Building on the stability of our banking system

Building on the stability of our banking system | Insurance Business

Building on the stability of our banking system

With the intense lockdown behind us, Alert Level 1 was a key step forward on our journey out of COVID-19. But the New Zealand economy still has some pretty big hurdles to overcome in the next few months.

Between government help and other emergency financial resources, a lot of levers are being pushed and pulled at the same time to counter the crisis, and the Reserve Bank of New Zealand is at the core of all this.

In early June, we held our webinar series Bring in the Experts with RBNZ’s Deputy Governor and General Manager of Financial Stability, Geoff Bascand. In this compelling session, Geoff helped us get a better sense of what current conditions may mean for the financial stability of the banking system, and how the different economic components at work are projected to behave. It is worth noting this environment is fluid and will stay fluid for quite some time as we watch the environmental factors unfold around us here in New Zealand and globally.

The good news is that the banking system appears to be resilient – not invincible, but resilient enough to withstand a wide range of adverse scenarios. However, no sugar coating can conceal reality; we’re likely to face a recession, and the strength of our banks is instrumental in softening the blow.

Without further ado, I welcome you to read on for a summary of the key points we discussed, and I’d like to thank again Geoff Bascand for shedding light on matters that are important to all financial advisers and their clients.

What’s in the latest Financial Stability Report (FSR)

Released in May, the latest six-monthly FSR was particularly critical, having been issued in a disruptive context. Unsurprisingly, the resulting picture wasn’t pretty, amid falling GDP and rising unemployment. But the overarching message is that, despite tougher-than-ever conditions, our banking system has key elements of strength to leverage.  

Unlike 2008, when a liquidity shock put banks at the very centre of the financial crisis, this time around they are well capitalised and have buffers in place to support customers and keep lending, which is a critical component in our recovery efforts. So, the banking system is on solid footing. The question is, how solid and for how long?

Pondering the ‘what-if’ scenarios

Among the insights that Geoff shared during the webinar, of particular interest was the stress test recently performed by the Reserve Bank to assess how banks would cope with increasingly adverse shocks.

The ‘baseline stress test’ considered an unemployment rate of about 13%, coupled with a house price fall of 36%. It’s important to note that this hypothesis is quite ‘gloomy’ compared to the more probable, less negative scenarios outlined in the Monetary Policy Statement. And yet, despite this high ‘baseline’ stress test level, banks are still projected to withstand the shock and ride through.

It’s reassuring to know that the banking system is strong enough to survive unprecedented (and I’d like to stress, unlikely) levels of disruption. Of course, it is not immune to any shock and in the second projected scenario (unemployment rising to about 18%, house prices falling by nearly 50%), banks would indeed struggle. But again, this is just a big, hopefully remote ‘what if’. Geoff highlighted that the RBNZ doesn’t view this scenario as ‘probable’.

Balancing strengths and vulnerabilities

According to Geoff, LVR rules have contributed greatly to banking resilience. At a 15% house price fall, only 5% of household debt is projected to go into negative equity, whereas it would have been 15-18% if LVRs had never been implemented – quite the difference.

Again, Geoff stressed that banks are well-positioned to take a long-term view on customers’ circumstances. For example, if a loan was performing satisfactorily for a household or for an SME before COVID-19, “it’s fair to treat it as a performing loan even if the client has recently defaulted a few payments” due to these extraordinary circumstances.

So far, lenders have been meeting many clients halfway. About 14% of personal loans and mortgages, and 15% of business loans, have either been deferred or restructured. But while these and other emergency moves have helped cushion the fall, they cannot entirely stop it, and this means that the long-tail impact will continue to unravel in the coming months. Its extent will largely depend on unemployment rates, which are closely intertwined with spending attitudes and consumer confidence.

What about resilience in the insurance sector?

So, as we’ve seen, building ‘resilience’ is the key objective to pursue for a number of economic actors, including businesses, households, lenders (both mainstream and non-bank) and, not least, insurers.

Just like lenders, insurance providers have taken wide-ranging steps to help customers through, and advisers have had a crucial role in assisting vulnerable clients. But from the viewpoint of our central bank, low solvency buffers within the insurance industry are concerning.

The RBNZ is urging the insurance sector to focus their efforts on looking ahead and building up longer-term resilience. As Geoff said, “not a panacea but it would help.”

What’s next for the economy, and for you?

At this point in time, predictions are anything but easy to make. According to Geoff, government support measures are significantly softening the blow and so are low interest rates, with an expectation that there might be room for further drops down the track.

On the other hand, the impact of the pandemic cannot be ‘removed’, and certainly not in a short period of time. Higher unemployment rates, falling GDP numbers, uncertain business environments, and a 10% drop in house prices are all possible outcomes. But the banks are well-paced to support the economic recovery.

I’d like to quote Geoff’s words here: “If banks keep supporting credit growth and lending to sound businesses, households and customers, the economy will be on the road to recovery.” In the meantime, your role as financial advisers is more challenging and important than ever – and know this, RBNZ acknowledges it.

The key piece of advice for you from this session with Geoff, was to be confident in the resilience of the system (banks are safe and profitable), and make sure that your clients receive all the support available from insurers and lenders. Encourage them to ask questions and help them work towards a more resilient future.