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RBNZ Warns Banks’ Ability to Absorb Shocks ‘Is Not Unlimited’

Wednesday 27th May 2020

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New Zealand’s central bank warned that the coronavirus pandemic presents a significant challenge to the country’s financial institutions, which could be stressed by failing businesses and loan defaults.

While the financial system entered the crisis in good shape, “it’s capacity to absorb shocks is not unlimited,” the Reserve Bank said in its semi-annual Financial Stability Report published Wednesday in Wellington.

“Covid-19 has caused a fundamental change to the viability of businesses in many sectors of the economy and credit impairments will rise significantly,” the RBNZ said. “Initial results from stress tests suggest banks will be able to absorb losses associated with a broad range of adverse scenarios. However, there are limits to this resilience, and banks’ capital positions could come under stress if the downturn in economic activity is more severe or prolonged than expected.”

New Zealand appears to have succeeded in stamping out the virus by closing its border and imposing one of the strictest lockdowns in the world, but the measures will take a toll on the economy. The RBNZ projects an almost 10% decline in annual gross domestic product this year, the steepest slump “in at least 160 years.”

“The associated losses in income will cause financial distress for a significant number of households and businesses,” said Nick Tuffley, chief economist at ASB Bank in Auckland. “Consequently, the RBNZ expects business failures and household income pressures to result in increased loan losses in the banking sector.”

Rising unemployment will put some households under financial stress, which could be accentuated by falling house prices, the RBNZ said today.

Housing Correction

“The current economic downturn could bring a significant correction” in the housing market, it said. “With the ratio of the median house price to median income near an all-time high, a major correction would test the resilience of households and lenders.”

It said commercial property is vulnerable, and a prolonged economic slump will put downward pressure on rents and lead to increases in vacancy rates.

“Current development pipelines also indicate that an above-average volume of retail and accommodation space is due to be delivered over the next 12 months in the Auckland and Queenstown markets,” the RBNZ said. “Demand may therefore struggle to keep pace with this increased supply, and the viability of some commercial property loans will be called into question.”

Agriculture had fared relatively well but was also vulnerable.

“Lending to the agriculture sector is a key concentration of risk for the banking system, accounting for around 13% of bank lending, of which around two thirds is to the dairy sector,” it said. “The sector is vulnerable to income shocks given its dependence on global commodity prices, and pockets of dairy lending have yet to recover from the 2015 downturn.”

Still, the financial system was “well positioned” to weather the economic impacts of the pandemic, the RBNZ said. “While there remains considerable uncertainty about the economic outlook, stress tests suggest that banks can withstand a broad range of adverse scenarios while retaining sufficient capital to continue lending.”


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