Banks asses what stressors could destroy capital buffers

RBNZ calls this a “reverse stress test,” rather than have all banks test whether they could withstand a particular set of economic impacts.

The banks chose geopolitical risks as the most common cause of a recession in New Zealand, unsurprising since the current recession was caused by governments' and central banks' overreaction to the covid pandemic and the previous recession was sparked by the collapse of most finance companies exacerbated by the global financial crisis.

“The impacts on the capital results were generally more severe than those from our traditional stress tests, apart from our 2020 covid-19 very severe scenario,” RBNZ said on Monday in a second pre-view of Tuesday's financial stability report.

“Concern about geopolitical tension has been increasing recently,” said Kerry Watt, RBNZ's director of financial stability assessment and strategy.

“As a small, open economy dependent on international trade and investment, geopolitical risks are clearly relevant to our financial system,” Watt said.

“Their potential impacts cannot be underestimated,” he said, though he probably mean they can't be overestimated.

“We must be aware of these risks and be prepared to manage them to ensure the stability of the financial system.”

Other events the banks' chose included an earthquake, a volcanic eruption in the Auckland region –the 600 square kilometre Auckland region is built on top of 53 extinct volcanoes, an outbreak of foot & mouth disease and another pandemic.

Some banks also chose to feature an insurance retreat in their scenarios.

“Banks are paying greater attention to insurability in their credit risk modelling,” RBNZ said.

And cyber incidents and climate-related events such as floods and droughts also featured.

While the results are interesting, one difficulty for an outsider in interpreting them is that none of the banks are named and nor did RBNZ say whether particular scenarios related to the big four Australian-owned systemic banks and Kiwibank or to the other much smaller banks.

For example, the scenarios for unemployment ranged from 8% through to 18% - the unemployment rate actually reached 11.2% in the third quarter of 1991, so an 8% rate doesn't look particularly severe.

Also, the range of declines in economic growth ranged from 3% to 24% - GDP has dropped more than five percentage points since the September 2022 quarter.