What to Know From RBA's Financial Stability Review

The Reserve Bank of Australia (RBA) acknowledges that some households are under pressure from high inflation and interest rates, noting that around 2% of borrowers are at risk of depleting their liquid savings buffers by 2026. Despite this, the RBA indicates a relatively low risk to financial stability from defaults. The pressure on household budgets is expected to ease due to stage 3 tax cuts and anticipated declines in the inflation rate.

The RBA explains that these 2% of borrowers may not necessarily default but could make difficult lifestyle adjustments, such as selling property or reducing other expenses, although these options may not be available to everyone. If inflation remains high and interest rates are not eased, the proportion of borrowers under stress is expected to increase. A significant rise in unemployment could also exacerbate this stress.

Currently, less than 1% of owner-occupied housing loan balances are 90 or more days in arrears, a figure expected to remain close to pre-pandemic levels. Only 0.5% of loans in arrears are in negative equity, amounting to 0.01% of all loans. About 5% of variable rate owner-occupier borrowers have essential expenses and repayments exceeding their income. However, more than 70% of borrowers have enough prepaid savings buffers to cover their expenses and mortgage repayments for six months if they become unemployed.

Despite the pressures, the RBA's review indicates that most borrowers have been able to service their debts and cover essential costs without depleting their savings through the first half of 2024. While some borrowers are experiencing acute budget pressures, most are still adding to their mortgage buffers, implying that they will remain able to service their debts under current projections.

However, it highlights several concerns including stress in China's financial sector, high global leverage, and vulnerabilities due to digitalisation and AI/cloud provider concentration. The review notes that the superannuation sector's growth could amplify shocks and that approximately 2% of owner-occupier borrowers are at real risk of defaulting. Despite these issues, the majority of borrowers can service their debt, and Australian banks remain well-capitalized and profitable. Regulators are focusing on strengthening operational resilience in banks.

Private credit, catering to middle market firms too risky for traditional loans, is growing rapidly, with global assets reaching $2.1 trillion in 2023. Managed by asset managers for investors like pension funds and insurance companies, this market involves riskier, illiquid assets with limited redemption options. Despite lower default rates compared to similar investments, potential synchronized asset write-downs and complex leverage chains pose financial stability risks. Data limitations hinder regulators' ability to monitor these risks and interconnections with the broader financial system.

Australia's central bank has cautioned that the rapid growth of the nation's A$3.9 trillion pensions industry poses new risks to financial stability. The sector, known locally as superannuation, is increasingly intertwined with the banking system, holding significant portions of banks' short-term debt and equity. The RBA highlighted that superannuation funds could amplify financial shocks, particularly during market stress, as seen during the pandemic. Challenges include managing liquidity as more people retire and the industry's growing exposure to offshore assets. The warning coincides with AustralianSuper appointing its first chief liquidity officer to manage these risks. The industry is expected to continue its rapid growth, outpacing the overall financial system. Regulators are closely monitoring the sector, especially its unlisted investments.