RBNZ FSR 20241105

November 2024

Purpose of the Financial Stability Report

The Financial Stability Report outlines our assessment of the state of, and risks to, New Zealand’s financial stability. The Report is one of our key publications, and aims to raise public awareness of developments in the financial system. It is published pursuant to section 170 of the Reserve Bank of New Zealand Act 2021, which states that the Report must:

• report on matters relating to the stability of New Zealand’s financial system, and other matters associated with the Reserve Bank’s prudential objective; and

• contain the information that is necessary or desirable to allow an assessment to be made of the effectiveness of the Bank’s use of its powers to protect and promote the stability of New Zealand’s financial system, and achieve the prudential objective.

Financial Stability Objective

Our prudential objective is to protect and promote the stability of New Zealand’s financial system. A stable financial system is one where resilient financial markets, institutions and infrastructures enable a productive and sustainable economy, and ultimately prosperity and well-being for New Zealanders. By resilient, we mean the ability to anticipate, prepare, absorb, recover and learn from shocks and imbalances.

By protecting and promoting financial stability, we are committed to ensuring that all New Zealanders can safely save, make everyday transactions, access credit, invest, insure against risks and plan for the future. In doing this, we take into account competition, efficiency and proportionality, which enable the financial system to deliver choice and value for money for New Zealanders. This also supports an inclusive financial system that is accessible to people from all walks of life.

Our Analysis and Strategy

The Report outlines our assessment of the state, resilience, and vulnerability of the financial system and its component parts. We assess how global and domestic developments are affecting the financial health of New Zealand’s households and businesses, and the performance and resilience of our financial institutions. We also highlight longer-term risks and issues that may affect financial stability.

This analysis feeds into setting our strategy and priorities for pursuing our financial stability objectives. These priorities, and progress towards achieving them, are also outlined in the Report, including actions to strengthen the regulatory framework, the use of our macroprudential policy tools to mitigate the build-up of systemic risk, work to enhance the resilience and risk management of regulated entities, and our enforcement activities.

REPORT AND SUPPORTING NOTES PUBLISHED AT:

www.rbnz.govt.nz/financial-stability/financial-stability-report

Subscribe online: www.rbnz.govt.nz/email-updates

A summary of New Zealand’s financial system is published at: www.rbnz.govt.nz/financial-stability/overview-of-the-new-zealand-financial-system

This Report uses data available up to 31 October 2024.

Copyright © 2024 Reserve Bank of New Zealand

ISSN 1176-7863 (print)

ISSN 1177-9160 (online)

rbnz.gov t .nz

Financial Stability Report .

1

Summary.

The Financial Stability Report outlines our assessment of risks to financial stability. Financial stability is critical for ensuring that New Zealanders can safely save, borrow and manage financial risk.

Currently, financial stability risks remain contained as we near the bottom of the economic cycle. The financial system is well positioned to continue providing credit to the economy, even if the downturn gets worse.

Globally, interest rates are coming down as inflation has subsided. Many central banks have started to reduce their policy interest rates. Financial markets have been volatile at times due to an uncertain outlook for economic activity and inflation.

Weakness in the domestic economy has become more pronounced. Households have reduced their discretionary spending and businesses have put investment plans on hold. While business confidence is recovering as inflation and interest rates fall, significant further weakening in the economy remains a risk.

In the housing market, lower demand has led to declining residential construction. High interest rates mean the costs for potential new buyers remain high despite house prices being lower (see Special Topic 2).

Debt-servicing costs are around their peak and are beginning to fall. Advertised mortgage rates have fallen over the past 6 months. Debt-servicing costs should become more manageable over time.

However, rising unemployment is causing financial difficulties for affected households. Banks expect the non-performing share of their lending to increase, although still well below previous recessions.

Banks are in a strong financial position to manage loan defaults. They continue to be profitable. Capital ratios are comfortably above our minimum requirements, even as those requirements increase.

As part of our stress testing programme, we asked banks to simulate a scenario that would cause them to breach minimum capital requirements (see Special Topic 1). Most banks included a geopolitical shock in their scenarios. We explain how geopolitical shocks could impact financial stability in Box A

Growth in premiums for residential dwelling insurance is likely to ease overall, although high-risk properties may see further increases. Global reinsurers have benefited from fewer events with large claims costs over the past year, helping to ease cost pressures faced by local insurers. For vulnerable properties, floodrisk premiums are becoming more common as the trend towards risk-based pricing continues.

We are implementing the Deposit Takers Act 2023 at pace. Our focus this year has been on developing and consulting on the standards for deposit takers. We also remain on track to have the Depositor Compensation Scheme in place by the middle of 2025.

The Commerce Commission finalised its market study into personal banking services in August. Competition is one of the principles we are considering as we implement the Deposit Takers Act. In response to the market study, we are enhancing our assessment of competition impacts and consulting on a number of initiatives that are likely to provide competition benefits.

Non-bank lenders and private capital funds remain small in New Zealand. We aim to raise awareness of developments across the financial system.1 In this Report, we summarise developments outside the traditional financing channels. Internationally, financing by non-bank lenders and private capital funds has grown significantly in recent years. This provides more financing options for businesses, but also poses new risks (see Special Topic 3).

Chapter 01

Financial stability risk and policy assessment

Mackay Falls. Photo: Tyler Smith

Chapter 1 . Financial stability risk and policy assessment

Financial stability risks remain contained as we near the bottom of the economic cycle. In this chapter, we summarise global and domestic economic developments, noting a more severe economic downturn is a risk. Then we step through the impacts on households and businesses. We focus on the sectors banks have significant exposures to, like agriculture. We explain why banks are well placed to deal with potential losses. Finally, we note our policy priorities.

Globally, interest rates are coming down as inflation has subsided Over the past 6 months, inflation has continued to trend lower globally. Goods inflation has driven this decline. Services inflation remains elevated but it is also expected to continue to decline in line with increased spare economic capacity (see our August Monetary Policy Statement). As a result, persistent above-target inflation has become less of a risk.

Global economic growth remains below trend. High interest rates are affecting spending by households and businesses. A more severe global economic downturn would be a concern. Some major central banks have started reducing their policy interest rates and market pricing suggests they will reduce them further over the next year (figure 1.1). The pace and extent to which interest rates will fall are uncertain.

Global financial markets have been volatile at times

Global financial markets can affect financial stability in New Zealand. They provide access to foreign capital for large businesses and the banking sector. In addition, New Zealanders own overseas equities and other investments.

Over the past 6 months, uncertainty around the economic and inflation outlook has been elevated. This has contributed to periods of volatility in financial markets, notably in Japanese equity prices (figure 1.2). After the Bank of Japan raised its policy interest rate in August for just the second time since 2007, the yen appreciated sharply and equity prices fell. This reverberated globally but proved short-lived as financial markets stabilised quickly.

Source: Bloomberg.

Note: New Zealand is the Official Cash Rate. United States is the midpoint of the fed funds target range.

Figure 1.1

Market pricing for policy interest rates in New Zealand and the United States (current vs 6 months ago)

1.2

Global equity prices (index = 100 on 31 January 2020)

Source: Bloomberg.

1.3

Household consumption per person (quarterly volume, seasonally adjusted)

Source: Stats NZ.

Investors’ willingness to hold risky assets has been sensitive to recent economic developments. Equity prices have appeared overvalued relative to fundamentals in some segments, including for example the technology sector.2 Geopolitical risks have also been a concern, given the conflicts in the Middle East and Ukraine (see Box A).

Despite periods of financial market volatility, New Zealand banks have continued to report favourable conditions in funding markets. Low corporate bond spreads indicate that companies have been able to borrow in markets at relatively low risk premiums over government bond yields. Government bond yields have also fallen this year in line with expectations of lower policy interest rates.

Weakness in domestic economic activity has become more pronounced Subdued global growth and high interest rates have reduced aggregate demand in New Zealand. The economy has shifted from a period of excess demand to one of excess supply. GDP in the June 2024 quarter was 0.5 percent lower than the same quarter a year earlier. This contraction was despite strong net migration until late 2023.

Households have reduced their discretionary spending to manage budget pressures. Consumption per person has fallen by a similar amount over the past year as it did during the Global Financial Crisis (GFC) (figure 1.3).

Businesses have put investment plans on hold. The weaker outlook for demand and high borrowing costs are key reasons for the pause. Government expenditure is expected to decline as a share of the economy. Lending growth has been weak across sectors.

Despite a significant house price cycle in recent years, financial stress has been contained

Nationally, house prices fell by 14 percent from their peak in November 2021 to April 2023. Since then, house prices have been broadly unchanged. Despite this, few households have more debt than the value of their houses (see Special Topic 2). Residential building consents have fallen and construction activity is declining.

We introduced debt-to-income (DTI) restrictions and eased loan-to-value restrictions in July. These adjustments have had a negligible impact on the housing market, as we expected. We intend for DTI restrictions to act as a guardrail. We set them at a level that will constrain the amount of high-risk lending during periods of low interest rates and rising house prices.

2 See BIS Quarterly Review Box B https://www.bis.org/publ/qtrpdf/r_qt2409.pdf

Figure

Figure

Debt-servicing costs are around their peak and are beginning to fall

High debt-servicing costs continue to squeeze household budgets. The average interest rate across mortgage lending has risen to 6.4 percent, slightly higher than 6 months ago.

Mortgages rolling off fixed rates are starting to reprice onto lower rates. The 1- and 2-year fixed mortgage rates have fallen to around 6 percent. This has occurred as the Monetary Policy Committee has reduced the Official Cash Rate (OCR) in response to the weaker economy. We expect the average mortgage rate to be around its peak now and to decline over the next year (figure 1.4).

Borrowers have preferred shorter-term fixed rates this year. As a result, more people will be able to roll onto lower mortgage rates sooner. We expect around 50 percent of mortgage lending to reprice within 6 months and around 75 percent within a year.

Debt-servicing costs will remain challenging for highly indebted households. Banks have reported to us that many highly indebted households have little incomes or savings buffers available. This makes them vulnerable to unanticipated costs or losses of income.

Unemployment is affecting more households and contributing to rising non-performing loans

Rising unemployment is starting to create acute financial difficulties for some households. In general, households tend to be able to manage high debt-servicing costs if their incomes are not affected. However, keeping up with mortgage repayments becomes much more difficult or impossible if borrowers lose their jobs.

Note: The average rate is calculated across all mortgage lending, including existing and new lending.

The unemployment rate increased to 4.6 percent in the September 2024 quarter. Our projection in the August Monetary Policy Statement has the unemployment rate rising to 5.4 percent in the March quarter of 2025 (figure 1.5). With debt-servicing costs generally remaining high for now, rising unemployment is likely to cause more borrowers to default on their mortgage payments over the next 6 months.

Figure 1.4 Mortgage rates

Source: interest.co.nz, RBNZ Income Statement survey

Figure 1.5 Unemployment rate

Source: Stats NZ, RBNZ estimates.

The non-performing share of mortgage lending has continued to pick-up from a low level (figure 1.6). It remains low compared with 2009 following the GFC.

Business conditions are challenging

Businesses are experiencing lower profitability. Weak demand and lingering cost pressures have made the trading environment difficult for firms. This is particularly the case in sectors where demand is more sensitive to interest rates. For example, insolvencies in construction, property development and some retail sectors have increased notably. This challenging environment is likely to continue in the near term.

Reduced profitability is affecting cash balances. Business deposits have declined relative to GDP over the past two years, from a strong position coming out of the pandemic. The decline is most notable for small- and medium-sized firms (figure 1.7). Businesses are also relying more on credit for working capital, for example by utilising their credit facilities with banks.

In August we released a special topic on commercial property in New Zealand.3 We highlighted the challenges for commercial property owners from high interest rates and increased working from home. Tenants preferring smaller but higher-quality offices has contributed to an increase in vacancies in lower-quality office buildings. Growth in online shopping and soft consumer spending have contributed to more vacancies in retail properties. However, stronger lending standards in prior years have helped to contain the impacts on banks.

Mortgage lending that is past due and non-performing (seasonally adjusted)

Source: RBNZ Bank Balance Sheet survey, private reporting, registered banks’ Disclosure Statements.

Note: Non-performing loans are those that are 90 or more days past due or impaired. An impaired mortgage refers to where the lender believes they will not receive all of the principal and interest repayments that have been contractually agreed with the borrower.

Business deposits by firm size (share of GDP)

Source: Stats NZ, RBNZ Bank Balance Sheet survey.

3 See Commercial Property in New Zealand - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz)

Figure 1.6

Figure 1.7

A recovery in export prices is helping farmers meet high costs

Sentiment in the agriculture sector has improved since mid-2023 owing to higher commodity prices (figure 1.8). Fonterra’s payout for the 2023/24 season was $7.83 per kilogram of milk solids, well above its forecast early in the season. Fonterra forecasts a $9.00 payout midpoint for the current 2024/25 season, which is above breakeven for most dairy farmers. Sheep farmers are facing challenging market conditions due to low sheep meat prices.

Farm operating expenses and debt-servicing costs have increased significantly over recent years. Farmers have adapted by cutting back their use of some inputs like feed and fertiliser. Many farmers have also been able to slow the pace at which they are paying down loan principal, having reduced their debts over previous years. As a result, the non-performing share of agriculture lending remains low.

The recent increase in commodity prices and the lower outlook for interest rates should help farmers over the coming year. However, a more severe global economic downturn, particularly in China, remains a risk for farmers.

Recent changes in government policy regarding emissions pricing will delay when the agriculture sector begins paying for its emissions. This additional time may provide the sector with an opportunity to reduce greenhouse gas emissions, for example through research into technological solutions. However, international pressure to price emissions remains significant.

Banks expect more of their lending to become non-performing

Weaker economic conditions and high debtservicing costs are resulting in more loan defaults. For both business and mortgage lending, the share that is non-performing has increased over the past 18 months.

However, the non-performing share remains low compared to previous recessions. Banks’ exposures to particularly weak sectors like construction and hospitality are relatively small. In addition, stronger lending standards

Figure 1.8

Meat and dairy export prices

(in New Zealand dollars, deflated by input costs)

Source: ANZ Commodity price index, Stats NZ, RBNZ estimates.

Note: We deflate prices with the input cost index for the agriculture sector from the Producers Price Index. We use the same deflator for both meat and dairy prices. The average level of the indices is standardised to 100 for the period since 2009.

Figure 1.9

Banks’ projections for non-performing loans by sector (share of lending by value in each sector)

Source: RBNZ estimates.

Note: The non-performing loan ratios are for the five largest banks (ANZ, ASB, BNZ, Kiwibank and Westpac). However, the ratio for businesses prior to 2016 is for the banking sector as a whole. The projections are weighted averages (based on lending amounts) of the five largest banks’ projections for their own lending. These are based on the economic outlook from our August 2024 Monetary Policy Statement.

since the GFC have reduced the riskiness of banks’ lending to traditionally cyclical sectors. Borrowers in the commercial property and agriculture sectors are in stronger financial positions than they were going into previous downturns.

Banks expect the non-performing share of their business lending to increase to levels similar to those in 2020. They expect the non-performing share of mortgage lending to increase a little further, peaking around the middle of 2025 (figure 1.9).

Banks are in a strong financial position to manage losses

Banks have built financial buffers that will help them maintain the supply of credit even if losses grow. They increased their provisions in 2023 when they anticipated an increase in non-performing loans. Strong profitability has also allowed banks to retain earnings and grow their capital positions (figure 1.10). Capital ratios are comfortably above our minimum requirements, even as those requirements increase (see Chapter 4).

Net interest margins remain high compared with the post-GFC period. Banks have benefited from an abundance of cheap deposit funding since the pandemic. Funding from deposits in transaction accounts became relatively cheaper as interest rates increased. This was because these accounts yield little or no interest, while contributing around a quarter of deposits. We have seen a further flow of deposits from these transaction accounts into term deposits. However, this trend has slowed recently as businesses prefer quickly-accessible funds in tough economic conditions.

Soft lending growth means banks have not needed to rely on more expensive forms of funding, like wholesale market funding. Bank contacts are confident that wholesale markets can meet future funding needs when credit growth recovers.

A reliance on overseas funding markets has been a vulnerability for the New Zealand banking sector. Many years of current account deficits led to an accumulation of foreign debt. It peaked as a share of GDP in 2009 and has trended down over the past 15 years (figure 1.11). Recent current account deficits have become sizable again. This could lead to an increase in foreign debt if they persist.

The introduction of core funding requirement since 2010 helps to mitigate this vulnerability. A large share of bank funding is from stable sources, such as long-term debt or deposits. Therefore, banks can step back from wholesale funding markets when conditions are unfavourable.

Bank capital ratios (share of risk-weighted assets)

Source: RBNZ Capital Adequacy survey, registered banks’ Disclosure Statements.

Net foreign liabilities (share of GDP)

Source: Stats NZ.

Figure 1.10

Figure 1.11

A severe recession remains the key risk to the New Zealand financial system

As part of our stress testing programme this year, we asked 13 banks to simulate the most plausible scenario that would cause them to breach capital requirements (see Special Topic 1). The aim of the exercise was to improve banks’ risk management by examining their vulnerabilities and the actions they could take in response.

The banks’ scenarios typically included a severe recession with extremely high unemployment rates and significant house price declines. The shocks that caused the recession included:

• geopolitical shocks and trade disruptions;

• seismic or volcanic events; and

• an outbreak of foot and mouth disease.

They also often included cyber incidents and climate-related events, such as floods and droughts.

Banks identified a broad range of mitigating actions to restore capital levels to above regulatory requirements. They also drew insights that will help them identify ways to better manage risks. For example, banks are becoming increasingly aware of the risks of declining insurance coverage on properties they lend towards.

Insurance premiums have continued to increase

In our May Financial Stability Report, we examined the reasons building insurance is becoming more expensive or unavailable in some locations. We noted this was a growing risk to households and businesses in those locations, and banks could also be exposed.

Since May, the trend towards greater riskbased pricing appears to have continued. For example, slightly more properties in floodprone areas have had premiums added to their insurance costs. There has not been any material change in the availability of online

Figure 1.12

Inflation rates for CPI insurance components (annual, CPI weights in brackets)

Source: Stats NZ.

quotes for dwelling insurance. Owners of houses in almost every suburb can get online quotes from more than one insurer.4 This means dwelling insurance cover is widely available.

Insurance premiums for consumers overall have increased further in the past six months for most types of insurance (figure 1.12). However, the outlook for insurance premiums has improved as cost pressures for insurers ease. Global reinsurers have benefited from fewer events with large claims costs in the past year, after several challenging years. Lower inflation in construction costs due to spare capacity in the sector will also ease pressure on dwelling insurance premiums.

The

CrowdStrike

outage highlights the importance of operational resilience

The outage caused by a failed update to the CrowdStrike security software in July temporarily disrupted banking and payment services in New Zealand. It highlighted the operational risks that come with increased digitalisation and reliance on common service providers. Robust systems and strong oversight are needed to manage these risks. We laid out how we are promoting cyber resilience in Box A of the May Financial Stability Report.

4 See https://www.treasury.govt.nz/sites/default/files/2024-07/insurance-data-collection-report-may24.pdf

Our work on implementing the Deposit Takers Act is continuing at pace

Implementing the Deposit Takers Act (DTA) is an important step to improve our approach to supporting financial stability in New Zealand (see Chapter 3). The DTA creates a single modern regulatory regime for banks and non-bank deposit takers, which is better aligned to global practice.

Our focus this year has been on developing policies for the prudential standards that deposit takers will need to adhere to from 2028.5 At the same time, we are progressing work on the Depositor Compensation Scheme (DCS), which is on track to commence in mid-2025. This will protect eligible depositors for up to $100,000 per institution if their deposit takers fail.

We support efforts to improve competition

Competition is a fundamental contributor to financial system efficiency, which ultimately supports broader economic prosperity and well-being. The Commerce Commission’s market study into personal banking services highlighted that customer inertia is a barrier to competition. Efforts to reduce barriers to switching banks and progress on open banking will assist in strengthening competition both among incumbent banks and from new entrants.

Elements of the DTA are likely to support competition, such as the DCS. The DTA also requires us to take into account competition in our decision making. We are enhancing our assessment of competition impacts to support this. We have also noted specific initiatives of ours that support competition in our submission to the Finance and Expenditure Committee inquiry into banking competition.6

Non-bank lenders and private capital funds remain small in New Zealand

As a special feature of this Report, we provide an overview of developments outside the traditional financing channels. Internationally, the share of business finance provided by non-bank lenders and private capital funds has increased since the GFC. Global regulators have raised concerns about the limited regulation of some sectors. For example, complex interlinkages with banks can lead to financial stability risks.7 We will continue to monitor global developments.

In New Zealand, non-bank lenders and private capital funds remain small and present little risk to financial stability. Further growth in this industry would be beneficial in promoting efficiency and competition. Access to multiple sources of financing would support business growth and potentially more stable access to credit (see Special Topic 3).

Within the sectors we regulate, non-bank deposit takers are a small but diverse sector. The financial performance of firms within the sector has been mixed over recent years. Firms in the sector have maintained capital above our requirements. However, scale has been an issue for smaller lenders, contributing to low levels of profitability. The number of credit unions has declined as entities have merged.

5 See https://www.rbnz.govt.nz/regulation-and-supervision/depositor-compensation-scheme/dta-dcs-timeline

6 See https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/publications/information-releases/2024/fec-submission---inquiry-intobanking-competition.pdf

7 See ‘Non-bank risks, financial stability and the role of private credit’, speech by Lee Foulger of the Bank of England, available at https:// www.bankofengland.co.uk/speech/2024/january/lee-foulger-keynote-address-at-the-dealcatalyst-afme-european-direct-lending

Box A Impacts of geopolitical risk on financial stability

Geopolitical risk refers to the potential for adverse events arising from international tension, such as trade restrictions, cyber attacks and conflicts. This box examines the potential impacts of geopolitical risk on financial stability in New Zealand. We also outline the actions we have taken to support financial system resilience to geopolitical risks.

In the past decade, geopolitical risk has featured more prominently in the risk assessment and surveys undertaken by financial regulators. Most banks identified geopolitical shocks as the biggest threat to their business

models in our 2024 Reverse Stress Test (see Special Topic 1 in Chapter 2). The Bank of England’s Systemic Risk Survey shows that geopolitical risk has been consistently perceived as a key risk. Quantitative measures of geopolitical risk have also increased sharply since 2022. This reflects Russia’s invasion of Ukraine, US-China tension and conflicts in the Middle East.

Transmission channels

Geopolitical shocks transmit to the financial system through two main channels (figure A.1). Shocks can affect trade flows and create economic uncertainty, which affect economic activity,

Transmission of geopolitical risk to financial stability

Geopolitical risk

Trade and uncertainty

• Market access

• Supply chains

• Commodity prices

Economy

• Economic activity

• Business costs

• Confidence

• Migration

• Unemployment

• Inflation

Financial institutions

• Lending rates

• Asset quality

• Market risk

Financial markets

• Funding cost

• Funding availability

• Asset price

• Exchange rate

• Global financial fragmentation

• Cyber risk

• Liquidity risk

business costs and employment. Shocks can also transmit through the financial market channel, influencing funding conditions and asset prices. The two channels may interact, increasing the impact on financial stability. For example, a decline in asset prices can magnify a simultaneous fall in household confidence and spending.

Trade and uncertainty are a transmission channel for geopolitical risks

Supply chain disruption and inflation

Heightened tension involving commodity-exporting countries or transit countries can push commodity prices higher. This could have pronounced impacts on small open economies like New Zealand. For example, Russia’s invasion of Ukraine resulted in higher and more volatile prices for crude oil, food, fertilisers and other commodities. Fixed-price contracts can mitigate the impact temporarily, but shocks might be persistent.

Geopolitical disruption to maritime trade routes would likely raise shipping costs, which would affect the price of imported goods. A significant share of our imports comes from the Asia-Pacific region, including for refined petroleum, machinery and vehicles. In more extreme cases of heightened physical risk to shipping, access to imports would be restricted.

Figure A.1

Supply chain disruption may lead to tighter monetary policy, for example through increases in the price of imported energy driving inflation. Debt-servicing cost of households and businesses could increase as a result, contributing to a challenging economic environment.

Reduced access to export markets and domestic demand

Geopolitical events could curtail New Zealand’s access to export markets. China is the largest export destination, accounting for 21 percent of export values in the year ended June 2024, followed by the US (17 percent) and Australia (16 percent). Southeast Asian countries collectively accounted for around 10 percent.8

Trade restrictions such as tariffs and import quotas can be used by countries for geopolitical purposes. If the relationship between New Zealand and our key trading partners deteriorates, market access could be restricted.

The more extreme scenario of a major conflict in the Asia-Pacific region involving one or more key trading partners would be highly disruptive for trade and investment. The effects would likely spill over to other trading partners, owing to the economic links between China, the US and other Asia-Pacific economies. For New Zealand, export disruption would have pronounced impacts on the agriculture, tourism and education sectors.

Geopolitical risks can affect domestic demand and worsen the economic outlook. If households become more cautious, they would reduce discretionary spending. If businesses perceive greater risks, they could reduce investment or hiring.

The impacts on migration depend on the nature of geopolitical shocks. Migration inflows are likely to be reduced by heightened tension, and may increase amid political instability overseas.

Geopolitical shocks can transmit through financial markets

Geopolitical risk can lead investors in wholesale funding markets to demand higher risk premiums. This would increase the costs of funding for governments and businesses. Severe shocks could lead investors to pull back altogether. This would reduce liquidity in funding markets, limiting banks’ ability to raise funds at reasonable costs. New Zealand banks source around a quarter of their funding from wholesale sources.

New Zealand equity and corporate bond markets are reliant on overseas investors. Heightened geopolitical risk incentivises investors to shift capital to safe assets, such as sovereign bonds. This dynamic could lead to sharp falls in riskier asset prices, such as equities. The effects of geopolitical shocks on real estate prices are less clear and remain a research area.

However, there could be an indirect drag on housing demand from lower household incomes and net migration. A decline in asset prices would lead to a loss of household wealth, reduced spending and weaker economic growth.

Commodity-based currencies like the New Zealand dollar tend to depreciate in response to risk aversion. This may lessen the impact on exporter incomes and asset prices associated with geopolitical shocks, but conversely may increase the costs of imported inputs. Banks tend to hedge their foreign currency borrowing, and therefore their debts do not rise when the New Zealand dollar weakens.9

Risk of global financial fragmentation

In the long term, financial markets may become more fragmented as investors reallocate capital away from countries that are less geopolitically aligned to their own. Governments may contribute to fragmentation by restricting cross-border investments and payments, or even seizing foreign assets. Geopolitical tension reduces the incentives and opportunities for international risk diversification by investors. Deglobalisation could gradually result in more concentrated investment linkages with fewer financial partners. Asset prices and funding conditions may become more volatile over time. This would reduce the resilience of the financial system to adverse shocks.

8 This group includes the 10 states in the Association of Southeast Asian Nations. Figure for China excludes Hong Kong.

9 Hargreaves and Watson (2011) argue that the free-floating New Zealand dollar and the mainly domestically denominated external debt will help to mitigate any disruption to external funding (see https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/publications/bulletins/2011/2011dec74-4hargreaveswatson.pdf).

Impacts

on the financial system vary across transmission channels and the severity of

the shocks

Effects on bank asset quality, funding conditions and insurers

A geopolitical shock to trade flows, domestic incomes and business expenses would flow through to the asset quality of lenders. Loan arrears would increase if economic activity slowed and unemployment rose, and mortgage borrowers struggled to service debt. In the case of a severe shock in the Asia-Pacific region, increased loan impairments would affect banks’ capacity to recover from an economic downturn. The supply of credit to the economy could be affected.

Shocks to financial markets would raise the costs of funding and increase market risks for financial institutions. Higher funding costs would likely increase borrowing costs for New Zealanders. Increased debt-servicing burden could put borrowers’ cashflow under pressure in a challenging economic environment. Under severe circumstances, banks’ access to funding could be restricted, hampering credit supply and increasing refinancing risks for borrowers. Volatility in asset prices, bond yields and exchange rates would increase the market risk faced by banks and insurers.

Geopolitical risk may also impact on insurance and reinsurance industries. For businesses in certain industries and regions, geopolitical shocks could affect their ability to operate. This could be through reduced incomes and possibly unfavourable impacts on the pricing and availability of some types of insurance cover.

Interaction between geopolitical tension and other emerging trends

Geopolitical tension is occurring alongside other emerging trends, such as climate change, advancement in artificial intelligence, and increasing social division. Geopolitical risk can coincide with other emerging risks to produce a cumulative financial stability impact. For example, geopolitical shocks can occur alongside climaterelated severe weather events and transition risks, putting the financial system under greater pressure.

Geopolitical factors may motivate cyber attacks from state actors, contributing to greater operational risk. The number of cyber attacks and associated losses have increased internationally over recent years.10 State actors may be incentivised to target financial institutions, due to the plentiful data they hold and the potential for economic disruption. Government entities, telecommunication and energy infrastructures are other sectors of vulnerability.

We have taken steps to mitigate the impacts of geopolitical risk

The International Monetary Fund (IMF) recommended policy responses to mitigate the impacts of geopolitical risk.11 Regulators should strengthen their oversight of geopolitical risks, by devoting resources to identifying, quantifying and strategising responses to prepare for geopolitical shocks. Regulators should also build adequate capital and liquidity buffers in financial institutions.

We have built up resilience in the New Zealand financial system

We have supported the financial system in building resilience, including to geopolitical risk. Our 2019 Capital Review committed to an increase in banks’ capital requirements. By 2028, the total capital ratio requirement will increase to 18 percent for domestic-systemically important banks, up from 13.5 percent currently. In part this reflects the fact that New Zealand is a small open economy that is exposed to global events. We also require banks to source a minimum proportion of their funding from stable sources. Banks must hold adequate liquid assets to meet expected outflows during liquidity stress. These regulations provide banks with enhanced buffers to absorb loan impairments, operational losses or liquidity pressure associated with geopolitical shocks.

10 Box A in the May 2024 Financial Stability Report discusses the growing concern posed by cyber risk for the financial system (see https://www.rbnz.govt.nz/-/ media/project/sites/rbnz/files/publications/financial-stability-reports/2024/may-2024/fsr-may-24.pdf).

11 See Chapter 3 of the IMF April 2023 Global Financial Stability Report, available at https://www.imf.org/en/Publications/GFSR/Issues/2023/04/11/globalfinancial-stability-report-april-2023

We are promoting cyber resilience in the financial system. We have included cyber scenarios in our regulatory stress tests of banks, and in the current General Insurance Industry Stress Test.12 We published cyber resilience guidance for financial institutions in 2021, and implemented reporting requirements for all cyber incidents by regulated entities starting in October 2024.

We are stepping up stress testing and the monitoring of geopolitical risks

Most banks identified geopolitical shocks as the biggest risk in our 2024 Reverse Stress Test. We are considering geopolitical risk scenarios for next year’s Industry Stress Test. Stress testing is aimed at building our and industry understanding of risks and the capability necessary to manage them. Discussions with banks suggest they are paying closer attention to geopolitical risks, and the impact they may have on their loan portfolios.

We also monitor and raise awareness of geopolitical risk through the Financial Stability Report, systemic risk frameworks and horizon scanning of risks.

12

Chapter 02 Special topics

Wellington. Photo: Charles Lilly

Chapter 2 . Special topics

This chapter covers topical issues relevant to financial stability in New Zealand.

In this Report, we cover the following:

1. Exploring vulnerabilities through reverse stress testing

2. Update on the housing market

3. Developments in financing channels outside the prudentially regulated sector

Selected special topics and boxes from the past 12 months

Topic Publication

Commercial property in New Zealand

Update on the financial strain faced by households and businesses

Insurance availability and risk-based pricing

Technology Risks and Cyber Resilience

An international perspective on the financial stability implications of higher interest rates

Developments in the agricultural sector

Trends in bank deposits through the period of monetary policy tightening

August 2024 Financial Stability Report Special topic

May 2024 Report (Chapter 2.1)

May 2024 Report (Chapter 2.2)

May 2024 Report (Box A)

November 2023 Report (Chapter 2.1)

November 2023 Report (Chapter 2.3)

November 2023 Report (Box C)

Exploring vulnerabilities through reverse stress testing

Stress testing assesses the resilience of banks and insurers to severe but plausible risks, including economic downturns. The results of stress tests help us monitor financial stability and inform our policy decisions. They also help entities manage risk, set capital and liquidity buffers, and improve recovery planning. In 2024 our solvency stress testing exercise for banks was a reverse stress test.

Some key insights from the 2024 Reverse Stress Test were:

• Several banks identified that a combination of events is most likely to cause a breach of capital minimums. The majority included some form of geopolitical event in their scenarios.

• A handful of critical factors drove large credit losses – unemployment and property prices being the most important.

• Banks are increasingly aware of the risks posed by changes or disruption in the insurance market.

• Banks highlighted the interaction between liquidity and solvency risks. Some banks modelled large increases in funding costs.

• Banks highlighted significant benefits from the exercise, e.g. insights for risk identification, modelling, governance and recovery planning.

What is a reverse stress test, and why do it?

The nature of this year’s exercise is very different to our traditional bank solvency stress test. In the traditional stress test, banks estimate the impacts of a common prescribed scenario featuring a severe recession on their balance sheets, profitability and capital ratios. For a reverse stress test, a specific capital outcome is set first. Banks then work in reverse to identify a plausible scenario that would result in that outcome, tailored to their businesses and vulnerabilities (figure 2.1).

In a reverse stress test, you design a scenario to achieve a target capital outcome

For the 2024 Reverse Stress Test, we asked banks to model a plausible scenario that would cause a breach in regulatory minimum capital ratios (CET1, Tier 1 and/or Total) within three years.13 These scenarios tend to be more severe and less probable than other stress scenarios. Banks then identified mitigating actions to improve their capital outcomes and triggers for when to act.

We last conducted a reverse stress test in 2016, with only the four largest banks participating in that exercise. For the 2024 Reverse Stress Test, 13 banks participated.14

13 In practice, other considerations in addition to plausibility factored into banks’ scenario design. For example, a given bank may have included a particular kind of risk in its scenario due to strategic interest; or to leverage related work that the bank had underway in that area; or because the bank had not explored that kind of risk in previous stress tests.

14 ANZ NZ, ASB, Bank of China (NZ), BNZ, China Construction Bank (NZ), Co-op, Heartland, Industrial and Commercial Bank of China (NZ), Kiwibank, Rabobank NZ, SBS, TSB, and Westpac.

Figure 2.1

What is a reverse stress test?

The purpose of a reverse stress test is to:

• assess triggers, feasibility and effectiveness of mitigating actions under stressful conditions;

• inform banks’ recovery planning;

• improve banks’ risk management capability by identifying risks to bank capital; and

• inform supervisors of major risks to regulated entities and feed that information into their risk assessments.

Banks designed bespoke scenarios for the 2024 Reverse Stress Test

How did the banks design their scenarios?

First, banks identified the types of shock that could have significant impacts on their profit and capital. They then built these shocks into a scenario with a consistent set of key economic variables. Banks typically had broad engagement across the organisation for this stage, for example with input from their board risk committees.

Once a bank settled on an initial scenario, they modelled the outcomes. They then iteratively adjusted the severity of the scenario until model results were broadly in line with those we prescribed.

The scenarios encompassed a wide range of risks

Banks found that designing a severe scenario required them to assume either: (i) a large shock with various adverse knock-on effects or (ii) a combination of shocks that may or may not be interrelated, with additive and compounding financial impacts.

Each bank designed a scenario with a severe economic downturn in New Zealand. The most common narrative for the cause of the recession was geopolitical in origin (table 2.1). Geopolitical shocks in the scenarios typically caused a global recession and some degree of financial crisis. These increased uncertainty and dampened consumer and investor sentiment. Some geopolitical scenarios involved a trade conflict with large effects on New Zealand’s exports, imports and exchange rates. Box A examines the impacts of geopolitical risk on financial stability in New Zealand.

Note: Each column represents one bank’s scenario. Some banks did not identify a particular shock that causes the

Table 2.1

In some geopolitical scenarios global supply chains were disrupted, leading to a resurgence of inflationary pressure and elevated interest rates. The elevated interest rates in a recessionary environment mainly added to banks’ modelled losses by increasing the difficulty borrowers had in servicing their debts. This raised the number of defaults.

In addition to geopolitical shocks, other primary shocks causing recessions in banks’ scenarios were:

• an earthquake on the Alpine Fault, preceded by a collapse of the global reinsurance industry;

• a volcanic eruption in the Auckland region, with insurance retreat;

• an outbreak of foot & mouth disease with severe impacts on farmers and the economy; and

• a pandemic, based on COVID-19 scenarios used in past stress tests.

In each case the shock directly affected particular groups of borrowers in addition to having broad economic effects. For example, in the volcanic eruption scenario, airport, port and highway closures impeded trade; tourists and students stayed away from New Zealand; businesses were disrupted; fiscal capacity was stretched; and properties were damaged, evacuated and/or became uninsured.

Apart from the primary shock that caused an economic downturn in each scenario, several banks included cyber incidents, climate-related events such as floods or droughts, and/or earthquakes. These added to the banks’ losses through credit risk and in many cases operational or reputational risk channels.15 They also provided insights for banks’ disaster recovery management and business continuity planning.

Several scenarios featured insurance retreat from properties exposed to climate-related events or seismic events. This reduced the value of affected properties, worsening banks’ losses on defaulted lending. Banks are paying greater attention to insurability in their credit risk modelling. This builds on the work that they did for our 2022 Flood Risk Assessment for Mortgages and 2023 Climate Stress Test.16 Our last Financial Stability Report featured a Special Topic on insurance availability and risk-based pricing.17

Additional scenario elements that worsened banks’ capital outcomes were:

• mass emigration from New Zealand, with feedback effects on the macroeconomy and house prices; and

• competitor entry compressing net interest margin, which worsened profitability.

Economic growth, unemployment, property prices and interest rates mattered most for driving the stress test results

The following variables typically mattered the most for driving up impairment expenses and risk-weighted assets, which had the largest effects on capital outcomes (figure 2.2):18

• GDP matters for business borrowers’ probability of default, and thus for banks’ impairment expenses and risk weights on business loans. Annual GDP generally declined by between 3 and 24 percent from start to trough.

• Unemployment mainly matters for the probability of default on residential mortgages. Peak unemployment rates ranged from 8 to 18 percent.

15 However, some banks assumed some relief from cyber insurance settlements in the event of a major cyber event.

16 See https://www.rbnz.govt.nz/hub/publications/bulletin/2023/rbb-2023-86-02 and https://www.rbnz.govt.nz/financial-stability/stresstesting-regulated-entities/climate-stress-test

17 See https://www.rbnz.govt.nz/hub/publications/financial-stability-report/2024/may-2024/fsr-may-24-special-topic-2

18 These compare in severity to our most severe bank solvency stress test scenario to date, our 2020 COVID-19 Very Severe Scenario. In that scenario, unemployment peaked at 17.7 percent, annual GDP declined by 18 percent from start to trough, and residential and commercial property prices fell by 48 percent. The reported ranges for bank scenarios are indicative, with some outliers dropped.

Figure 2.2

Economic variable severities in banks’ 2024 Reverse Stress Test scenarios

Residential property prices

Commercial property prices

Note: Each column represents one bank’s scenario, in the same order as in Table 2.1. Unemployment is peak level. GDP decline is start-to-trough change. Elevated OCR is the average extent to which the OCR exceeds 4 percent. Property price declines are start-to-trough changes in national indices, with adjustments for regional variation in some cases.

• Property price declines are key variables determining the loss that a bank incurs if a loan defaults. In the scenarios, residential property prices generally fell by 30 to 55 percent and commercial property prices by 40 to 70 percent. In some cases properties affected by natural disasters and/or insurance retreat had greater declines in value.

• Interest rates affect the serviceability of loans. Some banks assumed interest rates rising in response to higher inflation from supply shocks. Most had rates declining.

Scenarios affected bank capital through various channels

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:19

• The three-year cumulative loss rate on impaired loans was 4.7 percent on average across banks. This was caused by macroeconomic stress and the direct impacts of shocks on subsets of borrowers.

• Increases in risk-weighted assets, which rose 27 percent on average from start to peak, reflected worsening asset quality. An increase in risk-weighted assets lowers capital ratios for a given amount of capital the bank holds.20

• Net interest margin fell by 60 basis points on average and significantly more in some cases. This made banks less profitable and thus less able to increase capital through retained earnings. The largest changes in net interest margin were typically caused by events that affected given banks more than their competitors, e.g. reputational fallout from a major cyber incident.

19 For comparison, in our 2020 COVID-19 Very Severe Scenario the average four-year cumulative loss rate was 6.2 percent, and riskweighted assets increased by 28 percent on average (but only the five largest banks participated in the 2020 stress test, four of which use internal ratings based risk-weighting). Comparing net interest margin would not be informative because in 2020 we prescribed assumptions for this.

20 Regulatory capital ratios are calculated by dividing capital levels by risk-weighted assets.

Mild Severe

Not provided

These outcomes drove the large decline in the total capital ratio shown in figure 2.3. The size of the fall depended mainly on the bank’s initial capital buffer at the start of the stress test and the amount by which they breached regulatory minimums. This disparity in capital outcomes affected, in some cases, the selection of mitigating actions to improve the outcomes.

Banks identified a range of mitigating actions in response to the scenarios

Mitigating actions are an important part of the exercise given the severity of the scenarios. Banks identified a broad range of mitigating actions to restore capital levels above regulatory minimums. There were also actions on liquidity. Banks identified actions in the following categories:

• Capital: reduce dividends (if the bank is profitable and paying dividends in any of the scenario years); issue Tier 2 capital instruments if there is offshore demand.

• Credit risk: take actions to improve asset quality, reduce credit losses and/ or reduce risk-weighted assets by, for example:

• pausing, slowing or reallocating credit growth;

• tightening lending conditions and reducing credit limits;

• supporting customers;

• restructuring loans and engaging in mediation with distressed borrowers; and

• exercising caution in forced sales.

• Cost cutting, for example, reduce spending on marketing, travel, staff incentives and/or remuneration, projects/ investment, the use of mortgage brokers, and software licences.

• Re-pricing on deposits and lending, conditional on competitive conditions.

• Balance sheet management: optimise liabilities given changes in funding costs, for example by reducing the refinancing of wholesale funding, or improve liquidity position under adverse conditions, for example by raising institutional offshore term deposits.

The most material impacts on capital outcomes were targeted towards reducing credit risk and cost cutting. The mitigating actions were able to lift banks above regulatory minimums (figure 2.4), but well below requirements for prudential capital buffers. The latter would take several years of capital growth to reach.

Figure 2.4

Total capital ratio (average across banks)

Source: Bank submissions, RBNZ calculations.

Figure 2.3

Start-to-trough fall in total capital ratio (by bank)

Source: Bank submissions.

Insights and conclusions

The 2024 Reverse Stress Test challenged participating banks to think through plausible, existential threats to their businesses. These are likely to be combinations of a severe recession and subsidiary shocks such as major climate-related or cyber events.

It is worth noting that over the past five years New Zealand and the world have experienced several shocks (some modelled in this exercise) – a global pandemic, the two largest weather-related insurance events in New Zealand’s history, the war in Ukraine, high inflation and cyber attacks. None of these has had the extreme impacts on global economic and financial stability that could have eventuated. This is due in part to the fact that banks in New Zealand and globally are well capitalised by historical standards. However, these events highlight both the breadth and increasing likelihood of combinations of shocks being faced by the financial system.

The exercise also challenged banks to think through the actions they would take to mitigate and manage the risks under such an adverse scenario, while supporting their customers, and ultimately recover and continue to operate. This has informed banks’ recovery planning.

Banks have told us that the 2024 Reverse Stress Test was a worthwhile exercise. For some banks it was their first reverse stress test and for others the first in many years. Board members of some banks were very engaged in either identifying or reviewing the risks that threaten their business.

The scenarios that banks designed are helping to inform our own scenario planning. We are considering developing a geopolitical scenario for our 2025 Bank Solvency Stress Test.

We will be making recommendations to all the banks based on their submissions and our findings. We will follow up on these recommendations in future engagements with the banks.

Figure 2.5

Update on the housing market

New Zealand house prices have seen rapid growth and decline in recent years. After a run-up in prices and sales over the first two years of the pandemic, the market experienced broad-based price declines followed by a period of stabilisation. The drivers of this volatility were large changes in monetary policy (interest rates), government policy changes, population growth trends and new housing supply.

House prices and sales (seasonally adjusted)

Source: REINZ, Stats NZ, RBNZ estimates.

Note: Monthly turnover compares the monthly number of house sales to the total estimated dwelling stock in New Zealand.

House price-to-income ratios by region

(median house price as multiple of median household disposable income)

Houses and land account for most of New Zealand households’ wealth, and home loans make up over 60 percent of bank lending. The sustainability of house prices and the risk of correction therefore matter for financial stability.

When house prices are well above sustainable levels, this raises the risk of a sharp correction leading to significant losses on banks’ mortgage lending. A stable financial system is critical for long-term economic growth and the well-being of New Zealanders.

This special topic:

• provides an update on current conditions and the near-term outlook for the housing market;

• compares New Zealand’s recent house price cycle with house price cycles seen in other countries; and

• discusses how changes to housing supply and macroprudential policies are expected to affect house price cycles in the future.

Current developments in the housing market

Housing market activity remains subdued, with prices broadly flat nationally

Source: REINZ, Stats NZ, RBNZ estimates.

Activity in the housing market is weak but has picked up modestly over the past year. Sales volumes have recovered as prices have stabilised (figure 2.5). From their peak level in late 2021, prices have fallen an average of 14 percent nationally, although with significant regional variations. Auckland and Wellington prices fell 20 and 23 percent respectively, and have remained relatively flat over the past year. In contrast, prices in Canterbury experienced only modest declines, and have strengthened over the past 18 months. House price-to-income ratios have declined significantly from their peaks (figure 2.6).

Figure 2.6

New listings on the market have recovered to more typical levels. The stabilisation in prices has given those looking to move houses greater confidence to enter the market. Some owners facing debt-servicing stress may also be looking to downsize. With the volume of sales remaining subdued, inventories have built up in the market over the past year (figure 2.7). The average number of days to sell a property remains elevated.

High mortgage rates and lower population growth are limiting housing demand

Advertised mortgage rates have begun to decline over recent months, but they remain at relatively high levels. This is continuing to constrain the borrowing capacity of potential homebuyers. The test interest rates that lenders use to assess borrowers’ debt-servicing capacity have fallen, from an average of 9 percent in mid-2024 to around 8 percent in October (figure 2.8).

Banks typically apply a buffer above the average of the 1- or 2-year fixed mortgage rate, although there is some variation in methodologies. Banks generally review their test rates on a quarterly basis. However, given the rapidly changing interest rate environment, some banks reported that they will review their test rates more frequently. Borrowers’ capacity to take on more debt could increase quickly given further easing in monetary policy. With low overall lending growth, banks are facing competitive pressures to attract a limited pool of creditworthy borrowers.

The slowdown in New Zealand’s population growth due to falling net migration is also dampening housing demand. This is a reversal from the very strong levels of migration seen in 2022-2023, contributing to lower household formation. Growth in rents for new tenancies, which gives an indication of the near-term balance of demand and supply for housing services, has slowed sharply over the past six months (figure 2.9). This will also contribute to slowing consumer price inflation.

Source: RBNZ Credit Conditions survey, interest.co.nz.

Note: Test rate refers to the interest rate used by banks to assess a prospective borrower’s debt capacity and loan affordability. We survey bank test rates in our Credit Conditions survey during March and September.

Source: Stats NZ.

Figure 2.7

Source: realestate.co.nz, REINZ, RBNZ estimates.

Figure 2.8

Mortgage interest rates and test rates

Figure 2.9 Rental inflation

House prices remain stretched for prospective buyers, and are around the top of our estimate of sustainable levels

Despite house prices easing, the elevated interest rates mean that purchasing a new house remains relatively unfavourable compared with long-term averages. To assess the sustainability of house prices we consider the mortgage servicing costs for a new buyer, both relative to average household incomes, and relative to the alternative option (renting). These two indicators rose rapidly as house prices were peaking in late 2021, and they have remained at historically high levels (figure 2.10).

Overall, our metrics for house price sustainability suggest that current levels are around the top of the indicator range.21 This assessment is based on interest rates returning to neutral levels.

Investor activity remains weak, but may pick up following tax policy changes

Subdued rental inflation means that the expected yields on investment property also remain low compared with borrowing costs. Investors have been relatively inactive in recent years, commanding a low share of total new mortgage lending (figure 2.11).

Recent tax policy changes are favourable for investor demand. The deductibility of mortgage interest costs from taxable rental income will increase to 100 percent in April 2025, from 80 percent currently. Deductibility improves investors’ debtservicing capacity and will increase investors’ valuations of existing properties.22 Since July, the ‘bright-line’ period for assessing the taxable status of capital gains on investment property has been reduced to two years from 10 years.

Selected house price sustainability metrics

Source: REINZ, Stats NZ, RBNZ estimates.

Note: Mortgage-servicing costs are based on a purchase of the median-priced house with a 2-year fixed-rate loan, at an 80 percent loan-to-value ratio.

Figure 2.11

Share of new mortgage lending commitments by buyer purpose (share of lending by value, seasonally adjusted)

Source: RBNZ LVR new commitments survey.

This change could increase speculative housing purchases, at the margin. In the short term, the change means that investors facing cash flow pressures from high interest rates may seek to sell properties they had been holding on to, due to the previous longer bright-line periods that applied.

21 See https://www.rbnz.govt.nz/financial-stability/financial-stability-indicators

22 The interest limitation did not apply to purchases of new properties, i.e. interest was fully deductible for lending associated with new property purchase.

Figure 2.10

In the near term, new build houses will continue to come onto the market

The annual number of new dwelling consents has fallen from its high of 51,000 in 2022 to around 34,000 (figure 2.12). This remains substantially above the level that consents fell to following the Global Financial Crisis (GFC), and is closer to a level that the construction industry can deliver on a longterm basis. The pipeline for new public housing development by Kāinga Ora has also slowed over the past year, contributing to slowing consents.

The large pipeline of consents from recent years continues to convert into completed houses. Industry contacts reported a potential glut of new townhouses in Auckland in recent months, given currently weak demand. A material share of the current property listings in Auckland and Canterbury are new build properties (figure 2.13).

Risks to financial stability from residential development are contained Prudent lending standards by banks through the boom period mean that any surplus supply of new builds is unlikely to lead to material loan losses for them. Typically banks have required that the value of presales covers at least 100 percent of any borrowings. However, some non-bank lenders that provided additional financing, subordinated to the banks’ financing, may take some losses. Developers with unsold stock may also face equity losses if they are unable to achieve their desired prices.

Banks and industry contacts reported that presales of new builds have been weak. Buyers in the current market have the option of purchasing completed new builds, rather than committing to lengthy waits for developers to build off the plans. Banks have generally eased their presale requirements for high-quality developers who have established track records, to around 70 percent of borrowings. Banks want to maintain market share, and feel a competitive pressure to build back up their

Figure 2.12

Annual dwelling consents per 1000 working-age people

Source: Stats NZ.

New builds among property listings, by region (October 2024)

Source: Trademe.

lending portfolios as projects complete and existing loans are repaid. The Government has announced an underwriting initiative to support new developments given the weakness in presales.23

The slowdown in the development pipeline, combined with some financial stresses among developers, has seen many firms exit the industry. Although this is to be expected at the end of a development cycle, a large drop in industry capacity would impair supply responsiveness to future increases in demand.

23 See https://www.hud.govt.nz/our-work/residential-development-underwrite

Figure 2.13

An international perspective on the recent house price cycle

New Zealand’s recent house price cycle has been rapid compared to overseas examples, but with comparatively less financial system stress

Over the past five years New Zealand house prices have risen in real terms more rapidly, and declined more rapidly, than in many house price booms and busts in other advanced economies. This includes those associated with financial crises (figure 2.14).

Previous research has highlighted the link between boom-and-bust cycles in house prices and subsequent financial instability.24 This can arise through several channels, including:

• losses on direct housing loans, particularly for borrowers in negative equity;

• losses on lending for property development and construction, if there is an outsized supply response to high house prices; and

• the amplification effects that large swings in house prices can have on household balance sheets, consumption and broader economic activity, which affect banks’ commercial lending.

New Zealand’s financial system has been resilient to the recent house price cycle

Debt-servicing stresses are currently elevated and non-performing loans continue to climb. However, New Zealand has not yet seen the same widespread household balance sheet distress experienced in countries with similar house price boom-bust cycles. Several factors have mitigated the impacts of the recent house price cycle, including:

• The labour market has been relatively resilient as economic activity has slowed. This has supported household incomes, enabling borrowers to meet higher interest repayments without falling into arrears.

Figure 2.14

Real house price cycles in selected advanced economies

Quarters before / after peak

Source: BIS, RBNZ calculations.

Note: Nominal house prices are adjusted by the consumer price index or equivalent.

• The high inflation environment, including wage inflation, has eroded the real value of borrowers’ debts. This contrasts for example with Ireland in the GFC, where multiple years of deflation raised real debt burdens.

• Banks’ lending standards have meant borrowers have had financial buffers in place to handle shocks. Stringent testing of new borrowers’ servicing capacity has meant they have been able to absorb large increases in interest rates. Loan-tovalue ratio (LVR) requirements, including speed limits applied by the Reserve Bank, have meant that borrowers can absorb substantial price declines without falling into negative equity. We estimate that less than 2 percent of the current stock of lending is to borrowers in negative equity. In addition, as discussed above, banks’ stringent presale requirements have limited the extent of risky property development.

• House prices were at or near their peak level for only a brief period. This meant that a limited proportion of buyers from recent years purchased their properties at prices close to the peak. A prolonged period of purchases at unsustainable prices would have led to a larger accumulation of risk.

24 See for example Thornley (2016), Financial stability risks from housing market cycles, RBNZ Bulletin. https://www.rbnz.govt.nz/hub/ publications/bulletin/2016/rbb2016-79-12

Spain (Q3-07) Finland (Q1-89) Iceland (Q4-07) Ireland (Q1-07)

Japan (Q1-91)

United States (Q1-06) New Zealand (Q4-21)

Longer-term policy developments

Policy changes aim to improve long-term supply responsiveness

The Government has announced a package of policy measures that aim to improve housing supply responsiveness. Under the “Going for Housing Growth” programme, central government is working with local authorities to reform urban planning settings and infrastructure financing models, so that housing supply can be more responsive to demand.25

The Housing Technical Working Group – a joint initiative of the Treasury, the Ministry of Housing and Urban Development, and the Reserve Bank – was established to better understand the key drivers of the housing market. Its research has found that restrictions on land supply responsiveness have meant that declines in long-term interest rates over recent decades have resulted in higher house prices.26 With greater supply responsiveness, this trend in interest rates would instead have stimulated the construction of new houses and put downward pressure on rents.

The first phase of the Government’s programme will require councils to:

• amend their planning rules to allow for 30 years’ worth of feasible housing capacity;

• increase allowed intensification along strategic transport corridors; and

• remove urban-rural boundary lines to enable greenfield growth.

The Medium Density Residential Standards (MDRS), another planning instrument mandated by central government in 2022, aims to allow for greater densification of existing urban areas by removing resource consenting requirements. The MDRS will become optional for councils under the Government’s changes. Several councils have already adopted MDRS in their planning rules. Councils that have yet to adopt it, or that want to remove it from their rules, will be able to opt out only if they

can demonstrate they will meet the 30-year capacity target in alternative ways (e.g. through greenfield development).

Phase two of the programme will look at constraints on infrastructure provision, including financing models. Having infrastructure in place means that the supply capacity enabled by planning changes can be realised in practice.

The details of these policy changes will take some time to develop, and it may be several years before they take full effect in councils’ planning rules. While the programme is unlikely to impact housing supply in the near term, if successful it will help to moderate the extent to which future shifts in demand, such as from interest rates, contribute to house price cycles.

Debt-to-income restrictions will help to moderate demand cycles and the build-up of risk

In July 2024 we activated limits on banks’ high debt-to-income (DTI) mortgage lending.27 Under the rules, banks can lend no more than:

• 20 percent of new owner-occupier lending to borrowers with DTI ratios greater than 6, and

• 20 percent of new investor lending to borrowers with DTI ratios greater than 7.

Banks already undertake affordability assessments of borrowers using calculations that account for individual circumstances. This includes borrowers’ expenses and their different forms of income, which are not easily captured in a simple metric such as the DTI ratio. DTI ratios perform better at capturing risks to loan servicing at an aggregate level.

In addition, DTI limits will act as guardrails on banks’ lending without needing the Reserve Bank to regularly adjust the limits. If interest rates decline, borrowers’ DTIs are likely to trend up, and the policy setting will effectively become tighter. This provides an offset against the potential build-up of financial stability risks.

25 See https://www.hud.govt.nz/our-work/going-for-housing-growth-programme.

26 See https://www.treasury.govt.nz/publications/jp/assessment-housing-system-insights-hamilton-waikato-area and https://www.treasury.govt. nz/publications/jp/what-drives-rents-new-zealand-national-and-regional-analysis

27 See https://www.rbnz.govt.nz/hub/news/2024/05/reserve-bank-activates-debt-to-income-restrictions

Developments in financing channels outside the prudentially regulated sector

Key points

• Lessons from the Global Financial Crisis (GFC) led to a significant tightening in global banking regulation. This has supported a greater role for non-bank lenders and private capital (equity and credit) funds in providing financing internationally.

• At the same time, the number of companies that source finance by listing on public equity markets has declined in many countries, including New Zealand.

• Private capital markets provide benefits through broadening access to capital and enhancing competition and efficiency in funding markets. They also diversify the sources of credit available in the economy.

• While private capital provides benefits, overseas regulators have highlighted some potential financial stability risks, including the low transparency of their activities and the complex lending exposures they create for the banking system.

• In New Zealand, financial stability risks from the private capital sector are still low, due to its small size and limited exposure of the banking sector.

• We will continue to monitor global developments in the private capital sector and the potential risks to financial stability in New Zealand.

Financing channels for households and businesses

In this special topic we discuss trends in the three main channels of financing: traditional intermediation, public capital markets and private capital financing. In particular we discuss the financial stability implications of the global growth of private capital financing.

Alternative financing sources are sometimes called a ‘spare tyre’ for borrowers for when bank lending is unavailable.28

Most financing is done through traditional intermediaries such as banks and non-bank lenders. Large businesses may also obtain financing from public capital markets for equity or debt finance. Smaller firms are less able to access financing from public markets, partly due to high compliance costs. Private capital financing, from private equity and private credit funds, is a more limited source of finance available for some firms.29

28 The former Chair of the Federal Reserve System, Alan Greenspan, introduced the concept of capital markets as a ‘spare tyre’ for when the flow of bank lending is disrupted. https://www.federalreserve.gov/boarddocs/speeches/1999/19991019.htm

29 Two additional channels are peer-to-peer (P2P) lending and crowdfunding, although their contributions to household and business financing in New Zealand are very small.

Financing channels for households and businesses

Takers (banks and non-bank deposit takers)

Provide funding to:

• Households

• All businesses

• Households

• Small and mediumsized firms

• Growing mediumsized firms

• Corporates

• Corporates

• Small growing firms (venture capital)

• Mature firms (buyouts)

• Mediumsized firms

Prudentially regulated by the RBNZ Not prudentially regulated by the RBNZ

Source: RBNZ.

Traditional intermediary-based financing

Banks provide the vast majority of lending to households and businesses in New Zealand (figure 2.16). Their share of lending has been broadly stable over the past decade. Nonbank lending contributes around 3 percent of total bank and non-bank lending. This share is much smaller than in many other advanced economies. Internationally, the share of lending provided by non-banks has grown rapidly in the past 15 years.30

The non-bank sector competes with banks for some loan products, and in some cases provides loans to borrowers unable to obtain bank loans. Non-banks often have more flexibility to provide bespoke lending arrangements for borrowers. They may be more willing to provide loans to borrowers with adverse credit histories or with more complex financial situations than typical borrowers.

Non-bank lenders in New Zealand are either deposit takers or non-deposit takers:

• Deposit takers are finance companies, credit unions and building societies. Their share of total lending is very small.

• Non-deposit takers are funded by a variety of other sources. Some nondeposit takers are funded by securitising loans. Others use equity funding, bond issuance, or are structured as managed funds.

30 See https://www.fsb.org/2023/12/global-monitoring-report-on-non-bank-financial-intermediation-2023/

Figure 2.15

Figure 2.16

Bank and non-bank share of total lending (as at June 2024)

We are the prudential regulator for banks and non-bank deposit takers. Under the Deposit Takers Act 2023, both will be brought under a single regulatory regime. We do not regulate non-bank lenders that are not deposit takers.31 Financial stability risks from non-deposit taking lenders are low, because:

• their share of lending is small;

• the exposure of banks to non-deposit taking lenders is relatively low; and

• households have little direct exposure to non-deposit taking lenders.

Public capital market financing

In advanced economies, businesses wanting to expand their activities beyond what is possible with bank funding can raise equity (shares) or debt funding through public capital markets. Investors in these markets are generally willing to take on more risk than banks. However, the number of companies financing their growth by listing on public exchanges has declined in many countries, including New Zealand, over the past decade.

New Zealand’s capital markets are smaller than those in many other countries relative to the size of the economy (figure 2.17). There have been several studies of the reasons for this and possible solutions. The most recent report was Growing New Zealand’s Capital Markets 2029, published in 2019.32

Public equity markets

In many countries, the number of companies listed on public exchanges has declined in recent years (figure 2.18). Fewer new companies have chosen to list on public exchanges and some have delisted.33 There are many factors driving this trend, including the upfront and ongoing costs of public listings, the movement of listed companies from smaller to larger and

Equity market capitalisation of listed domestic companies (share of annual GDP in 2022)

Number of listed companies on public exchanges (indexed)

Source: World Federation of Exchanges, RBNZ calculations.

more liquid markets, strategic decisions by firms regarding ownership and control, and increased access to private capital financing.34

Declines in company listings can reduce overall market liquidity, increasing the cost of equity capital, which reduces the incentive to list.

31 Although non-deposit taking lenders are not prudentially regulated by the Reserve Bank, their conduct in how they treat customers is regulated by the Financial Markets Authority (FMA). For further details on the non-deposit taking sector, see Box D, https://www.rbnz.govt. nz/-/media/project/sites/rbnz/files/publications/financial-stability-reports/2022/nov-2022/fsr-nov-22.pdf

32 See https://www.fma.govt.nz/assets/Reports/Growing-New-Zealands-Capital-Markets-2029.pdf

33 See for example https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/uk-s-ipo-slump-hits-10-yearlow-exposing-structural-weakness-of-equity-market-79712352

34 See https://www.weforum.org/agenda/2024/04/equities-stock-market-health-investing/

Figure 2.17

Source: World Bank.

Figure 2.18

In New Zealand, no new companies have been listed on the NZX through initial public offering (IPO) since 2022, although listed companies have raised new equity capital. During the first nine months of 2024, NZX-listed companies raised around $4.6 billion in additional equity.

Public debt markets

The market for New Zealand public corporate debt is relatively small. Fewer than 50 corporates have debt securities listed on the NZX Debt Market.35 Issuers are concentrated in the banking, property and energy sectors. Central government and local government debt products are also listed on the market. The issuance of New Zealand government bonds has increased sharply since 2020.

Market participants have said that liquidity in local debt markets is volatile and is strongly influenced by changes in demand for bonds from international investors. The share of New Zealand government bonds held by overseas investors has increased in recent years (figure 2.19). This may increase the market’s vulnerability to swings in sentiment.

Private capital financing

Tighter banking regulation and lower risk appetites among lenders after the GFC reduced the availability of bank credit, increasing lending opportunities for nonbank providers. This contributed to the growth of financing by non-bank financial intermediaries, including pension funds, hedge funds, sovereign wealth funds, money market funds and private capital funds. Around half of total global financial assets are now held by non-bank financial intermediaries.36

Government debt securities held by non-residents (share of outstanding issuance)

Source: RBNZ.

Note: The total includes nominal bonds, inflation indexed bonds and treasury bills that are available for trading in the secondary market. Securities held by the Reserve Bank and the Natural Hazards Commission Toka Tū Ake (formerly EQC) are excluded.

Private capital refers to equity or debt financing for businesses that is not provided through public exchanges or banks. Private equity and private credit markets have grown rapidly in recent years internationally. The global private equity industry now has around US$8.2 trillion in assets under management. The global private credit market grew to around US$2.1 trillion in 2023.37 For comparison, total domestic bank credit to non-financial sector borrowers was around US$91 trillion.38

Private capital can increase financial system efficiency by providing financing to small growing companies that are unable to access bank finance. In some cases, private equity investors can also bring management expertise to the companies in which they invest. Private credit investors can structure loans more flexibly than banks to meet the needs of borrowers.

35 See https://www.nzx.com/markets/NZDX

36 See https://www.fsb.org/2023/12/global-monitoring-report-on-non-bank-financial-intermediation-2023/

37 See https://www.imf.org/-/media/Files/Publications/GFSR/2024/April/English/ch2.ashx

38 See https://data.bis.org/topics/TOTAL_CREDIT

Figure 2.19

Private equity

Private equity funds invest in companies that are not listed on public equity markets, or buy shares of publicly listed companies. The most common private equity investment strategies are:

• Venture capital – buying a share in startup companies that need equity finance to grow;

• Growth / mid-market equity – buying a share in companies that are more mature than start-ups that need capital to expand; and

• Buyout – buying a well-established but usually underperforming company, and restructuring it to improve performance before selling the company.

There has been a general upward trend in private equity transactions in New Zealand in recent years (figure 2.20). However, market contacts have reported that the development of private equity has been slower than in many other advanced economies. Private equity transactions (investments and divestments) declined in many countries, including New Zealand, during 2023 as a result of high interest rates and financial market volatility. Over the past decade, the cumulative amount invested was around $13.6 billion. Most transactions were for buyouts and growth equity. In comparison, the total bank loans outstanding to all businesses are around $125 billion, with $33 billion in new lending flows during 2023.

Private credit

Private credit funds typically provide loans to mid-sized companies that are too risky for banks and too small to get funding from public debt markets.39 Data on the size of private credit investments in New Zealand are limited.

Private credit firms have some similarities to the traditional non-bank non-deposit taking sector discussed earlier, but they also differ in some aspects. Many private credit firms operating in New Zealand are overseasbased entities. Also, private credit firms often rely more on funding from large institutional investors.

Market participants have suggested that the private credit market in New Zealand is smaller than the private equity market.40 In some cases, private credit funds compete with banks for lending. At other times, they lend jointly with banks through syndicated lending to corporate borrowers.

Financial stability risks in New Zealand from private capital are currently low

As private capital funds have grown globally and become more interconnected with the wider financial system, several overseas regulators have raised concerns about their potential financial stability risks.41 Private capital funds and unlisted companies are subject to less stringent reporting requirements than publicly listed companies and regulated lenders.

39 A corporate may want to borrow more than a bank’s credit limit for a single customer. In this case, the loan could be provided by a syndicate of banks and private credit lenders.

40 For estimates of the scale of the private credit market in Australia, see https://www.rba.gov.au/publications/bulletin/2024/oct/growth-inglobal-private-credit.html

41 See for example https://www.bankofengland.co.uk/prudential-regulation/letter/2024/private-equity-related-financing-activities and https://www.ecb.europa.eu/press/financial-stability-publications/fsr/special/html/ecb.fsrart202405_03~bc23a48dbc.en.html

Figure 2.20

Private equity transactions in New Zealand

Source: EY Private Capital Monitor (multiple editions).

This makes it harder to assess their financial performance and evaluate financial stability risks. In many countries, lending from private capital has become increasingly complex.

Banks sometimes lend to both private equity funds and companies in their portfolios, creating multiple layers of lending (‘leverage on leverage’) that can make it hard to monitor the overall risk to the bank. In some cases, overseas banks are unable to measure their overall exposure to the private equity sector. International private capital funds operating in New Zealand may pull back their supply of financing if economic conditions become stressed. Finally, under stressed conditions private capital funds may face liquidity pressures and be unable to repay bank loans. So far, the resilience of private capital funds to stressed financial conditions has not been tested to a large extent.

In contrast to some other jurisdictions, financial stability risks from private capital in New Zealand are currently limited. Private equity and private credit markets are at an earlier stage of development than in other countries and the scale of investments is low. In addition, banks in New Zealand have a simple business model for transacting with the private capital industry. New Zealand banks lend primarily to companies invested in by private equity or private credit funds but have little direct exposure to the funds. This reduces the risk of ‘leverage on leverage’ highlighted by UK and euro area regulators.

Banks need to hold capital against lending based on the risk of that lending. This is reflected in their risk weights. Lending to private capital funds should reflect the underlying risk of the assets in which the fund invests. While lending to private capital funds is not currently common in New Zealand, banks’ risk assessments should consider the overall level of leverage involved.42

In New Zealand, households’ investments in private capital are still limited. Most private capital investments are restricted to institutional investors and wholesale investors. So far there has been very limited investment in private capital by KiwiSaver funds compared to investments by Australian superannuation funds. The limited investment so far may partly reflect that the KiwiSaver industry is in an earlier development phase compared to the Australian market.

Private capital will bring benefits for New Zealand, as well as risks

Having multiple sources of financing available provides a range of funding options for borrowers, increasing competition for bank lending. It can also support more stable access to credit, reducing the impacts of negative economic shocks. Most financing is done through traditional intermediaries such as banks and non-bank lenders. Large businesses may also obtain financing from public capital markets for equity or debt finance. Smaller firms are less able to access financing from public markets, partly due to high compliance costs. In recent years, firms have had increasing albeit still limited access to private capital financing from private equity and private credit funds. We expect the private capital markets to grow over time in New Zealand.

Overseas regulators have highlighted financial stability risks from the rising role of private equity and private credit markets. In New Zealand, the financial stability risks of private capital funds are still limited, given the funds’ small size and the conservative lending practices by banks to these investment funds. As the private capital industry grows, we will continue to engage with market participants and to monitor global and domestic developments in the sector and the growth of potential risks.

42 For further details on how risk weighting impacts bank lending, see https://www.rbnz.govt.nz/hub/publications/bulletin/2024/how-riskweights-affect-bank-lending

Chapter 03 Regulatory developments

Sylvia Park, Auckland. Photo: Charles Lilly

Chapter 3 . Regulatory developments

Our work on implementing the Deposit Takers Act 2023 (DTA) is continuing at pace. This will ultimately strengthen New Zealand’s financial system. Meanwhile, we continue to deliver prudential functions through ongoing regulatory stewardship, supervision and enforcement activity.

This chapter provides an update on recent policy and supervisory developments in the deposit-taking and insurance sectors

Activation of debt-to-income restrictions

We activated debt-to-income (DTI) restrictions for residential mortgage lending on 1 July 2024.43 These restrictions are designed to reduce the probability of widespread defaults by targeting the ability of borrowers to repay debt. DTI restrictions complement the loan-tovalue ratio (LVR) restrictions that have applied to banks’ residential mortgage lending since 2013. LVR restrictions seek to reduce the losses incurred when households default on their mortgages. Both act to reduce the buildup of high-risk lending in the system.

We will review the settings of the DTI and LVR policies around the middle of 2025, and then annually after that. We are consulting on proposals to incorporate the DTI and LVR policies into a new Lending Standard that will be issued under the DTA.

Crisis management and depositor protection

Crisis Management Framework

The disorderly failure of a deposit taker can have wide-ranging and long-term negative impacts on consumers and businesses, the financial system and the broader economy.

The DTA establishes a new framework for crisis management and designates us as the resolution authority for distressed deposit takers.

In August 2024, we published an issues paper that sets out our initial policy direction for operationalising the framework,44 including:

• the tools available for different resolution strategies, including Open Bank Resolution (OBR), sale of business and orderly wind down;

• the potential role of bail-in tools to recapitalise a failed deposit taker using funds from its creditors; and

• the potential introduction of new crisis preparedness requirements relating to recovery and exit planning, and to resolvability.

The issues paper is the first of several stages that seek external feedback on the new standards, plans and statements needed to fully implement the new framework. Any new crisis management requirements would be additional to our existing policies on pre-OBR and outsourcing, which are being updated and converted to standards under the DTA. The DTA also requires us to prepare resolution plans for each deposit taker and publish a Statement of Approach to Resolution. The crisis management provisions in the DTA are currently expected to come into force in the middle of 2028.

43 For further information, see https://www.rbnz.govt.nz/hub/news/2024/05/reserve-bank-activates-debt-to-income-restrictions

44 See https://consultations.rbnz.govt.nz/dta-and-dcs/crisis-management-under-the-deposit-takers-act/user_uploads/crisis-managementissues-paper-august-2024.pdf

Depositor Compensation Scheme on track to commence in the middle of 2025

The Depositor Compensation Scheme (DCS) is another tool under the DTA to reduce the risk of deposit taker failure and mitigate financial stability impacts. The DCS will commence in the middle of 2025, promoting resilience in our financial system. It will protect eligible depositors for up to $100,000 per depositor, per institution if their deposit takers fail. The DCS will be funded by levies on deposit takers.

Earlier this year, we consulted on policy proposals for regulations to implement the DCS. We anticipate the regulations will be made by the end of the year. This would give deposit takers six months to make any changes necessary before the DCS commences.

We are developing our own capability to operate the DCS, including the ability to make a DCS payout if necessary. We are on track to meet the mid-2025 start date. We have developed a trademarked logo to help depositors identify the products that are protected.

Review of the Interim Solvency Standard for insurers

Solvency standards impose minimum capital requirements on insurers. The purpose of these requirements is to support financial stability by increasing the likelihood of insurers being able to meet their obligations to policyholders and remain solvent. This means New Zealanders can continue to rely on the insurance industry to manage risks effectively.

We are reviewing the solvency standards in two stages. Stage 1 addressed structural changes and the introduction of a new accounting standard, the NZ IFRS 17. This stage resulted in the introduction of the Interim Solvency Standard 2023 (ISS). Following stakeholder feedback and an external review, and subject to approval by

the Reserve Bank Board, we plan to publish an amendment to the ISS by the middle of December. The amendment will be effective for all insurers from 1 March 2025. The second amendment does not introduce new policy or require an increase in capital requirements beyond what was intended when the ISS was first issued. Instead, this amendment aims to restore the original policy intent of the ISS.

Stage 2 of the review will result in a permanent standard. It will be a multi-year process. We intend to engage with industry next year to learn lessons from Stage 1 for how we run Stage 2.

Capital review implementation for banks

Minimum capital requirements increased for all registered banks on 1 July 2024. This increased the regulatory minimum Tier 1 capital ratio from 6 to 7 percent, and the minimum total capital ratio from 8 to 9 percent. This was the scheduled increase resulting from the 2019 Capital Review decisions. Additional Prudential Capital Buffers (PCB) for domestic-systemically important banks (D-SIBs) were also introduced, increasing the total capital ratio requirement for these firms to 13.5 percent. Other banks need a total capital ratio of 11.5 percent. Further PCB increases are scheduled for each July until 2028. At that point, the total minimum plus PCB will be 18 percent for D-SIBs and 16 percent for other banks.

In June 2024 we updated the Order in Council for locally incorporated banks. The new version incorporates dual reporting for banks that use their own internal ratingsbased (IRB) models to calculate capital requirements for credit risk. They will be required to publish what their capital ratio would be if they used the approach of nonIRB banks in their six-monthly disclosure statements. This will provide greater transparency on any differences between IRB modelling and standard risk weights.

Competition

Subject to its legislative purpose of promoting financial stability, the DTA requires us to take into account a number of principles, including competition. The DTA also introduces the DCS, which is inherently likely to support competition. This principle is already influencing our work. We have developed a proportionality framework that will influence how we design standards for deposit takers.

We have outlined specific initiatives that are likely to support competition in our submission to the Finance and Expenditure Committee inquiry into banking competition.45 For example, our proposed capital settings include lower minimums for smaller firms.

In recent years, our standardised floor has made sure that the largest banks get only limited reductions in required capital from IRB modelling. We intend to review elements of the standardised approach to risk weighting to ensure that it accurately reflects risk. We are also enhancing our assessment of competition impacts more generally to feed into our decision making.

The Future of Money work aims to enhance competition and innovation. Recently, we consulted on digital cash, and in October we published a revised access policy consultation paper for the Exchange Settlement Account System.

Restriction on the use of the term ‘bank’

The Commerce Commission recommended that we place greater emphasis on competition in upcoming decisions, including permitting more entities to be ‘banks’.

The DTA permits us to authorise entities to use restricted words like ‘bank’ and ‘banker’ in a name or title. Currently non-bank deposit takers (NBDTs) are not permitted to use ‘bank’. We are considering whether all deposit takers, or a subset, may use these

restricted words. This will be reflected in a new Statement of Prudential Policy published next year, including any relative benefits to competition.

Standards under the Deposit Takers Act

We are progressing the prudential standards that will operationalise the new regulatory regime for all deposit takers under the DTA. These standards are rules that will apply to deposit takers from 2028.

One of the major drivers for the DTA was the International Monetary Fund (IMF) review of New Zealand’s financial sector regulatory framework. This was carried out in 2016 under the IMF’s Financial Sector Assessment Programme. The IMF found that, relative to international standards, our approach to supervising banks was light-handed, and our rulebook for banking had significant gaps.

The DTA directly addresses most of the relevant recommendations from the IMF. Another IMF review of our regulatory framework is scheduled for 2027/28. Our approach to banking supervision relies on three pillars. Historically we put most emphasis on the market discipline and self-discipline pillars. The DTA will put more weight on the regulatory discipline pillar –specifically prudential standards.

Consultation on the core standards (those standards on which deposit takers will be relicensed under the DTA) closed in August 2024.46 Consultation on the noncore standards is currently under way.47 We will be consulting on exposure drafts of all the standards in 2025 and 2026, ahead of issuing the standards in 2027.

45 See https://www.rbnz.govt.nz/hub/news/2024/09/rbnz-releases-banking-competition-select-committee-submission

46 See https://consultations.rbnz.govt.nz/dta-and-dcs/deposit-takers-core-standards/consult_view/

47 See https://consultations.rbnz.govt.nz/prudential-policy/deposit-takers-non-core-standards/consult_view/

Figure 3.1:

Proposed deposit taker standards

Financial resilience

• Capital

• Liquidity

+ Lending Governance and risk management

+ Risk management

+ Governance

+ Operational resilience

+ Related party exposure

• Core Standards + Non-core Standards

Supervision and enforcement

Anti-money laundering (AML) and countering financing of terrorism (CFT)

We are working with other agencies across the AML/CFT system to prepare for New Zealand’s next global assessment against international standards in 2028/29.

Consistent with that focus, we are continuing our more intensive AML/CFT supervisory approach through our on-site inspection programme. Our first full cycle of extended inspections (2 weeks on site) of all the largest deposit takers is expected to be

Table 3.1

Market discipline and reporting

• Disclosure

• Depositor Compensation Scheme (DCS)

Crisis management

+ Crisis management and resolution (including OBR)

+ Outsourcing

Restrictions

+ Restricted activities

+ Branches

Commencement dates for cyber reporting Reporting

Cyber material incident reporting

completed by the end of this year. This has been invaluable in identifying trends in AML/CFT compliance (including risks and opportunities) across New Zealand’s highest-risk sector.

Cyber reporting

We are continuing the implementation of our three cyber resilience reporting requirements being phased in over 2024 (table 3.1). These requirements enable closer monitoring of operational resilience in the sector and will form part of our ongoing engagement with regulated entities on this topic.

8 April 2024 Ongoing

Cyber periodic incident reporting 1 October 2024 (start of data collection)

30 April 2025 for large entities for the period from 1 October 2024 to 31 March 2025 (and every 6 months thereafter)

30 October 2025 for all other entities for the period from 1 October 2024 to 30 September 2025 (and annually thereafter)

Submissions are due 30 days after the end of the reporting period

To collect information during a material cyber incident

To collect information during a material cyber incident

Cyber periodic capability survey

1 October 2024

1 October 2024 (and annually thereafter for large entities; biennially thereafter for all other entities)

To collect selfassessments against our Guidance on Cyber Resilience

Thematic Review

We have progressed work on a thematic review of financial inclusion practices in the deposit-taking sector. The aim is to build our understanding of the financial inclusion landscape to feed into policy considerations and other Reserve Bank workstreams, and to identify and share good practice across the sector. We plan to publish our findings in early December 2024.

Stress testing

In addition to the reverse stress test and annual liquidity stress tests noted in this Report (see Special Topic 1 and Chapter 4), work has continued on the solvency stress test with general insurers based on seismic and cyber scenarios. We plan to publish aggregate results across participating entities in Q1 2025.

Cross-border supervisory cooperation

Effective home country supervision of crossborder banking and insurance activities is important. This is emphasised by both the Basel Core Principles (BCPs) on Banking Supervision and the International Association of Insurance Supervisors’ (IAIS) Insurance Core Principles (ICPs). Home country supervision is complemented by cooperation with host country supervisors. This model aims to ensure comprehensive oversight without unnecessary regulatory burden.

The BCPs and ICPs require home supervisors to establish institution-specific supervisory colleges for groups with material crossborder exposures. Host supervisors who oversee subsidiares or branches also attend the colleges. This brings together regulators from different jurisdictions and facilitates cooperation.

Challenges remain around aligning national interests with global financial stability goals. Establishing Memorandums of Understanding (MoUs) with other supervisory bodies can facilitate cooperation and information exchange. We are a signatory to several MoUs with other supervisors and government agencies.

Since May 2024, we have engaged in crossborder supervisory meetings and colleges for 13 financial institutions. A further four are planned for November 2024.

The most frequent cross-border cooperation was with the Australian Prudential Regulation Authority (APRA) as the Australian home supervisor. We attended six APRA-hosted colleges across banking and insurance. The colleges raised our awareness of group strategy, key and emerging risks and APRA’s approach to group supervision. The colleges also strengthened relationships and our ability to coordinate effective supervisory activities.

We are the home country supervisor for one international banking group. This follows the recent acquisition of an Australian bank by a New Zealand registered bank. Our approach to group supervision is evolving and includes regular meetings and information sharing with the host supervisor, APRA.

We also regularly engage in global and regional supervision groups. Recent examples have included the annual Pacific Financial Technical Assistance Centre (PFTAC) meeting in August 2024. The PFTAC’s objective is to promote financial stability, and provide technical assistance and training to Pacific supervisors. Also in August, we attended the Executives’ Meeting of East-Asia and Pacific Central Banks (EMEAP) Working Group on Banking Supervision. The focus of this meeting was on regional financial stability and regulatory developments.

We are a member of the IAIS, the global standard-setting body for insurance supervision. The IAIS helps to ensure that members take an effective and consistent approach to insurance supervision.

Institutional resilience

Redwood Forest, Rotorua. Photo: Esther Bonaparte

Chapter 4 . Institutional resilience

New Zealand’s financial system remains resilient to a range of shocks. Solvency is strong as banks continue to build capital buffers. Holdings of liquid assets remain high but are coming down as COVID-era funding winds down. Bank profitability has eased slightly, as funding costs have increased and banks have increased provisioning in anticipation of higher credit impairments. The resilience of non-bank deposit takers varies, and some will face challenges due to their lack of scale. General insurers’ profitability has benefited from low claims relating to large catastrophes, but life and health insurers face weak premium growth as cost-of-living pressures reduce insurance demand. Financial market infrastructures continue to function effectively, and were resilient to recent IT disruptions.

Banks

Solvency

Asset quality

• Bank capital ratios continue to increase and remain well above the current regulatory minimum. This reflects the fact that Common Equity Tier 1 (CET1) capital has been growing faster than risk-weighted assets over the past six months.

• Banks are progressing towards meeting the higher capital requirements that will continue to be phased in through to 2028 (figure 4.1). The minimum total capital requirement was increased from 8 to 9 percent in July.

• With additional capital, banks will be more resilient to unanticipated shocks. They will be better placed to support credit availability during periods of stress. However, increased capital requirements are expected to marginally raise banks’ average funding costs, leading to slightly higher lending rates.

• Additional Tier 1 (AT1) capital, such as preference shares in New Zealand, is used to absorb losses in addition to CET1 capital. Banks have been issuing AT1 instruments to increase their Tier 1 capital ratios. They report that there is a limited market capacity for these types of instrument. If investor demand for AT1 instruments is limited, banks could need higher levels of CET1 capital to meet the increased requirements.

• Non-performing loans have risen from 0.6 to 0.7 percent of lending over the past 12 months. The small increase shows that borrowers have generally adjusted to higher interest rates well. Those who borrowed at large multiples of their incomes and businesses that were already stressed during the pandemic are particularly at risk.

• Credit growth remains subdued. Demand for credit remains low among households and businesses, due to the housing market downturn and weak economic conditions. Banks are competing for lending to creditworthy borrowers, especially borrowers with low existing debt and high discretionary incomes. Competition is strongest in the market for loan refinancing.

Asset quality (continued)

• Banks’ individual and collective provisions to cover expected credit losses increased in 2023, as the economy slowed and credit risks increased. This was driven primarily by an increase in provisions for higher losses on housing and business loans.

• Banks have indicated they are continuing to identify stressed borrowers and manage debt serviceability problems at an early stage. Lenders are generally willing to support borrowers through interest-only lending and extending loan maturities, particularly for borrowers ahead on payments or with low loan-to-value ratios.

Profitability

• Profits remain high, despite easing slightly over the past six months. They have been affected by low credit growth and higher costs of funds.

• Return on assets has remained stable while return on equity has decreased. Increases in CET1 capital, primarily through retained earnings, have lowered returns on equity. Increased provisioning, reflecting a worsening economic climate, has also dampened profitability.

• Net interest margins (NIM) have remained stable at a high level, despite high interest rate volatility. Funding costs can be volatile, but banks manage the impact of this on their earnings through hedging and other strategies.

• Increases in deposits over the COVID-19 pandemic provided banks with cheap funding. The costs of deposits in low-interest transaction and on-call savings accounts also became relatively cheaper as monetary policy tightened. As interest rates rose, switching from on-call and transaction accounts to term deposits increased the average cost of funding.

Liquidity

Funding

• Mismatch ratios, which are a measure of banks’ short-term liquidity positions, remain high (figure 4.6). Banks’ holdings of primary liquid assets have increased due to the Reserve Bank’s Large Scale Asset Purchase Programme and Funding for Lending Programme (FLP). Settlement account balances are now decreasing as these programmes unwind, contributing to a decline in mismatch ratios.

• Our 2024 Bank Liquidity Stress Test examined the resilience of 13 banks to liquidity shocks over a 6-month period. We have run the test using the same scenarios for the past four years. Overall liquidity resilience has increased. In the very severe scenario, the average length of time before the banks can no longer meet deposit outflows (the survival horizon) improved from 10 weeks in 2021 to 14 weeks in 2024 (figure 4.8).

• The core funding ratio, a measure of a bank’s funding stability, remains elevated (figure 4.7). Slow credit growth and relatively abundant deposits have meant banks have not needed to raise wholesale funding.

• As COVID-19 support programmes such as the FLP unwind over the coming year, banks will be well positioned to gradually replace FLP funding with retail and wholesale funding, although this is costlier.

• Households continue to transition from transaction and on-call savings accounts to term deposits to take advantage of high interest rates. Some businesses, particularly those in vulnerable industries, are holding higher levels of cash in transactional accounts to prepare for greater economic uncertainty.

• Banks’ issuance of debt securities in wholesale funding markets has fallen to low levels. Banks have sufficient deposit funding to support lending activity. Current bank issuance is primarily to maintain a presence in important overseas funding markets such as the US and Europe. Investor demand has been strong, pointing to capacity in offshore markets to meet funding needs once credit growth recovers. Geopolitical risks have highlighted the importance of diversified funding sources.

Non-bank deposit takers (NBDTs)

• New Zealand’s NBDT sector consists of building societies, credit unions and deposit-taking finance companies. The sector is very small relative to the banking sector in terms of total lending. However, the sector provides services to a relatively large number of customers.

• There has been a broad-based slowdown in new lending by NBDTs over the last 18 months, particularly by building societies and credit unions (figure 4.9). Slower credit growth is driven by the high-interest rate environment, an uncertain economic outlook, and increasing competition with banks for new lending.

• The Government has amended the Credit Contracts and Consumer Finance Act 2003. NBDTs have commented that the speed and cost of processing loan applications have improved as a result of the changes.

• Non-performing loans have increased moderately from low levels over the past year (figure 4.10). This has led to higher provisioning for losses.

• The resilience of NBDTs varies across the sector. Low profitability continues to be an issue in the sector (figure 4.12), particularly for credit unions. Some NBDTs continue to face challenges from the softening economic environment and a lack of scale.

Insurers

• Life and health insurers have faced some challenges recently. Cost-of-living pressures have led to more people cancelling or not renewing policies and fewer new customers. Health claims expenses have experienced double-digit inflation rates, while premium increases have lagged. We expect financial performance in the health market to stabilise as inflation pressures ease.

• Profit metrics for life and health insurers have been further impacted by IFRS17 technical specifications, where losses and asset impairments need to be immediately accounted for on a granular basis. We expect profit volatility to decline as industry and accounting professionals develop a common understanding of the IFRS17 changes, and insurers incorporate strategic IFRS17 solutions into their financial models.

• The recent lack of large natural catastrophe claims has helped property insurers achieve stronger profitability. Conditions in reinsurance markets have improved. Insurers report that reinsurance capacity remains readily available and price increases have moderated from last year. However, excess levels on reinsurance remain high, requiring insurers to hold higher levels of capital to cover potential claim costs. Premium growth has been strong as property insurers pass on additional reinsurance costs and improve their pricing of natural hazards.

• The amendment of the Interim Solvency Standard in March 2025 is expected to bring the calculation of property insurers’ solvency ratios in line with international norms. In the interim, insurers have generally maintained a conservative approach to capital management.

• Supervisory discussions have focused on strategic priorities for insurers, such as technology improvements, cyber resilience, compliance, financial performance and risk management.

Financial market infrastructures (FMIs)

• The CrowdStrike incident on 19 July 2024, which saw widespread disruptions to computer systems, was not materially disruptive to designated FMIs. They reported being able to complete settlements generally on time, with the incident causing only very minor slowdowns for some of their participants.

• Information notices have been issued that will standardise information requirements across designated FMIs. These requirements under the new Financial Market Infrastructures Act 2021 (FMI Act) will help with monitoring and oversight of the sector. Following consultations, on 22 October notices were issued jointly with the Financial Markets Authority (FMA) to the ASXCF, NZCDC and NZClear settlement systems. The information notice currently in force for the Exchange Settlement Account System was also amended.

• The Reserve Bank and the FMA published a Guidance Note on 18 October 2024 that sets out how FMIs are designated under the FMI Act. The note explains the roles and approach the joint regulators use (for FMIs that are jointly supervised) when FMIs are recommended for designation. It highlights the difference in approach between when regulators recommend designation versus when an application for designation is made by an FMI operator.

• The transition to the new FMI Act, which fully came into effect on 1 March 2024, involved significant work including the redesignation of systemically important FMIs. Supervisory focus has now shifted to regular operations, including identifying and reviewing the designations of other FMIs that may be systemically important. The process of assessing which FMIs are systemically important and recommending designation is ongoing under the FMI Act.

Charts

Figure 4.1

Common Equity Tier 1 ratio for locally incorporated banks

Source: RBNZ Capital Adequacy survey, RBNZ estimates.

Figure 4.3

Bank non-performing loan and provisioning ratios

Source: RBNZ Bank Balance Sheet survey, private reporting

Figure 4.5

Bank operating expenses

Source: RBNZ Income Statement survey, registered banks’ Disclosure Statements

Figure 4.2

Bank net interest margins

Source: RBNZ Income Statement survey, registered banks’ Disclosure Statements

Figure 4.4

Bank profitability measures

Source: RBNZ Income Statement survey, registered banks’ Disclosure Statements.

Figure 4.6

Bank liquidity mismatch ratios (3-month moving average)

Source: RBNZ Liquidity survey

Figure 4.7

Bank core funding ratio

Source: RBNZ Liquidity survey.

Figure 4.9

Total lending by NBDT subsectors

Source: RBNZ Non-bank Deposit Takers survey.

Figure 4.11

NBDT operating expenses to total income ratio

Figure 4.8

Annual bank liquidity stress test (net liquidity position over 26 weeks, average across banks)

Source: RBNZ Non-bank Deposit Takers survey.

Source: RBNZ Liquidity Stress Test.

Note: Net liquidity position is liquid assets less deposit outflows as share of total funding.

Figure 4.10 NBDT non-performing loan ratio

Source: RBNZ Non-bank Deposit Takers survey.

Figure 4.12

NBDT return on assets

Source: RBNZ Non-bank Deposit Takers survey.

Table 4.1

Key metrics for registered banks

Tier 1 capital ratios have increased in preparation for higher future minimum regulatory requirements.

Mismatch ratios are high and well above pre-pandemic levels, and near an all-time high.

Banks’ funding positions remain strong owing to low credit growth.

The banking sector’s return on assets is stable at around pre-pandemic levels. Annual

Ongoing capital growth has been a key driver of a decrease in banks’ return on equity in the past 12 months.

Net interest margins remain higher than pre-pandemic levels.

The non-performing loan ratio remains low but has started to increase, reflecting a more difficult economic environment.

Impairment expenses have remained constant over the last 12 months as banks hold more provisions in a weak economic environment.

Banks’ operating models continue to become more efficient, with increasing digitalisation and automation. Recent falls in income due to stagnating margins have decreased this metric.

Source: RBNZ Capital Adequacy survey, Liquidity survey, Income Statement Survey, Bank Balance Sheet survey.

1 Mismatch ratio (one month) is presented as a three-month moving average to remove short-term volatility.

* Tier 1 capital ratio of 2024 is up to August.

** Includes the capital conservation buffer of 2.5 percent of risk-weighted assets, which banks must maintain to avoid dividend restrictions. For domestic-systemically important banks, the capital conservation buffer is 4.5 percent as of July 2024, and the regulatory minimum for their Tier 1 capital ratio is set at 11.5 percent of risk-weighted assets.

Key metrics for NBDTs (for year ended June)

Source: RBNZ Non-bank Deposit Takers survey.

1 Other NBDT refers to Christian Savings Limited.

2 Employees Credit Union merged with Steelsands Credit Union in December 2020. Firefighters Credit Union merged with Credit Union Auckland in June 2022. Westforce Credit Union, Steelsands Credit Union, Fisher & Paykel Credit Union and Credit Union Auckland merged with First Credit Union in August 2022, December 2022, October 2023 and June 2024 respectively.