Geopolitical Tensions Highlighted As Risk To Financial Stability

The Reserve Bank of New Zealand - Te Pūtea Matua today announced key findings from its 2024 Reverse Stress Test, alongside an assessment of how geopolitical tensions could impact financial stability in New Zealand.

The findings are being pre-released from our upcoming Financial Stability Report and highlight the importance of proactive risk evaluation and management to safeguarding New Zealand’s financial stability.

The Reverse Stress test asked participating banks to model severe but plausible scenarios that could cause their capital levels to fall below the regulatory minimums. The scenarios banks used featured severe recessions, with significant increases in unemployment and falls in property prices. Several banks identified escalation of geopolitical tension as the primary driver of economic downturns. Scenarios were often accompanied by secondary shocks, such as cyber-related events or insurance retreat.

Banks also identified actions they could take in response to the scenarios to rebuild their capital positions. Responses included reducing dividends, cutting costs, tightening lending standards, repricing and extending loan terms for existing customers.

“The Reverse Stress test prompted banks to explore severe scenarios that threatened their businesses and identify how they might respond. The exercise has improved our understanding of the potential vulnerabilities of the financial system. It has also been a valuable exercise for testing and enhancing industry’s risk management capabilities,” Director of Financial Stability Assessment & Strategy Kerry Watt says.

An important part of Te Pūtea Matua’s financial stability work is promoting public understanding of risks. This stress testing exercise highlighted geopolitical risks as material for New Zealand. These risks arise from international tensions and can impact the financial system through various channels.

Geopolitical risk can disrupt international trade, weaken domestic demand and lead to financial market volatility. This in turn can lead to higher loan defaults, raise funding costs, and increase cyber risks for financial institutions. The nature of the impact will depend on the transmission channel, severity and location of the geopolitical shock.

“Concern about geopolitical tension has been increasing recently. As a small open economy, dependent on international trade and investment, geopolitical risks are clearly relevant to our financial system. Their potential impacts cannot be underestimated,” Mr Watt says.

“We must be aware of these risks and be prepared to manage them to ensure the stability of the financial system.”

More information

• Read our Reverse Stress Testing special topic here 
• Read our Geopolitical box article here
• The 2024 November Financial Stability report will be published on our website at 9am on Tuesday 5 November, with a media conference at 1pm. See full details 
• What is the Financial Stability Report

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