Insurers and non-bank deposit takers, Reserve Bank’s biggest worry
Unemployment could rise to 18 per cent, house prices could halve, and the viability of the banks could be “called into question” if the coronavirus prompted a further period of economic lockdowns, the Reserve Bank has warned.
The Reserve Bank said in the central bank’s annual report on financial stability published on Wednesday that banks had coped well with the coronavirus pandemic so far.
But under “severe enough scenarios, the viability of banks would come into question”, it warned.
In the event of its worst-case lockdown scenario “initial modelling suggests that, without significant and timely mitigating actions, banks would fall below minimum capital requirements under this scenario,” it said.
The Reserve Bank has also cautioned that some other financial institutions that take deposits from the public, and some life insurers, are already more vulnerable.
The Reserve Bank said that the situations that could result in its worst-case scenario were “broadly based” on the country having to return to a level 4 lockdown for about eight weeks and a worsening of the world economy that resulted in a “credit crunch”.
Deputy governor Geoff Bascand said that model was “not strictly based on the time in lockdown”.
“It is the economic results that are running though that scenario that really matter.”
Commenting on the bank’s report Governor Adrian Orr appeared to highlight the positives, saying that the financial system was in a solid position to weather the “significant economic impact caused by the Covid-19 pandemic and support New Zealand’s recovery”.
Banks entered the crisis with significant capital and liquidity buffers, he said.
“These buffers can now be used to support their customers’ long-term economic future.”
But despite banks’ good position, the Reserve Bank forecast the resilience of the banking system would be “tested in the coming months”.
“Covid-19 will have prolonged and sustained effects on some parts of the economy and it is inevitable that some firms will fail,” it said in its report.
That meant bad loans would “rise materially from current low levels”, it said.
“There remains considerable uncertainty about the future trajectory of the pandemic, and how this will affect the New Zealand economy,” it said.
The Reserve Bank said that even accounting for an expected recovery in the second half of the year, the projected annual change in GDP — from about 2 per cent growth before the crisis to an 8 per cent drop afterwards — would be the largest in at least 160 years.
“The associated losses in income will cause financial distress for a significant number of households and businesses.”
The Reserve Bank also warned that the good position that banks were in prior to the crisis was not mirrored everywhere.
“Some non-bank deposit takers have low profitability and are operating with low buffers,” the Reserve Bank reported.
“Some life insurers have also been operating with low solvency buffers, while other insurers have experienced investment losses and/or rising credit insurance claims.
“We are continuing to work with insurers to see them build better resilience and maintain a strong focus on long-term customer outcomes,” the bank said.
Life insurers appeared to have been spared from a sudden big rise in claims because of New Zealand’s handling of the pandemic, but a number of insurers were exposed to investment losses due to of movements in interest rates, bond spreads and equity prices, it said.
Insurers that offered credit insurance appeared vulnerable to a significant increase in unemployment, it added.
“The Reserve Bank estimates that some of these insurance providers would come under stress from increasing redundancy claims if unemployment reached 10-13 per cent.”
But it said general and health insurers were likely to be resilient to “all but the most catastrophic of scenarios” and many of them might see reduced claims in the near term due to the decreased economic activity.
Orr said he didn’t believe people should be “particularly worried” about their life insurer or income insurer not being able to pay out.
But Bascand said the Reserve Bank had to look ahead to “how they would be if this went on for another year or more with low premium growth, increasing claims and low interest-rates on the investment side”.
“This is not saying they are in any danger or weakness right now,” he said.