Financial Stability Review – April 20251. The Global Macro-financial Environment

1.1 Key developments

In most advanced economies, households and businesses remain resilient, although there are pockets of financial stress.

The resilience of households in advanced economies has strengthened alongside strong employment and income growth outcomes. Despite recent easing, robust labour market outcomes in recent years have allowed households to strengthen their balance sheets, with debt-to-income ratios declining from recent peaks in most advanced economies. Further declines in policy rates in most advanced economies are also expected to assist households, particularly borrowers with variable-rate loans. The average interest rate paid by outstanding mortgage borrowers has started to stabilise or fall from recent peaks in countries with a high share of variable-rate mortgages, such as Australia, Norway and Sweden, and is expected to fall in New Zealand over 2025 as fixed-rate mortgages with shorter tenors reprice onto lower rates (Graph 1.1). However, outstanding mortgage rates could continue increasing in the United Kingdom over the next few years, as substantial portions of mortgagors are yet to roll off low fixed-rate terms locked in during the pandemic.

Loan arrears remain low in advanced economies, with severe financial stress concentrated in specific household segments. Mortgage loan arrears have increased modestly from extremely low pandemic-era levels, but remain comparable with the low levels seen before the global financial crisis (GFC). However, pockets of stress remain. Elevated interest rates and cost-of-living pressures continue to exert pressure on renters, highly indebted and low-income households. Many of these households have drawn down on savings and have continued to rely on consumer credit to manage budget pressures. While consumer credit makes up a relatively small share of banks’ lending to households in advanced economies (typically less than 20 per cent and much less in Australia), consumer credit arrears have risen above pre-pandemic levels for the United States, Canada and Sweden. In the United States, this has been concentrated in non-prime borrowers. A further easing in labour markets could weaken these households’ ability to service debt, leading to an increase in loan arrears.

Increasing housing prices in most advanced economies are supporting household balance sheets, but policymakers in some economies have expressed concern about high valuations. Housing prices have either increased or remained stable in most advanced economies (Graph 1.2). Most homeowners maintain positive equity buffers – even in economies where housing prices are below previous peaks such as Canada and New Zealand. However, some central banks, including the Reserve Bank of New Zealand² and the US Federal Reserve,³ have raised concerns around the level of house prices relative to fundamentals. Housing prices relative to rental costs also remain well above their long-term average in the United States, euro area, Japan and even in markets, such as New Zealand, that have recently experienced price corrections. Easing credit conditions and declining mortgage rates in most major advanced economies – driven by recent and further anticipated policy rate reductions – could exert further upward pressure on housing prices. While higher housing prices have the immediate effect of increasing borrower equity buffers and household wealth, they could also potentially weaken longer term resilience if households respond to easing financial conditions by taking on excessive debt (see Chapter 2: Resilience of Australian Households and Businesses).

Most corporations have demonstrated resilience and continue to service their debts. Corporate earnings have remained strong, which is supporting debt serviceability. Although cash buffers have been drawn down from pandemic-era highs, they remain around their historic averages. Financing conditions have remained favourable for most firms. Spreads on most corporate bonds have remained compressed around the lower end of historical ranges (Graph 1.3), leading to an increase in issuance as corporates are incentivised to buyback debt and issue new debt at lower rates. However, spreads on US speculative-grade debt have widened slightly recently as investors reassessed risks.

Some higher risk firms may experience refinancing challenges in the coming years, and pockets of corporate stress have emerged, such as in the US leveraged loan market. Despite the easing of policy rates in most countries and generally favourable market conditions, some borrowers are still expected to refinance pandemic-era debt at higher rates over 2025 and 2026; this potentially poses challenges for some higher risk borrowers. The share of publicly listed firms in the United States with a distance-to-insolvency (DI) – a timely measure of corporate health – in the most vulnerable category remains elevated (Graph 1.4). Corporate default rates for speculative-grade debt also remain elevated in the euro area, but market commentary suggests that this will decline over the coming months. Meanwhile, US leveraged loan defaults have increased to their highest level since the GFC. A significant share of this is because some firms have delayed payment of only a portion of their debt obligations; there is a risk that these firms could default on obligations or declare bankruptcy if the underlying issues are not resolved.

Systemically important banks in advanced economies are expected to remain resilient.

Bank capital and liquidity ratios remain well above regulatory minimums as bank profitability has been supported by higher non-interest income, particularly in the United States. Common Equity Tier 1 capital ratios remain relatively steady across most advanced economies, with supervisory reviews and stress testing indicating that banks would continue to remain well capitalised even if a severe economic downturn were to materialise. Investment banking and trading revenues have supported profitability, particularly for banks in the United States, offsetting a weakening in interest income. Net interest margins declined over the first half of 2024 in most advanced economies and are expected to remain under pressure as key policy rates continue to fall (Graph 1.5). Liquidity coverage ratios remain well above regulatory minimums, though regulators are continuing to discuss the suitability of liquidity risk frameworks to appropriately protect against the stresses experienced in Switzerland and parts of the US banking system in the 2023 liquidity crisis.⁴

Bank loan books in advanced economies remain healthy, with non-performing loans (NPLs) still at low levels and losses well provisioned for. The share of NPLs remains around multi-year lows (Graph 1.6) and loan losses have been concentrated in riskier lending segments such as consumer credit, which make up a small component of bank loan books. Banks have continued to increase provisions in anticipation of higher unemployment leading to loan losses.

Although commercial real estate (CRE) exposures remain limited for most banks and the near-term outlook has improved in some segments, CRE market fundamentals generally remain soft. Structural shifts – such as the shift to remote work and online shopping – continue to suppress demand, keeping CRE prices well below their recent peaks in most advanced economies. However, the US office and retail segments have started to experience positive price growth in recent months as market activity has started to pick up alongside the fall in interest rates and the return-to-office policy in some large financial service and technology companies. Despite this, continued pressures on CRE borrowers have led to a decline in CRE loan quality at US banks in the past six months, though the share of NPLs remain relatively low and well below their GFC peak (Graph 1.7). Looking ahead, a large amount of CRE loans are scheduled for refinancing in the coming years, potentially at higher rates, which could increase borrower serviceability pressures. Some banks, particularly in the United States, have sought to extend loan terms to avoid large refinancing jumps, though their ongoing capacity to do so may become constrained as upcoming maturities increase. Nevertheless, the risk of spillovers to Australia from overseas CRE markets – via common sources of ownership and funding – has declined (see Chapter 2: Resilience of Australian Households and Businesses).

NBFIs are playing a growing role in the global financial system, while investors are demanding higher returns on long-term government debt.

Recent increases in equity prices and declining yields on short-term bonds are supporting growth in the total value of assets managed by US and euro area funds. In 2023, the size of the NBFI sector globally grew 8.5 per cent, more than double the pace of banking sector, resulting in NBFIs managing US$239 trillion or just under half, of global financial assets by the end of 2023.⁵ Segments of NBFIs that have experienced significant growth include hedge funds, open-ended funds and money market funds, which accounted for 4, 19 and 5 per cent, respectively, of NBFI assets under management at the end of 2023. While global figures are not yet available for 2024, growth in the value of NBFIs’ assets has continued to be supported by strong growth in equity prices and declining yields on short-term bonds. In the year to September 2024, the gross notional exposure of hedge fund assets managed in the United States increased by 24 per cent to reach US$33 trillion (Graph 1.8). Similarly, total assets under management in open-ended and money market funds in the United States and euro area grew between 11 and 17 per cent over 2024.

Government bond yields have generally risen in most advanced economies over the past six months, particularly at the long end, reflected in higher term premia (Graph 1.9). The rise in term premia is partly in response to high debt levels and deteriorating fiscal outlooks (including higher defence spending demands in Europe), coupled with greater take-up of government debt by price-sensitive investors (such as non-banks) in response to reductions in central banks’ holdings. In Australia, the level of federal government borrowing is relatively low. However, strong bond issuance by state and territory governments (semis), alongside increasing participation from price sensitive investors, has led to a widening in the spread of semis relative to the (maturity-matched) federal government bonds over recent years.⁶ In January, concerns about government indebtedness in Queensland following a mid-year budget update resulted in the spread on some longer term semis increasing notably, though these movements have since largely been retraced.

1.2 Key vulnerabilities that could affect financial stability in Australia

Against the background discussed above, and in light of heightened uncertainty, there are three global vulnerabilities – related to market vulnerabilities, the Chinese economy and digitalisation – that could affect financial stability in Australia.

The current environment is punctuated by heightened geopolitical and policy uncertainty. The announcement of tariffs between the United States and other major economies – and the potential for further measures – could pose substantial headwinds to the outlook for global economic activity. Additionally, significant changes to fiscal and defence – and in the case of the United States, immigration, cryptocurrency and other – policies are being considered in a number of jurisdictions. These policy changes, and potential responses from other countries, could alter the trajectory of the global economy. The elevated level of sovereign indebtedness could limit governments’ ability to support their local economies in the event of a significant slowdown. This challenge could be particularly pronounced in Europe, where governments may face difficult economic trade-offs if defence spending increases substantially. Separately, the appetite across advanced economies to reduce the regulatory burden on banks could ease financial conditions and support economic growth in the short term, while undermining banks’ resilience to future shocks. These international developments are evolving rapidly, and the greater uncertainty surrounding trade policies and the economic outlook may, in itself, dampen activity as households and companies delay spending and investment decisions until greater clarity emerges. The global financial system also remains exposed to potential disruptions from climate change shocks, while operational risk, including the rising intensity of cyber-attacks, are an ongoing concern for policymakers internationally.

All these uncertainties could interact with existing vulnerabilities and lead to the sudden materialisation of financial stability risks. Three key vulnerabilities that stand out as having the potential to significantly impact financial stability in Australia are discussed below.

Key vulnerability #1 – Vulnerabilities in key international financial markets could be crystalised and lead to disorderly price adjustments, amplified by global NBFIs’ procyclical behaviour.

Equity risk premia remain low, raising the risk of volatility and sharp adjustments in global markets. Despite recent market moves, risk premia in global credit and equity markets are generally low by historical standards, leaving global asset prices susceptible to large adjustments in the event of unexpected news or developments (Graph 1.3; Graph 1.10). For example, a sharp repricing of risk, from current low levels, could abruptly increase borrowing costs for corporations and exacerbate refinancing challenges. This could be triggered by geopolitical tensions, such as the imposition or threat of tariffs by the United States and its trading partners, which could impact earnings not only for firms directly affected but also for corporations more broadly from a weakening in economic conditions. While sentiment in international financial markets has shifted markedly in recent weeks, as at finalisation of this Review, there was still a large degree of uncertainty about the effects of higher tariffs on US and global growth and inflation.

The nature of the rally in equity markets over recent years has contributed to increased concentration risk. The technology sector has become a large and growing share of equity indices in advanced economies, with some indices having exceeded regulatory concentration thresholds prompting index providers to cap weights allocated to the largest companies (Graph 1.11).⁷ Valuation in stocks related to artificial intelligence (AI) continue to appear stretched and investor positioning remains crowded. On a cyclically adjusted basis, the price-to-earnings ratio in the S&P 500 is around its highest level since the ‘dot-com bubble’. Greater market concentration, alongside low risk premia, increases the potential for unexpected technology-related news to set off a disorderly repricing across equity markets.

Some types of global NBFIs – such as hedge funds, private markets, open-ended and money market funds – have the potential to amplify shocks through procyclical behaviour. Hedge funds, in particular, have more pronounced vulnerabilities due to their reliance on highly leveraged investment strategies. In the year to September 2024, hedge funds increased their borrowing from both repo and prime brokerage, while the high level of leverage funds’ short positions in US Treasury futures suggests a build-up in the US Treasury cash-futures basis trade (Graph 1.12).⁸ In part due to these trades, hedge funds’ share of US Treasury debt outstanding has increased from just over 2 per cent to just over 10 per cent over the last few years, and it is now higher than it was pre-pandemic.⁹ A sudden spike in yields could force the rapid unwinding of these leveraged trades and trigger a margin spiral – where traders are forced to sell in an illiquid market to meet margin calls, leading to a cycle of further price decreases and margin calls – like the one that occurred in March 2020.¹⁰

Private markets also use a high degree of (potentially hidden) leverage. While risks in private credit markets appear contained,¹¹ private equity funds are finding it difficult to sell assets in order to realise a return on their investment. A higher-than-normal share (approximately half) of committed capital in US private equity funds are in funds that are six or more years old, at which point they would typically be looking to realise returns within the next few years, yet sales of private equity assets are relatively low.¹² Furthermore, the default rate on leveraged loans (used to fund private equity deals) reached 7.2 per cent in November, its highest level since the GFC. For open-ended and money market funds, the key vulnerability is the potential for fire sales in response to large liquidity mismatches if investors redemptions surge unexpectedly. The Financial Stability Board (FSB) continues to develop¹³ and encourage the implementation of policies to mitigate vulnerabilities in NBFIs, although progress on implementation has been slow.¹⁴

Key vulnerability #2 – Longstanding vulnerabilities throughout the Chinese financial system could result in stress spilling over internationally through trade channels and heightened global risk aversion.

Vulnerabilities of Chinese banks and local governments have been exacerbated by the ongoing weakness in the Chinese real estate sector. While property prices and housing sales in China appear to have stabilised, China’s property market remains weak. The Chinese banking sector’s exposure to the Chinese property market remains substantial, including to property developers who remain under severe financial stress. The profitability of China’s large banks continues to decline, with most reporting net interest margins below the 1.8 per cent threshold recommended by the Chinese authorities (Graph 1.13). While reported NPL ratios remain low and stable, some commentators have suggested these ratios are under-reported.¹⁵ Additionally, the most recent stress testing by the Chinese authorities shows that some domestically systemically important banks would be vulnerable to a sudden credit deterioration.¹⁶

Chinese policymakers have adopted a more supportive policy stance, but it is unclear whether these actions will help to address or potentially worsen persistent financial vulnerabilities. Since September 2024, the Chinese authorities have announced a range of policies designed to support economic activity and address financial stability concerns. However, some of these initiatives may fall short of tackling, or potentially magnify, the underlying issues. For instance, the local government debt-swap program is expected to strengthen local government balance sheets and help to address local government payment arrears. Nevertheless, without a recovery in the property market or broader fiscal reform, local governments could continue to struggle in generating sufficient revenue to service debt and provide public services.¹⁷ Similarly, while the recapitalisation of state-owned banks may boost lending in the medium term, it does not address the underlying profitability and asset quality concerns, while potentially encouraging riskier lending practices. In addition, US tariffs on Chinese imports may necessitate a further policy response from the Chinese authorities to support economic activity, potentially including easing in financial conditions. This could increase the debt overhang in some sectors of the economy.

Instability in the Chinese financial system could affect Australia, and the rest of the world, via increased risk aversion in global financial markets and slower global economic growth. A shock to the Chinese financial system is unlikely to have a direct impact on financial stability in Australia as the financial links between China and Australia are limited. The key channels of transmission of financial stress in China to Australia would likely be via increased risk aversion in global financial markets, a sharp slowing in global economic activity, lower global commodity prices and reduced Chinese demand for Australian goods and services. In turn, this could spillover into weaker spending by Australian consumers and businesses. In this circumstance, the Australian dollar exchange rate would be expected to continue to act as an automatic stabiliser and help to offset some of the negative impact on the Australian economy.

Key vulnerability #3 – As digitalisation reshapes the financial sector, the complexity and interconnectedness of the financial system is creating operational vulnerabilities.

Digitalisation is redefining how financial services are delivered, while also increasing vulnerability of the financial system to operational disruptions, which could undermine public confidence. Technological innovation, such as the use of AI,¹⁸ is broadening the range of financial services and products, facilitating the entrance of new providers, and altering how risks emerge and are managed (see 4.2 Focus Topic: Looking at Digitalisation through a Financial Stability Lens). Digitalisation offers the potential for substantial efficiency gains in the financial system, yet it also increases exposure to technology outages and cyber-attacks. Geopolitical tensions could lead to an increase in the frequency and sophistication of disruptive cyber-attacks. In addition, recent operational incidents have highlighted the growing concentration of dependencies on key service providers, and the importance of financial institutions intensifying their efforts to strengthen operational resilience.¹⁹

Endnotes

Jones B (2023), ‘Emerging Threats to Financial Stability – New Challenges for the Next Decade’, Speech at the Australian Finance Industry Association Conference, 31 October. 1

Reserve Bank of New Zealand (2024), Financial Stability Report, November. 2

Federal Reserve Board (2024), Financial Stability Report, November. 3

Basel Committee on Banking Supervision (2024), ‘The 2023 Banking Turmoil and Liquidity Risk: A Progress Report’, October. 4

FSB (2024), ‘Global Monitoring Report on Non-Bank Financial Intermediation 2024’, December. 5

For background on the semi-government bond market, see Batchelor S and M Roberts (2024), ‘Recent Developments in the Semi-government Bond Market’, RBA Bulletin, January. 6

In November 2024, FTSE Russell capped the standard Russell US Style Indexes in response to recent increases in market concentration within the large and mega cap growth indexes. 7

The US Treasury cash-futures basis trade involves exploiting the price differential between Treasury securities and the related Treasury futures contract by purchasing the asset that is undervalued and selling the other on the assumption that prices between the two assets will converge on maturity. This arbitrage activity improves market efficiency and liquidity. 8

International Monetary Fund (2024), ‘Global Financial Stability Report’, October. 9

Glicoes J, B Iorio, P Monin and L Petrasek (2024), ‘The Fed – Quantifying Treasury Cash-Futures Basis Trades’, FEDS Notes, 8 March. 10

Chinnery A, W Maher, D May and J Spiller (2024), ‘Growth in Global Private Credit’, RBA Bulletin, October. 11

Pitchbook (2024), ‘US 2025 Private Equity Outlook’, December. 12

See, for example, FSB (2024), ‘Leverage in Non-Bank Financial Intermediation: Consultation Report’, December; FSB (2024), ‘Liquidity Preparedness for Margin and Collateral Calls: Final Report’, December. 13

See, for example, FSB (2024), ‘Thematic Review on Money Market Fund Reforms: Peer Review Report’, February. 14

See, for example, Charoenwong B, M Miao and T Ruan (2025), ‘Non-Performing Loan Disposals Without Resolution’, Management Science, 71(1), pp 898–916. 15

People’s Bank of China (2023), China Financial Stability Report, September. 16

For further information on local government financing vehicles, see Hendy P, E Ryan and G Taylor (2024), ‘The ABCs of LGFVs: China’s Local Government Financing Vehicles’, RBA Bulletin, October. 17

For further details on the financial stability implications of AI, see RBA (2024), ‘4.1 Focus Topic: Financial Stability Implications of Artificial Intelligence’, Financial Stability Review, September. 18

RBA (2024), ‘Chapter 1: The Global Macro-financial Environment’, Financial Stability Review, September. 19