RBNZ bank flood study points to insurance importance

A Reserve Bank of New Zealand (RBNZ) report on residential mortgage lenders exposure to flood risks has highlighted implications from potential insurance availability changes.

The report, released after excerpts were published in November, looks at impacts from coastal flooding and sea level rises nationwide and risks associated with flooding caused by excessive rainfall in Auckland.

Deputy Governor Christian Hawkesby says the exercise modelled the financial risk associated with increasing frequency and severity of flood events through the channels of declining insurability and the values of at-risk properties.

“We have all seen the devastating impact of the recent upper North Island floods and Cyclone Gabrielle,” Mr Hawkesby said.

“Although this exercise was conducted before these catastrophic events, they emphasise the importance of conducting these types of exercises to help manage these risks in the future.”

The report says that, looking at each hypothetical shock in isolation, the banks’ capital ratios are resilient to the flood sensitivities, but there’s more work to do in understanding compounding risks across the financial system, for example from recessionary risks.

“The exercise also made clear the importance of the insurance and policy landscape for banks’ risk management. That notably includes the outcome of the government’s National Adaptation Plan,” it says.

The adaptation plan’s actions include developing options for home flood insurance.

“Future effects of climate-related flooding on bank capital are uncertain. In an environment where flood risk is not accurately priced into the residential mortgage market there is potential for capital stress to be generated via unanticipated losses,” the report says.

“The magnitude and nature of the impact on bank capital will be dictated by a range of factors, especially the prevalence of at-risk properties across the mortgage portfolio, and how insurance coverage changes in these areas.”

Mr Hawkesby says an upcoming Climate Stress Test will improve understanding of the combination of risks to bank balance sheets. The scenario for the stress test is due to be published later this year.

The report is available here.