New Zealand's major banks could survive even the most severe economic scenario - much worse than COVID-19 - but they would come under serious strain.
Stress testing of banks' balance sheets carried out by the Reserve Bank (RBNZ) shows if unemployment hit 17.7 percent and property prices fell by 50 percent, banks would run close to their minimum level of capital of 8 percent.
Capital is the money banks are required to put aside to pay for credit losses in a crisis. Average levels are currently around 14 percent but the RBNZ wants to raise this.
In the most 'severe but plausible' hypothetical scenario, that is forecast to happen once every 200 years, banks would need significant capital injections.
"This shows that there are limits to bank resilience," the RBNZ said.
In a less severe scenario, or a one-in-50-year event where unemployment hits 13.4 per cent and house prices fall by 37 per cent, bank's capital levels would remain above the requirement and they could keep lending money.
House prices have never fallen by that much in New Zealand, but they have in other countries following the global financial crisis, including the United States.
RBNZ's own forecasts for the COVID-19 crisis see the unemployment rate peaking at 8 percent and house prices falling by 9 percent.
However, the RBNZ said the tests and the current recession proved banks needed to put aside more capital.
"The onset of the COVID-19 pandemic provides a stark reminder to us all of the importance of being prepared for the unexpected," RBNZ deputy governor Geoff Bascand said.
"The more bank capital there is, the less the banks and the New Zealand economy are exposed to the risks of decision making under uncertainty."
The RBNZ has put its plan to force banks to increase their capital levels on hold until July next year. It will decide when to resume it in the coming months.
