Future stress tests of the New Zealand banking system

1. Future stress tests of the New Zealand banking system David Hargreaves Reserve Bank of New Zealand ISCR Banking Regulation Conference 4 Aug 2014

2. Roadmap • RBNZ stress testing objectives • Emerging international practice • Key risks in New Zealand context • Past NZ stress tests • RBNZ thinking on next steps

3. Objectives of tests – RBNZ view • Strengthen risk management within banks (help boards and management understand potential consequences of stress scenarios) • Test adequacy of capital and liquidity buffers held by the banking system • Develop RBNZ’s understanding of systemic risk, as communicated e.g. in FSR

4. International Practice • Massive data returns • Feeding regulator-run loss models • Some de-emphasis of capital models • Regulator view published (bank by bank), dividend/capital-raising implications.

5. Key risks for NZ Banks • Credit risk in loan book dominates RWA • Trading books and market risk exposures limited • Reliant on offshore funding markets – funding stress can exacerbate downturn issues.

6. Loan Book: ~57% Residential Mortgages

7. Risk Weighted Assets: ~34% Residential Mortgages

8. Mortgage risk characteristics • Residential: “Dual default” – negative equity AND income problems often drive downturn defaults – relatively safe • Farm, Commercial Property: Land price and farm income likely to be quite correlated and can be volatile • RBNZ prefers TTC models that preference downturn drivers over normal default predictors

9. Impairment experience broadly fits risk weights

10. Past RBNZ stress tests • Recent exercise with smaller domestic banks. • 2010,2012: 4 Largest banks, Jointly with APRA • Templated data based on IRB model risk grades • Serious macro/financial downturn scenario • Aggregate results published

11. Phase 1: Bank models and judgement Phase 2: Harmonise based on Central Bank models and judgement

12. Future: Roadmap • Stress testing is a RBNZ ‘initiative’ for next few years; internal steering committee formed • Likely to seek more understanding of IRB bank stress testing practices in late 2014 • …and follow up with smaller domestic banks after recent stress test. • Identify priorities for improvement, test with industry

13. Future: initial thoughts • Continue to run IRB tests using risk weight buckets rather than micro data • Data validation and lessons from stress tests or IRB model scrutiny are then mutually reinforcing • Retain phase I/phase II process • Build better ‘regulator’ credit risk models for Phase II results. • Publish aggregates (only)

14. Objectives of tests – RBNZ view • Strengthen risk management within banks (help boards and management understand potential consequences of stress scenarios) • Test adequacy of capital and liquidity buffers held by the banking system • Develop RBNZ’s understanding of systemic risk, as communicated e.g. in FSR