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Stress testing shows most banks would struggle to pay out deposits in a severe scenario lasting over six months

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Just one out of New Zealand’s 10 largest banks would be able to meet demand from depositors wanting to withdraw money in a very severe scenario which lasted more than six months, testing by the Reserve Bank has revealed.

The banking regulator today released the results of two stress tests it has been undertaking on the banks this year.

The Reserve Bank regularly tests the solvency of the banks but for the first time since 2003 it also tested their liquidity – what would happen if something major went wrong for an individual bank, causing savers to pull their money out.

The banks were tested on two scenarios – an “adverse” event in which they could be faced with a one-notch downgrade in their credit rating and a “very severe” scenario where they were hit by a three-notch downgrade.

A potential cause ranged from a cyber attack, IT systems disruption or fraud leading to reputational damage which resulted in a significant amount of deposits flowing out of the bank as well as limits on new funding.

The scenarios were designed to last for six months.

Banks applied the scenarios to their March 2021 balance sheets with results revealing just four out the of the 10 major banks would be able to meet withdrawals for the full six months under the adverse scenario and just one could do so under the very severe scenario.

The banks that took part in the test included the five largest – ANZ, ASB, BNZ, Westpac and Kiwibank as well as Co-operative Bank, Rabobank New Zealand, Heartland, SBS and TSB.

The Reserve Bank’s testing results did not reveal how each bank performed under the tests but found that larger banks had a much shorter survival horizon under both scenarios.

This was because the largest banks derived more of their funding from wholesale funding and large deposits which were assumed to exit the bank faster than smaller deposits.

“In the Very Severe scenario some of the largest banks fell into deficit fairly quickly following the one-month period of our maturity mismatch ratio. The driver of the difference in outcomes between the large and small banks was the difference in funding compositions,” the Reserve Bank report notes.

But banks were also able to identify actions that could improve the outcomes.

The banks were allowed to model the use of mitigating actions to counter the issue as long as these were already part of their contingency plans.

Those mitigations included a reduction or halt in new lending, leaning on their parent company for financial support, raising deposit rates to reduce the outflow on money and borrowing more from the Reserve Bank under its residential mortgage-backed securities programme.

The tests revealed banks would be quick to reduce lending in the event of a very severe scenario.

Deputy government Geoff Bascand said the liquidity stress test had provided useful insights into the resilience of banks to liquidity shocks and highlighted areas for improvement in banks’ internal stress testing capability.

The findings would be used as part of a liquidity policy review which is due to begin in 2022.

Meanwhile its solvency stress test showed the banking system had a stronger level of resilience than a year ago as a result of higher capital levels and was and would be well placed to support the economy if conditions were to worsen.

“However, the results also indicated that a major stress event could make it difficult for banks to meet higher capital requirements in the lead up to full implementation of the new capital review standards in 2028. This reinforces the need for banks to continue to build capital in good times.”

Resource:Stress testing shows most banks would struggle to pay out deposits in a severe scenario lasting over six months

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