After spending a year trying to convince New Zealand that banks needed significantly higher capital to withstand a one-in-200-year financial shock, the Reserve Bank is now in the awkward position of explaining why the banks are already able to weather the largest decline in annual GDP in at least 160 years.
"Even accounting for an expected recovery in the second half of the year, this year's projected decline in annual GDP is the largest in at least 160 years," the RBNZ said in its latest financial stability report.
But the central bank said it has initiated stress testing of the banks which "suggests that under a scenario featuring a larger increase in unemployment and a slower recovery than the severe scenario published in the monetary policy statement, banks are likely to maintain capital ratios above minimum requirements."
This is exactly the same outcome as the RBNZ's previous stress tests going back a number of years, but governor Adrian Orr has argued previously that such stress testing can't be relied upon.
The new bank capital rules, which would have required the four major banks to lift minimum tier 1 capital from 8.5 per cent to 16 per cent over seven years from July 1 this year, have been deferred until July 1 next year. The four major banks account for about 88 per cent of the banking system.
The latest RBNZ data available shows that at December 31, ASB Bank's tier 1 capital was 13.5 per cent, ANZ Bank's 13.6 per cent, Bank of New Zealand's 12.8 per cent and Westpac's 14 per cent, all well shy of the 16 per cent the new rules mandated.
The FSR notes that banks are in a far stronger position, both from a capital and liquidity point of view, than they had been going into the global financial crisis in 2008.
"Nevertheless, banking system resilience will be tested in the coming months. Covid-19 will have prolonged and sustained effects on some parts of the economy and it is inevitable that some firms will fail," it said.
Households will also come under pressure as a result of rising unemployment and some may have difficulty servicing their mortgages. About 60 per cent of the major banks' balance sheets are housing loans, ranging from 65.8 per cent at December 31 for ASB, 62 per cent for ANZ, the largest bank, and 60.9 per cent for Westpac to BNZ at 49.3 per cent.
House prices will probably fall "although strong equity buffers as a result of loan-to-value ratio restrictions will limit the number of borrowers who face negative equity."
The RBNZ removed LVR restrictions after the coronavirus crisis hit New Zealand. The latest Real Estate Institute data showed house prices rose 8.5 per cent in the year ended April.
"Loan losses for banks will rise materially from current levels. This could weaken banks' capital positions" but stress testing shows they are likely to maintain capital ratios above minimum requirements.
"Under severe enough scenarios, the viability of banks would come into question."
Using Treasury's third worst scenario, which would see unemployment reach nearly 18 per cent and house prices nearly halving, "initial modelling suggests that, without significant and timely mitigating actions, banks would fall below minimum capital requirements," the FSR said.
"The Reserve Bank is working with industry to better understand the impacts that these scenarios would have on banks and to assess appropriate mitigating actions."