The country’s biggest banks are facing up to the possibility of outsized losses from their agricultural loans in the decades to come as the climate warms up.
The Reserve Bank last week published the results of climate stress testing on the loan books of the five largest banks out to 2050.
Using extreme climate change scenarios, the lenders were asked to model the impact on borrowers of more floods and droughts as well as increased costs to farmers from pricing of carbon emissions.
Also modelled was the impact on export markets of more extreme weather and higher carbon taxes.
Bank profits fell by $32 billion, or 26%, between 2031 and 2050, compared to a business-as-usual scenario, as more borrowers defaulted and banks increased provisioning for bad debts.
The banks’ models predicted higher loss rates for agricultural loans than for all other types of lending.
While residential mortgages had the highest share with 27% of total losses, that was in the context of their accounting for 60% of total loans between 2031 and 2050.
Next was agriculture, which accounted for 24% of losses while only making up 9% of total bank loans during the period under consideration.
Sheep and beef loans were projected to be the worst-affected by the warmer climate with default rates reaching 25% of borrowers by the mid-2040s.
Lower farm profitability and rising defaults could also be expected to reduce rural land values, and increase bank losses.
“Alternative land uses provided some support for rural land values although this was tempered by growing risks of wildfire and pests for forestry,” analysts at the Reserve Bank write.
The higher anticipated rate of losses also means more capital will need to be held against agricultural loans, absent “any actions by banks, their borrowers or government that would mitigate the financial impact [of climate change]”, the analysts say.
The risk weights banks attached to agricultural loans, determining the amount of capital required for each dollar of lending, are forecast to rise from 80% for non-defaulting loans in 2030 to 120% by 2050, the central bank says. By comparison, risk weights for business loans rose more modestly from 60% to 80%.
Higher capital requirements for agricultural loans can be expected to reduce bank returns from agricultural loans relative to other types of lending, the analysts say.
Following the stress test, the Reserve Bank said it had asked participating banks for “mitigating actions to manage their climate-related risks”.
“In response banks identified actions which mainly involved working with their customers to mitigate the financial impact of severe weather events and assist in any transition of the business model; and tightening risk appetite settings to reduce exposure to high-emitting customers and farms in higher risk areas, such as drought areas without irrigation.”
Actions to assist existing customers to move to a more resilient footing included financial assistance for farm borrowers during droughts, more research into land use change, and low-interest loans to finance the adoption of low carbon technologies, water storage and irrigation.
Banks also identified steps they could take to limit their own exposure to agricultural loans most vulnerable to climate change’s impacts.
These included “factoring in the impact of drought on property valuation” of farms in drought-prone areas without “adequate” irrigation.
In these cases a “higher haircut ratio may be applied”, the banks reported.
Limits on lending are also likely in parts of the country deemed to be more exposed to the negative impacts of climate change.
Emissions profiles of individual farms will also be increasingly considered when determining applications for loans by farmers, the banks said.
The participating banks were ANZ, BNZ, Westpac, ASB and Kiwibank.
