Reserve Bank fears loan losses and restructurings

In its latest Financial Stability Report, the Reserve Bank said banks' resilience would be tested during the Covid-crisis "as loan losses rise materially from current low levels".

The report warned households would come under pressure, with rising unemployment in the wake of the Covid-19 outbreak and subsequent economic crash. 

According to the central bank, "a high proportion of recent entrants to the housing market has taken on debt at high debt-to-income ratios". 

The report suggested households with high DTI ratios would have "less resilience to absorb declines or losses of income, and are more likely to be left in positions of being unable to service their mortgages".

While banks have granted hardship requests to borrowers, the RBNZ said households may struggle to service loans once those deferral periods are over.

It warned banks may be forced to restructure loans if current conditions continue.

"By shifting loan repayments to future dates, payment deferrals ultimately increase households’ debt servicing burden over the remaining term of their borrowing," the report stated. "If current pay reductions and elevated unemployment persist for a longer period than expected, households and banks may find that more substantial loan restructuring or remediation is necessary when deferral periods end."

In a press conference this morning, Reserve Bank governor Adrian Orr said one of the "main issues" for banks would be the "sustained level of unemployment".

Overall, the Financial Stability Report declared New Zealand's financial system "solid" enough to weather the impact of Covid-19 and support the nation's economy. 

It said trading banks had coped well so far with the Covid-19 crisis. Banks are "resilient to all but the most severe scenarios", the RBNZ said.

However, the central bank warned "the viability of banks would come into question" under "severe enough scenarios".

If NZ unemployment rose to 18% and house prices halved in a worst-case scenario, banks would fall below minimum capital requirements, according to RBNZ modelling.