New Zealand's well-capitalised banks could probably withstand a major blow to one of their two major lending markets but not both, the International Monetary Fund says.
In a working paper on the resilience of the Kiwi banking system, the international economic organisation found ASB, ANZ, BNZ and Westpac held high-quality capital well above regulatory requirements, equivalent to about three times that of their Canadian counterparts.
That would broadly allow them to withstand a blow to one of their lending markets, but the interlinked nature of the economy suggests a fiscal blow would likely come from multiple fronts where the banks look vulnerable.
The IMF report says that given the large size of the four systemically important banks in New Zealand with similar business models, careful attention needs to be paid to their vulnerabilities and resilience to shocks.
"Any distress in one of the four banks could have significant repercussions for the entire financial system and, in turn, the real economy in New Zealand."
The working paper said the "too-big-to-fail" institutions were vulnerable to a rapid rise in mortgage rates combined with a spike in unemployment, which would put pressure on the ability of heavily indebted households to service their debts.
In addition, the country's major banks were also vulnerable to a large fall in commodity prices which would impact on farm loans.
In isolation, stress tests showed the banking sector could withstand one of these risks, but a rapid slowdown in China or Australia would put pressure on exports, terms of trade, and could trigger a sudden decline in house prices.
Of these risks, corporates were seen as the most likely to default on their debts, with a probability of 3.88 per cent, followed by other retail lending at 3.87 per cent, and retail mortgage lending at 2.85 per cent.
The IMF recommended the Reserve Bank consider implementing prudential policy measures such as lifting capital requirements among major lenders.
This would reduce fiscal risks in times of market uncertainty by maintaining bank asset quality and keeping access to international funding markets open.