Financial Stability Review – April 2025Financial Stability Assessment

The Australian financial system has continued to display a high level of resilience.

Risks to the Australian financial system from lending to households, businesses and commercial real estate have remained contained. Budget pressures remain pervasive across the Australian community, but they have eased a little for some and the share of borrowers experiencing severe financial stress remains small, reflecting the continued strength in the labour market and the maintenance of prudent lending standards. After earlier increases, the share of households that have fallen behind on their mortgages appears to have stabilised at pre-pandemic levels and almost all borrowers now benefit from home values that exceed their mortgage balances (substantially so in many cases). Company insolvencies have picked up over the past couple of years to be at the top of the range observed in the 2010s – particularly among smaller firms that face a challenging operating environment – although on a cumulative basis they remain slightly below their pre-pandemic trend. Additionally, broader spillovers to the financial system have been limited, largely due to these firms’ small size and limited bank debt. Overall, most household and business borrowers and owners of commercial real estate have been able to manage the pressures on their finances. This has helped maintain credit quality across the financial system.

Australian banks’ resilience has been supported by a long period of prudent lending standards, the high quality and quantity of capital, and large liquid asset buffers. Banks have steadily increased their capital over the past decade – largely through retained earnings – to be well above regulatory requirements. Despite some borrowers experiencing severe financial stress, overall asset quality has remained high and loan losses have been minimal.

The financial stability risk posed by the non-bank financial (NBFI) sector in Australia is contained by its composition. A small share of NBFI assets is held by entities that operate outside the regulatory perimeter and have risky features, such as high leverage or opaque business structures. By contrast, a relatively large share is held by APRA-regulated superannuation funds, which are primarily defined contribution funds that pass through investment risk to their members and hence do not directly bear the consequences of market outcomes. These funds are restricted from taking on leverage directly, and most still benefit from a steady net inflow of liquidity from members, further mitigating the risk they pose to financial stability. However, given the sector is now a large participant in key financial markets, liquidity challenges for the broader financial system could arise in the event of large shocks to the superannuation sector; for example, where an unexpected policy change allowing for early withdrawal of superannuation balances occurred alongside capital calls on private asset commitments and a large, sustained decline in the Australian dollar drained liquidity through payments related to foreign exchange hedges.

The global financial system has proved resilient to a range of shocks in recent years.

Easing inflation and lower policy rates in advanced economies have reduced the pressure on households and businesses, although stress has picked up in pockets of the corporate sector where profits are under pressure. Robust labour markets have been key in maintaining the resilience of households, while most businesses have been supported by solid earnings and cash buffers.

However, economic growth has remained sluggish, labour markets have eased in many economies, and rapid shifts in trade and fiscal policies could alter the trajectory of global growth and undo some of the progress on inflation. A significant economic downturn, including a sharp deterioration in labour markets, is the principal risk to the resilience of borrowers. Yet the sizeable capital and liquidity buffers maintained by large banks in advanced economies, including Australia, should help them to navigate a scenario where economic conditions deteriorate, while continuing to support the economy.

Heightened geopolitical tensions and policy uncertainty in major economies has the potential to interact with existing vulnerabilities.

Ongoing uncertainty about the United States’ international trade policies, and the reactions this may trigger, could have a chilling effect on business investment and household spending decisions, and pose substantial headwinds to the outlook for global economic activity and inflation. There is also considerable uncertainty about the effects of possible fiscal, regulatory and other government policy changes on global growth and inflation. All these uncertainties add to existing risks from cyber and operational incidents and climate change shocks.

Three key vulnerabilities stand out as having the potential to significantly affect financial stability in Australia:¹

• Vulnerabilities in key international financial markets, amplified by longstanding vulnerabilities in the global NBFI sector. Compressed risk premia and concentration of exposures in equity markets increase the likelihood that adverse news – triggered by any number of global risks in a highly uncertain environment – sparks a disorderly correction in global asset prices. Rising leverage and the risk of liquidity mismatches among some NBFIs has the potential to amplify such a shock.
• Imbalances in China’s financial sector. Chinese policymakers appear to have adopted a more supportive counter-cyclical policy stance of late, but in easing financial conditions, these policies could exacerbate long-term debt vulnerabilities in the Chinese financial system. US tariffs on Chinese imports may necessitate a further policy response from the Chinese authorities to support economic activity. If macro-financial risks were to materialise in China, stress could spill over into the global financial system, including Australia, via trade channels and increased risk aversion in global financial markets.
• Operational vulnerabilities resulting from growing complexity and interconnectedness. While digitalisation offers the potential for substantial efficiency gains in the financial system, it can also increase the complexity and interdependence in supporting systems. As a result, operational systems in key financial market infrastructure and key institutions are increasingly vulnerable to technology outages and malicious cyber-attacks. The threat landscape for operational risk could worsen further in the context of escalating geopolitical tensions.

If risks were to materialise, these vulnerabilities could cause spillover effects to the Australian financial system in three main ways:

• Via a significant increase in risk aversion in global financial markets. This could sharply increase financing costs, including in Australia, and restrict Australian firms’ and financial institutions’ access to funding and liquidity in global markets. It could also create liquidity strains for Australian banks and NBFIs, such as superannuation funds. Such an event would intensify financial pressures on domestic borrowers and, if severe enough to strain financial institutions’ balance sheets, could limit credit availability in the Australian economy. However, there is considerable scope for most borrowers and lenders to draw down on buffers in the event of a liquidity shock, and any depreciation of the exchange rate would similarly play a shock-absorbing role for the wider economy.
• Via the impact on the outlook for the real economy. A global economic downturn, particularly one that leads to a sharp slowdown in China (Australia’s most significant trading partner), could negatively affect Australia through trade channels – including commodity prices and investment – and spill over into weaker spending by Australian consumers and businesses.
• Via a severe operational disruption. A direct and rapid impact could arise from disruptions to financial system and national infrastructure, or to a key financial institution, and could also undermine public confidence.

The Australian financial system is well placed to continue to provide vital services in the event of a severe downturn.

Cash flow pressures on borrowers will remain widespread in the near term but are expected to ease a little further. The forecasts presented in the February Statement on Monetary Policy (based on the market-implied cash rate path at that time) suggested that most households and businesses would see some improvements in their cash flow positions over the months ahead, supported by an improvement in the economic environment and easing financial conditions. However, the most vulnerable borrowers will continue to face significant challenges.

Considerable uncertainty surrounds the outlook. If the economy, and thus the labour market, proves materially weaker than assumed in the central forecast or if financial conditions do not ease as much as markets expect, a larger number of borrowers would experience stress, other things equal. Additionally, if downside risks to the global outlook materialise, they could spill over to some Australian businesses via trade linkages or tighter access to offshore funding markets. Nevertheless, the strong financial positions of most households, businesses and owners of commercial real estate are likely to limit the risk of widespread financial stress.

Even in the event of a significant economic downturn, banks are well positioned to absorb large loan losses while continuing to support the economy through lending to households and businesses. Banks are well provisioned for loan losses and continue to maintain capital and liquidity buffers well above regulatory requirements.

The superannuation sector has in the past generally displayed a high level of resilience and funds’ activities have tended to support financial stability. While the sector supports long-term capital formation in Australia and has previously been a supplier of liquidity to the system in periods of financial stress, the growth and size of the sector now introduces the potential for it to amplify stress if several extreme-but-plausible liquidity risks materialised simultaneously. It is also exposed to the risk of operational disruptions. Continued strengthening of superannuation funds’ governance and liquidity and operational risk management practices is therefore an area of ongoing focus of regulators.

The general insurance sector also displays resilience, but insurance affordability and availability may become increasingly challenging over time. The general insurance sector is well capitalised and profitability has been supported by low claims, higher premiums and a moderation in the growth of reinsurance costs. However, claims are expected to rise due to the impact of Cyclone Alfred in Queensland and New South Wales in March. And insured losses from the Los Angeles wildfires in January could drive up global reinsurance costs. This could put upward pressure on home insurance premiums in Australia, further reducing affordability in areas at risk of natural perils. These trends could continue as climate change intensifies weather-related risks to physical infrastructure over time. If this were to lead to declining insurance coverage for mortgaged properties, banks may be increasingly exposed to financial losses from physical climate risk, potentially leading to financial stability risks in the longer term.

However, it is important that lending standards remain sound …

Looking further ahead, resilience could be undermined if lending standards deteriorate and households respond to an actual or anticipated easing in financial conditions by accumulating excessive debt. While lending standards have been very sound in recent years, and the ratio of net household debt to income has been little changed, the RBA and other regulators will closely monitor for signs of emerging housing-related vulnerabilities. In the business sector, an actual or anticipated easing in financial conditions does not appear likely to contribute to a material build-up of vulnerabilities given the current outlook; business leverage is at historically low levels and tends to be most influenced by demand, which is expected to grow only moderately in the period ahead based on the forecasts presented in the February Statement on Monetary Policy.

… and that financial institutions continue to enhance their resilience.

Strengthening crisis readiness and cyber and operational resilience in the Australian financial system is a regulatory priority. Advancing digitalisation of the financial system increases the prospect that cyber-attacks could have systemic implications. The Council of Financial Regulators (CFR) agencies are actively working with government and industry towards strengthening resilience within firms and across their networks, with a particular focus on better understanding service provider concentration risks, testing crisis management and cyber defence plans, and developing back-up payments capabilities.

Strengthening preparedness for the potential impacts of geopolitical risk is increasingly important. Heightened international tensions create the potential for adverse effects on the economy and financial system, including from cyber threats and conflicts. The CFR agreed a work program in December 2024 to reinforce system-wide resilience to geopolitical risk. The CFR noted that geopolitical risk is an increasing concern for regulators and industry internationally, and is likely fundamentally to characterise global affairs for some time.

Endnote

For background on the conceptual framework the RBA uses to assess financial stability, see 4.1 Focus Topic: A Conceptual Framework for Assessing Financial Stability. 1