The Reserve Bank stress tests banks to see whether they would survive an economic crisis.

A property price crash wouldn't be the opportunity house-hunters dream of, bank stress-testing indicates.

That's because banks would severely ration loans to new borrowers, the Reserve Bank (RBNZ) found when it simulated economic armageddon to see how big banks would react.

As bank regulator, the RBNZ's stress-tests banks to check they are strong enough to survive an economic crisis.

JACK MONTGOMERIE/FAIRFAX NZ Test shows banks would survive a severe house price crash, says the Reserve Bank's Bernard Hodgetts.

In its most recent round of testing, highlighted in a video clip posted on its website, it simulated a severe economic downturn lasting three years, where house prices fell 40 per cent across the country and 50 per cent in Auckland.

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Over that time the economy contracted by 6 per cent, unemployment rose to 13 per cent, dairy incomes slumped, rural and commercial property prices collapsed, and the Official Cash Rate was slashed by about 3 per percentage points.

The good news is all the big banks survived without needing the kinds of help they got from the taxpayer during the Global Financial Crisis, which included a government deposit guarantee.

The bad news is banks' slashed new lending, with first time home buyers hoping to pounce on affordable homes among those least likely to get loans.

BORROWERS

Faced with the simulated economic downturn, banks reported a sharp rise in bad debts, with about 30 per cent of losses coming from mortgages, indicating homeowners falling victim to rising joblessness losing their homes, half of them in Auckland.

Small business and farm debt made up the rest of the bad debts, representing businesses going to the wall.

In response to rising bad debts, banks would shrink their loan books. They told RBNZ they believed they could reduce credit exposures by around 11 per cent.

Some of that would be a result of people and businesses deciding not to borrow.

But banks would also ration lending. They could cut credit limits on facilities like small businesses' revolving credit facilities, as well as clipping limits on personal overdrafts and credit cards.

As the Global Financial Crisis showed, small businesses would be among the first to have the credit tap turned off.

"International experience tends to point to a larger contraction in business sector exposures following periods of financial stress," said RBNZ's head of macro-financial stability, Bernard Hodgetts.

It is much harder to decrease mortgage lending rapidly, though in theory bank mortgage contracts allow them to ask for more capital from homeowners if their security position is eroded.

Hodgetts said: "It is more difficult for banks to call in domestic mortgages."

New mortgage lending would sharply reduce, Hodgetts said.

"A total freeze on mortgage lending seems unlikely, but it is clear from bank responses that they would tend to tighten lending criteria during a period of stress, especially for new borrowers, as they would wish to limit balance sheet expansion," he said.

Banks would also be doing deals with financially-stressed homeowners, trying to help them get through, keeping properties off the market to prevent prices dropping further.

"It is likely that banks would seek to renegotiate some terms and conditions on lending for stressed borrowers and that might potentially involve interest-only terms for some borrowers," Hodgetts said.

Cuts in the official cash rate - the rate which central banks charge commercial banks for overnight loans - would likely be made to stimulate the economy, but they would not be fully passed on to borrowers, the RBNZ found, as the banks attempted to stem crashing profits.

SAVERS

Those with money on deposit would find their cash in demand.

Banks indicated they would seek to increase the proportion of their funding provided by savers, and rely less on money sourced from international money markets.

That could trigger competitive rate rises for depositors, though there might also be a flight to safety with people taking their money from riskier investments and sticking it into accounts at the big banks.

"To the extent banks assume that they could increase the proportion of deposit funding, it is reasonable to think they would need to pay more for those deposits," Hodgetts said.

There could be other opportunities for investors.

All banks assumed they would be able to issue new bonds listed on the NZDX market to both mum and dad investors as well as institutional investors like KiwiSaver fund managers.

These bonds would give them secure, stable, long-term funding.

One group of investors who would not be happy would be bank shareholders.

The banks indicated that declines in profitability and financial strength would lead to restrictions on dividend payments to shareholders, RBNZ found.

The value of bank shares would fall, but even so, the results of the stress-testing suggest each of the big banks would remain well away from the point of economic failure.

Previous crises indicate brave investors who are willing to buy bank shares after a price fall, could reap windfall gains as the crisis passes.