RBNZ Releases Results of COVID-19 Stress Test on Largest Banks
RBNZ published the results of a stress test that was launched in March 2020 to determine the resilience of banks and the financial system to the posed by the COVID-19 pandemic. The results of the stress test suggest that banks could draw on their existing capital buffers and continue to lend to support economy during the downturn in the hypothetical pessimistic baseline scenario. However, in a more severe scenario, capital of banks fell below the regulatory minima, thus requiring significant mitigating actions, such as capital injections, for banks to continue lending.
The COVID-19 stress test consisted of two parts. In the first part, RBNZ conducted a desktop stress test involving nine largest banks in New Zealand, which hold 92% of total bank loans. These banks are ANZ Bank New Zealand, Bank of New Zealand, ASB Bank, Westpac New Zealand, Kiwibank, TSB Bank, Southland Building Society, Heartland Bank, and The Co-operative Bank. Using bank data, RBNZ modeled the effect on banks’ capital under two scenarios involving a rapid decline in economic activity, increase in unemployment, and fall in property prices. In the second part, RBNZ coordinated a process in which the five largest banks used their own models to estimate the effect on their capital under the same two scenarios. The scenarios—the pessimistic baseline scenario and the very severe scenario—were set at different levels of severity taking elements of the scenarios developed by Treasury in April, in combination with different degrees of global economic stress. These scenarios are hypothetical and are significantly more severe than the baseline scenario of RBNZ.
The results of this stress test show the banking system in New Zealand has a good level of resilience and is well-positioned to continue lending to support the economy. In the pessimistic baseline scenario, all banks were able to meet minimum capital requirements. However, capital is projected to fall significantly, requiring plans to restore capital over time. Furthermore, banks are not invincible; the second very severe scenario is an example of a more severe, albeit less likely, scenario in which banks would fall below their regulatory minimum capital requirements without significant mitigating actions, including capital injections. Therefore, strong capital buffers are required to provide resilience against severe but unlikely events. Banks incorporated their modeled results of the pessimistic baseline scenario and very severe scenario into the annual capital management process.
The results of this stress test reinforce the importance of bank capital and support decisions that were made as part of the capital review to increase bank capital levels. In December 2019, RBNZ had finalized decisions in its review of the capital adequacy framework for locally incorporated banks, including confirming the proposed increase in regulatory capital requirements from current settings. The implementation of the capital review has been delayed until at least July 01, 2021 and RBNZ will be considering, over the coming months, whether further delays are warranted. The findings of this stress test exercise will help to inform RBNZ decisions on the timing of implementation of the capital review and on any changes to the current dividend restrictions.
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Keywords: Asia Pacific, New Zealand, Banking, COVID-19, Stress Testing, Regulatory Capital, Capital Adequacy Framework, Basel, RBNZ
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