Geopolitical risks from Russia, China, and the Middle East pose one of the most serious threats to New Zealand’s financial stability, according to the Reserve Bank.
It pre-published a chapter from its upcoming Financial Stability Report, warning that armed conflict, trade restrictions, or cyberattacks could harm the financial system.
Kerry Watt, the central bank’s director of Financial Stability Assessment & Strategy, said concern about geopolitical tension had been increasing.
“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,” he said
Geopolitical risks have featured more prominently in recent risk assessments, with most New Zealand banks identifying geopolitical shocks as the biggest threat to their business in the RBNZ’s 2024 Reverse Stress Test.
Unlike a typical solvency stress test, which asks banks to predict the impact of a specific recession, a reverse stress test starts with a target capital level and asks banks to imagine a realistic scenario that could result in that outcome.
Most banks included some form of geopolitical event in their scenarios, while others considered scenarios like another pandemic or a natural disaster such as an earthquake or volcanic eruption.
“In some geopolitical scenarios, global supply chains were disrupted, leading to a resurgence of inflationary pressure and elevated interest rates,” the RBNZ said.
Geopolitical shocks can disrupt trade flows and create uncertainty, affecting economic activity and tightening financial markets by influencing funding conditions and asset prices. These two channels can combine to amplify risks to financial stability.
Interruptions to trade could push commodity prices higher, as occurred when Russia invaded Ukraine, and disruption to maritime trade routes could drive up shipping costs. This would likely lead to tighter monetary policy and higher debt costs for households and businesses, given that a large portion of New Zealand’s imports comes from the Asia-Pacific region.
The RBNZ noted that a “more extreme scenario” involving a major conflict in the Asia-Pacific region with “one or more key trading partners” would be highly disruptive for trade and investment. This may reference a potential scenario where China attempts to use force to reintegrate Taiwan or seizes other territory in the South China Sea.
Whatever the cause, factors like economic growth, unemployment, property prices, and interest rates were the key drivers of the stress test results. Most banks only reached the targeted capital level in scenarios involving severe recessions, with unemployment peaking between 8% and 18%, and property prices dropping 30% to 55%. The RBNZ noted that most of these scenarios were more severe than those used in typical solvency stress tests.
The RBNZ is considering incorporating a geopolitical scenario in its solvency stress test next year. New Zealand’s strict capital requirements, which aim to shield its economy from global shocks, mandate that large banks increase their total capital ratio to 18% by 2028, up from 13.5% today.
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