19, Basel, Credit Risk, Liquidity Risk, Stress Testing, Regulatory Capital, Financial Stability Report, RBNZ
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