The Reserve Bank is predicting the largest decline in annual GDP in at least 160 years but a central bank official has said that doesn't mean that the coronavirus crisis is a one-in-160 year event.

"When we talk about one-in-200-year events, you can't just look at an annual change in GDP," Chris Bloor, the RBNZ's financial system policy and analysis manager, told BusinessDesk.

While the economy has suffered a deep shock, "we wouldn't see this as anything like a one-in-200-year event for banks," Bloor said.

"It's more like a one-in-30-year event. It doesn't look that different from what happened to New Zealand in the early 1990s."

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A one-in-200 year event would have outcomes more akin to the most severe scenario used in its recent stress testing of the banks, which assumed unemployment would peak at 18 per cent and house prices would nearly halve, Bloor said.

Nobody is forecasting the coronavirus crisis will result in anything like these outcomes.

Bath-tub recovery

The base case the RBNZ used in its monetary policy statement earlier this month saw unemployment peaking at 9 per cent and house prices falling 9 per cent before GDP recovers to its December 2019 level by March 2022.

The MPS forecast a 2.4 per cent GDP decline in the March quarter – the actual figures won't be released until June 18 – and a 21.8 per cent slump in the current quarter before a 23.8 per cent bounce-back in the September quarter.

"It's difficult to describe exactly what this recovery looks like because it's so extraordinary in terms of one quarter," Bloor said.

While the bank is expecting a very strong third quarter, it will take about two years for the economy to return to its pre-covid levels, he said.

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Rather than the V, U or L-shaped recovery that global equities markets and economists are debating, Bloor opted for a "bath-tub shaped recovery. It takes a long time to come out to where we were before this event."

A lot will depend on the number of business failures, the level unemployment reaches and how long New Zealand's borders remain closed, he said.

'Hugely uncertain'

A business group working on creating a trans-Tasman "bubble" is hoping to achieve open borders between New Zealand and Australia in time for the July school holidays but a wider reopening could be years away.

Given all of those factors, it's difficult to see the economy recovering rapidly, Bloor said.

"The thing we are trying to highlight as much as anything is that it's a hugely uncertain environment."

In the RBNZ's latest financial stability report published on Wednesday, the central bank said its stress testing of banks "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."

That scenario envisaged a longer lockdown, unemployment peaking at 12 per cent and GDP troughing at 31 per cent in the September quarter.

Governor Adrian Orr made it clear that, notwithstanding RBNZ's expected outcomes, he still wants the banks to substantially increase their capital once New Zealand has survived the current crisis.

Reserve Bank Governor Adrian Orr. Photo / Mark Mitchell
Reserve Bank Governor Adrian Orr. Photo / Mark Mitchell

Asked why the latest stress tests should be believed when he had said through all of last year that stress tests couldn't be relied upon, Orr said that "the main challenge that I've always personally had with stress tests is that they're useful, what's the saying. All models are wrong, some are useful.

"They're very useful for creating a narrative and being able to understand that impact. The most unrealistic part of a stress test is you kind of know how the game plays out. So it's not as significant."

The stress tests that Bloor and Toby Fiennes, the bank's head of financial system policy and analysis, had been working on were "desk-top efforts," Orr said.

Lower capital starting point

"This is why we've argued and insisted on a much higher level of capital in total. If we had relied on just stress tests, we would have started this pandemic, shock, at a much lower level of capital and I wouldn't be giving you this same story I'm giving you today that the banks are in a sound position to weather the storm."

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 Dec. 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.

Orr said the banks would probably have a lower capital starting point once the pandemic was gone and so the RBNZ might adjust the phase-in period.

Bloor reinforced the message that the RBNZ wouldn't be backing down on the new capital requirements. "It's really important that the banks survive with a degree of additional capital and have the ability to continue lending," he said.

"We would be much more assured of an economic recovery had we had that additional capital" required by the new rules.

- BusinessDesk