The Reserve Bank is turning up the heat, monitoring financial institutions’ abilities to weather geopolitical shocks.

The regulator is cognisant that problems stemming from wars, trade disputes, cyber attacks, and other geopolitical tensions are at the top of financial institutions’ lists of risks.

“Discussions with banks suggest they are paying closer attention to geopolitical risks, and the impact they may have on their loan portfolios,” the RBNZ said in its biannual Financial Stability Report, released this morning.

It noted the landscape has changed since 2022, with Russia’s invasion of Ukraine, tensions between China and the United States, and widening severe conflicts in the Middle East.

So, the RBNZ is planning to stress-test banks next year to see how they’d pull through various scenarios.

It said loan arrears could rise if economic activity plummeted. Interest rates could spike if shocks to financial markets raised funding costs.

“Under severe circumstances, banks’ access to funding could be restricted, hampering credit supply and increasing refinancing risks for borrowers,” the RBNZ said in its report.

“In the long term, financial markets may become more fragmented as investors reallocate capital away from countries that are less geopolitically aligned to their own...

“Deglobalisation could gradually result in more concentrated investment linkages with fewer financial partners. Asset prices and funding conditions may become more volatile over time.”

The RBNZ also alluded to concerns Governor Adrian Orr aired in a media interview a fortnight ago around traders in equity markets inadequately pricing in geopolitical risk.

“Equity prices have appeared overvalued relative to fundamentals in some segments, including for example the technology sector,” the RBNZ said.

While the RBNZ cast its eye forward to looming risks, it said: “currently, financial stability risks remain contained as we near the bottom of the economic cycle”.

Inflation is falling around the world and some central banks have started cutting interest rates.

“The pace and extent to which interest rates will fall are uncertain,” the RBNZ said.

However, it believed the average interest rate being paid on mortgage debt is likely at its peak, at 6.4%.

“We expect around 50% of mortgage lending to reprice within six months and around 75% within a year,” it said.

“Debt-servicing costs will remain challenging for highly indebted households. Banks have reported to us that many highly indebted households have little incomes or savings buffers available. This makes them vulnerable to unanticipated costs or losses of income.”

The RBNZ warned rising unemployment was starting to create “acute financial difficulties” for some households.

It expected the unemployment rate to rise to 5.4% by the March 2025 quarter, from 4.6% in the June 2024 quarter.

Accordingly, banks told the RBNZ they expected their bad debts to keep rising, but not nearly to 2009 Global Financial Crisis levels.

“Banks expect the non-performing share of their business lending to increase to levels similar to those in 2020,” the RBNZ said.

“They expect the non-performing share of mortgage lending to increase a little further, peaking around the middle of 2025.”

The RBNZ said banks were well-placed to absorb losses, noting they increased their provisions in 2023 in anticipation of there being an uptick in defaults.

“Strong profitability has also allowed banks to retain earnings and grow their capital positions.

“Capital ratios are comfortably above our minimum requirements, even as those requirements increase.”

Jenée Tibshraeny is the Herald’s Wellington business editor, based in the parliamentary press gallery. She specialises in government and Reserve Bank policymaking, economics and banking.