Stress testing by the Reserve Bank of New Zealand (working with APRA) shows the Australian-owned Big Four banks would remain solvent under two scenarios, as reported in the latest RBNZ bulletin. The first scenario modelled was a severe Chinese downturn with effects spreading through the global economy resulting in a collapse in demand for commodity products. The RBNZ predicted this, and the resulting negative investor sentiment to New Zealand, could result in a double digit rise in unemployment and a 35 per cent fall in house prices. The second scenario added in an industry-wide misconduct event. The RBNZ said the modelling showed the Big Four, as a group, was able to avoid breaching capital requirements and remain solvent thanks to their strong underlying profitability. But their combined pre-tax profit could be slashed by up to NZ$32 billion over five years to just $4 billion. The Reserve Bank of New Zealand has decided that the Big Four Australian-owned banks will be allowed to continue using internal models to estimate credit-risk related RWA, although with more restrictions on the modelling used. In practice, this means that ANZ, ASB, Westpac and BNZ will have to start reporting using both the internal models approach they have been using and the standardised approach used by the other, mostly locally-owned, New Zealand banks. The RBNZ said it would be consulting stakeholders next year on the detail of the decision. Consistent with the views of the Basel Committee and the IRB, the RBNZ said it continued "to believe that credit risk models need to be constrained more in the light of our experience with the IRB framework."