The Business Herald is running a series looking at New Zealand banking.
New Zealand banks are well positioned to negotiate a one-in-15-year economic downturn, but the concentration of lending in the housing market has its risks, experts say.
Andrew Dinsdale, chairman of accounting firm KPMG's banking group, said the banks had learned a lot from previous failures or difficulties that stemmed from overexposure to a single market, such as equities or commercial property.
"There's just not the same concentration of risk or the same policies that created the risk back then occurring today."
He said the sturdy credit quality banks now enjoyed had much to do with the period of sustained high employment and economic growth in the past few years.
"Certainly we've had a very benign economy and therefore low losses, but the banks are very well provisioned for adverse events. Most of the banks today have adopted what is called dynamic provisioning. They're basically looking at a 15-year credit cycle and what they need to put away today for the loan they write today.
"One good hit in 15 years shouldn't have a big impact on profit."
Reserve Bank Deputy Governor Adrian Orr last week said New Zealand's banks were enjoying "a robust historical period" with the lowest levels of non-performing loans across the sector seen in recent decades.
That was due to the increasing concentration of their lending into the housing market, which traditionally had low levels of defaults.
But while the banks may quite literally be as safe as houses, the Reserve Bank was not without concerns about the security of those same houses.
Orr said the high concentration of lending in the housing market left banks vulnerable to simultaneous shifts in house prices and unemployment.
"We're working closely with the banks to ensure that they're adequately capitalised for those sorts of events to be able to buffer through it."
While the level of non-performing loans was at historic lows, "the issue we always have to think about is if things turn bad they can go quite quickly and you can have quite significant turnarounds".
But Massey University head of banking studies David Tripe believes it's virtually impossible to see from the outside how robust the banks' home lending books are.
Analysis of the riskiness of the banks' home lending portfolio was limited by a lack of information disclosed about their composition.
"The figure for the amount of lending to first-home buyers with low equity could be only 10 per cent of their bank loan portfolios, in which case they're probably not exposed to any great risk. But we don't know enough about their portfolios to know if that's true," Tripe said.
Furthermore, it was "a point of concern" that the banks' adoption of International Financial Reporting Standards meant they could no longer keep large sums on their balance sheets to provide for loan defaults, effectively putting an end to dynamic provisioning.
While the banks might have learned lessons from the difficulties of the 1980s and 1990s, "whether they can still remember them is another story".
"Their controls and management of it is probably better than it was in those days, however. The proof of the pudding is going to be in the eating to a large extent. Things may well be considerably better but I wouldn't want to be putting large amounts of my own money in placing a bet."
Tripe, the Reserve Bank and Dinsdale do not say a downturn in the housing or employment markets is likely, but Tripe believes banks may ultimately face the biggest risks elsewhere.
"The most dangerous risks are the ones you've not planned for."
Banks fail a bit more often than 'once every 900 years'
Two years ago, in opposing Reserve Bank measures intended to minimise the impact of an overseas bank failure on New Zealand's economy, the Australian Banking Association commissioned a report which found the risk of one of the major Australian banks failing was "less than once every 900 years".
"They're a bit more recurring than that," said KPMG banking group chairman Andrew Dinsdale last week.
In the last 20 years across the Tasman, the State Bank of Victoria and the State Bank of South Australia have failed and even Westpac found itself in a parlous condition over property deals in the 1990s.
In 1990 the Bank of New Zealand was bailed out by the taxpayer to the tune of $635 million. In the aftermath of its near failure the bank was bought out by National Australia Bank, ending local ownership of any of the large banks.
Reserve Bank sees downside to deposit insurance schemes
While most developed countries have deposit insurance schemes to protect depositors' cash in the event of a collapse, New Zealand does not.
Reserve Bank Deputy Governor Adrian Orr has said "deposit insurance brings risks and costs, which need to be weighed against alternatives".
The RBNZ argues that deposit insurance may actually increase the risk of bank failures in the first instance by reducing the incentives depositors might otherwise have to monitor and to exert pressure on their banks.
They could also reduce the incentives bank boards had to ensure prudent management.
Instead, the Reserve Bank favours "using consistent incentives to encourage bank boards and management, financial markets, and the public at large to manage and monitor banks prudently".
* Under the Basel international framework, the Reserve Bank requires New Zealand's big four banks to hold a minimum level of capital in reserve to absorb losses associated with ups and downs in the economy.
* At present they must hold at least 8 per cent of their risk-weighted exposure in reserve.
* ANZ/National: 10.14 per cent at September 30
* BNZ: 10.68 per cent at June 30
* ASB: 10.8 per cent at September 30
* Westpac: Became subject to Basel requirements when it became New Zealand incorporated this month. It says its capital adequacy ratios exceed minimum requirements.
* The pros and cons of foreign ownership