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Financial sector feedback wanted on climate related guidance

The Reserve Bank (RBNZ) is seeking feedback on proposed new guidance for the financial sector on managing climate-related risks.

Thursday, March 30th 2023, 9:00AM 2 Comments

by Sally Lindsay

Nearly a quarter of banks’ residential mortgages in Auckland are at risk in a one-in-100-year rainfall flood event, data from the bank shows.

RBNZ deputy governor Christian Hawkesby says despite banks’ flood exposure, their capital ratios are resilient to the most severe flood sensitivities.

However, climate-related risks continue to evolve, with the potential to significantly affect the financial system in the future, he says.

“The financial stability risks associated with climate change are significant, necessitating an urgent and collaborative response.”

Hawkesby says the RBNZ is obliged to identify, manage, and mitigate these risks as part of its daily activities.

The draft guidance has been adapted from international best practice to suit the New Zealand context and applies to all of our regulated entities including registered banks, licensed insurers, licensed non-bank deposit takers, and operators of designated financial market infrastructures.

The RBNZ is proposing entities develop their capabilities in climate-related scenario analysis and stress testing.

“It is important for entities to look ahead to a range of plausible future climate scenarios, for example more frequent floods and droughts, in developing actions and targets to ensure that their business model and strategy is resilient,” Hawkesby says.

Submissions to the RBNZ close on June 7th.

Banks calculate mortgage loan losses in flood zones

The RBNZ recently released a 2022 paper on flood risk assessment for residential mortgages written by Rebecca Newman, Jonathon Adams-Kane, and Ken Nicholls.

The trio undertook risk assessments of the biggest banks covering banks’ residential mortgage and agricultural exposures.

The main purpose of these exercises is to support banks to build their capability to identify climate risks and find solutions to the significant data and modelling challenges involved.

In turn, this will lead to more proactive management of climate risk.

The climate stress test required banks to calculate loan loss provisions for mortgages affected by coastal flood zones, taking into account a customer's ability to service the loan and changes to the underlying value of the property.

The rationale was that people whose homes had flooded were likely to come under financial stress, and be unable to make their mortgage repayments, even as the value of their homes fell.

The RBNZ assumed price falls on individual homes could be as high as 30-60 per cent. Since then, house prices have fallen and mortgage rates have risen, making homeowners more vulnerable to the shocks if the exercise was rerun today.

The Reserve Bank says 2.5 per cent of the total dollar value of residential mortgage lending is exposed to the coastal flood zone with 50 centimetres of sea level rise. That rises to 3.8 per cent in a more severe outcome with one metre of sea level rise.

Hawke’s Bay is the region most exposed with more than 10 per cent of homes with mortgages at heightened risk if sea levels rise by 50 centimetres, or 20 per cent if they rise one metre.

The results are consistent with estimates based on a National Institute of Water and Atmospheric Research (NIWA) study that 2.9 per cent of the country’s population and 3.5 per cent of buildings are in the coastal flood zone at 50 centimetres of sea level rise.

Coastal flood exposure is concentrated in certain regions. According to aggregate bank submissions, for 50 centimetres of sea level rise, Christchurch contributes 22 per cent percent of the national exposures at-risk. This is followed by Wellington with 14 per cent of the national total.

Across regions, there are significant differences in the share of mortgage lending on properties that lie within a coastal flood zone. Hawke’s Bay is particularly at risk, with 15 per cent of mortgage lending in the region’s flood zone for 50 centimetres of sea level rise, and almost 20 percent for 1 metre of sea level rise.

In the report, ‘very severe’ property price sensitivity and sea level rise of 20 centimetres aggregate mortgage provisions for the five banks rise to $660 million; more than 45% higher than the 0 centimetre baseline level of $450 million.

Provisions increase to $900 million, double that of the baseline level, at a sea level rise of one metre.

Future effects of climate-related flooding on bank capital are uncertain, but higher provisions reduce bank profitability and capital.

Banks provision on a forward looking basis and will increase provisions if the likelihood of customer defaults increase and/or property values decline.

In the at-risk areas, the probability of default increases due to higher insurance costs, lower rental income from investment property, and lower property prices.

Potential losses on any of these defaulting properties increase due to the fall in property prices which reduces homeowners’ equity and security for the bank. Both of these factors are likely to increase the banks’ levels of provisions.

However, these effects on total provisions are much smaller than the outcomes of the 2022 solvency stress test, which featured a major economic downturn, but are significant for the relatively small amount of exposures at risk.

Insurance at risk

The paper says If owners of mortgaged homes could no longer get insurance, banks would face the risk of losses on existing loans..

Insurers generally issue insurance cover on a 12-month term, meaning that annually they can re-evaluate a policy based on any new information or understanding gained regarding the risks associated with a property or area, or a change in the cost of reinsurance.

A change in the affordability or availability of insurance could trigger a fall in property values, as reduced insurance cover would shift greater risk onto homeowners and lenders. This could occur quickly given the annual insurance cycle.

Other factors that could see a drop in flood-affected property values include greater homeowner awareness and risk aversion when buying a property in a flood zone, lower rental income, a sudden increase in flood zone properties for sale in anticipation of future events, or a reduction in the quality and provision of key infrastructure in flood-affected areas.

Tags: RBNZ

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Comments from our readers

On 30 March 2023 at 11:38 am Amused said:
This article is proof yet again that the RBNZ has lost credibility as an inflation targeting institution and has become politicised by the current Minister of Finance.

In a report earlier this month, “Made by Government: New Zealand's Monetary Policy Mess” - senior research fellow Bryce Wilkinson renewed criticism of the RBNZ's handling of monetary policy before and during the pandemic, which left interest rates too low for too long resulting in inflation getting out of control, and stimulating the economy triggering the housing boom.

In summary Wilkinson said of the RBNZ;

“The Minister of Finance bears the heaviest responsibility for monetary policy decisions. He determines its objectives and appoints the RBNZ Governor. He plays a decisive role in making appointments to the Reserve Bank Board, and also influences MPC appointments.”

“The Reserve Bank's Board, its governors and its MPC (monetary policy committee) seriously lack relevant expertise. The RBNZ's senior executive levels and the board lack knowledge and experience in key areas such as monetary policy, macro-economics, and financial market regulation.”

“The Bank has lost much technical expertise in monetary policy and institutional knowledge because of high staff turnover and its employment focus."

“The Minister of Finance has loaded the RBNZ with extraneous duties and remits in areas that has no relevance to monetary policy and which could not be affected by it i.e. climate change”

"They (the next Government) need to pay serious attention to what changes they might make to reposition the Bank. As a boat, it is off course and far from watertight."
On 31 March 2023 at 3:41 pm JPHale said:
I'm seeing a lot of financial risk management not being done effectively around many of these things. It's almost a tick-box exercise with the banks and council; anything highlighted is managed through a minimisation (not mitigation) process to make the problem insignificant and not needing it to be addressed.

We have a she'll be right culture, poor with maintenance and constant surprise about breakdowns; it needs to change. I'm all for managing things reasonably and without stress, but humans seem not to be wired that way. Just look at the around 500 advisers unable to give advice and the constant last-minute activity to get things done!

The additional dynamic to this is a lot of the Auckland damage has come from lack of or minimal maintenance of waterways and rubbish in them.

What has Auckland Council done; jumped into action with an updated maintenance plan? Nope, they extended the flood plain to accommodate for their inefficiency and effectiveness. (coming from people in places that know, understand, and are qualified in this stuff)

So if the various bodies keep avoiding addressing the issues, guess who's going to be footing the bill?

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Lender Flt 1yr 2yr 3yr
AIA - Back My Build 6.19 - - -
AIA - Go Home Loans 8.74 7.24 ▼6.75 6.65
ANZ 8.64 7.84 7.39 7.25
ANZ Blueprint to Build 7.39 - - -
ANZ Good Energy - - - 1.00
ANZ Special - 7.24 6.79 6.65
ASB Bank 8.64 7.24 ▼6.75 6.65
ASB Better Homes Top Up - - - 1.00
Avanti Finance 9.15 - - -
Basecorp Finance 9.60 - - -
Bluestone 9.24 - - -
Lender Flt 1yr 2yr 3yr
BNZ - Classic - 7.24 6.79 6.65
BNZ - Green Home Loan top-ups - - - 1.00
BNZ - Mortgage One 8.69 - - -
BNZ - Rapid Repay 8.69 - - -
BNZ - Std, FlyBuys 8.69 7.84 7.39 7.25
BNZ - TotalMoney 8.69 - - -
CFML Loans 9.45 - - -
China Construction Bank - 7.09 6.75 6.49
China Construction Bank Special - - - -
Co-operative Bank - First Home Special - 7.04 - -
Co-operative Bank - Owner Occ 8.40 7.24 6.79 6.65
Lender Flt 1yr 2yr 3yr
Co-operative Bank - Standard 8.40 7.74 7.29 7.15
Credit Union Auckland 7.70 - - -
First Credit Union Special - 7.45 7.35 -
First Credit Union Standard 8.50 7.99 7.85 -
Heartland Bank - Online 7.99 6.69 6.45 6.19
Heartland Bank - Reverse Mortgage - - - -
Heretaunga Building Society 8.90 7.60 7.40 -
HSBC Premier 8.59 - - -
HSBC Premier LVR > 80% - - - -
HSBC Special - - - -
ICBC 7.85 7.05 6.75 6.59
Lender Flt 1yr 2yr 3yr
Kainga Ora 8.64 7.79 7.39 7.25
Kainga Ora - First Home Buyer Special - - - -
Kiwibank 8.50 8.25 7.79 7.55
Kiwibank - Offset 8.50 - - -
Kiwibank Special - 7.25 6.79 6.65
Liberty 8.59 8.69 8.79 8.94
Nelson Building Society 9.00 7.75 7.35 -
Pepper Money Advantage 10.49 - - -
Pepper Money Easy 8.69 - - -
Pepper Money Essential 8.29 - - -
Resimac - LVR < 80% 8.84 8.09 7.59 7.29
Lender Flt 1yr 2yr 3yr
Resimac - LVR < 90% 9.84 9.09 8.59 8.29
Resimac - Specialist Clear (Alt Doc) - - 8.99 -
Resimac - Specialist Clear (Full Doc) - - 9.49 -
SBS Bank 8.74 7.84 7.45 7.25
SBS Bank Special - 7.24 6.85 6.65
SBS Construction lending for FHB - - - -
SBS FirstHome Combo 6.19 6.74 - -
SBS FirstHome Combo - - - -
SBS Unwind reverse equity 9.95 - - -
Select Home Loans 9.24 - - -
TSB Bank 9.44 8.04 7.55 7.45
Lender Flt 1yr 2yr 3yr
TSB Special 8.64 7.24 6.75 6.65
Unity 8.64 6.99 6.79 -
Unity First Home Buyer special - - 6.45 -
Wairarapa Building Society 8.60 6.95 6.85 -
Westpac 8.64 7.89 7.35 7.25
Westpac Choices Everyday 8.74 - - -
Westpac Offset 8.64 - - -
Westpac Special - 7.29 6.75 6.65
Median 8.64 7.29 7.32 6.65

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