The Reserve Bank is confident the banking system can cope with a severe downturn in the dairy sector.
Reserve Bank Governor Graeme Wheeler. Photo: RNZ / Diego Opatowski
Lower dairy prices are putting the financial squeeze on dairy farmers, with about a half of them experiencing a second successive season of operating losses.
Banks have lent $38 billion to dairy farmers, and the central bank put the five biggest - ANZ, Westpac, ASB, BNZ and Rabobank - under the spotlight to test how they would cope with sustained low milk prices and sharp falls in land values.
It tested two severe scenarios, with scenario one assuming that the dairy payout recovers to $5.25 a kilo of milk solids by the 2017/18 season and a fall in dairy land prices of 20 percent.
Under the second, and tougher scenario, the dairy payout was assumed to fall to $3 in 2015/16 and remain below $5 a kilo until the 2018/19 season, and land prices to fall 40 percent.
RBNZ head of macro financial Bernard Hodgetts said the stress test was intentionally severe.
"On average, banks reported losses under the two scenarios ranging between 3 to 8 percent of their total dairy sector exposures."
That equalled about $1 billion to $3 billion.
Dairy accounts for about 10 percent of $348 billion in total lending, and Mr Hodgetts said even under the worst-case scenario, banks could comfortably cope.
"We would expect losses of the order seen in the stress scenarios to be absorbed largely through lower bank earnings rather than through an erosion of bank capital," he said.
The test results indicate that in the short term, banks would increase their dairy lending in order to support farmers facing negative cash flow.
If the dairy downturn is prolonged, banks will face a rise in loan losses.
Under scenario two, loans written off totalled about 25 percent of dairy debt, and 12 percent under scenario one.
Mr Hodgetts said while the scenarios generated significant increases in loss rates which were manageable for the banking system, there could be a period of uncertainty for banks trying to sell failed farms.
"There is a risk that the lags involved in resolving stressed dairy assets are larger than reported."
The stress tests did not consider the wider effects of loan losses on the economy.
Bankers' Association acting chief executive Antony Buick-Constable said banks were committed to supporting farmers.
"Banks with large dairy portfolios remain resilient, well funded and are well positioned to continue working with dairy farmers through any further movements in dairy prices," he said.
"Despite the current lows in the dairy cycle, the longer-term outlook for dairy and protein production remains positive. It's important to keep this bigger picture in mind and support our farmers during tough times, and that's exactly what our banks do."