(Bloomberg) -- The share of Australian borrowers in severe financial stress remains small with the vast majority still able to service their debts, the Reserve Bank said in a half-yearly review, while highlighting other areas of threat to the banking system including from China.

"The risk of widespread financial stress remains limited due to generally strong financial positions of most borrowers," the RBA said in its Financial Stability Review released in Sydney on Thursday. "Very few mortgage borrowers are in negative equity, limiting the impact on lenders in the event of default and supporting their ability to continue providing credit to the economy."

The RBA cautioned that domestic vulnerabilities could increase if households responded to any easing in financial conditions by taking on excessive debt. It noted that periods of low or falling interest rates historically have coincided with borrowers taking on higher levels of debt and in some cases lenders extending credit to risky borrowers.

"International experience has highlighted the danger of boom-bust asset price cycles, particularly those amplified by the widespread use of borrowed money," the RBA said. "Residential property stands out in this regard."

Australian households are under pressure as most are on floating-rate mortgages, meaning the 4.25 percentage points of rate increases between May 2022 and November 2023 rapidly passed through to increases in loan repayments. The RBA has kept its cash rate at a 12-year high of 4.35% this year and has signaled it will remain at that level for the time being.

The RBA said Thursday that Australian banks are resilient and even though lenders anticipate an increase in loan arrears, their capital and liquidity buffers are well above regulatory requirements.

Many businesses also continue to manage pressure on their cash flows and balance sheets, supported by sturdy finances prior to the inflation breakout of 2021, the review showed. Most businesses that have entered insolvency are small and have little debt, limiting the broader impact on the labor market and thus household incomes, and on the capital position of lenders.

"Financial pressures are expected to ease," the RBA said, pointing to tax cuts that kicked in on July 1 and slower inflation. "However, the expected easing in labor market conditions and subdued growth in activity are likely to present challenges for some households and businesses."

Most mortgagors have experienced an increase in minimum scheduled payments of 30%-60% since May 2022, when the current interest rate tightening campaign began. Even so, less than 1% of all owner-occupier housing loan balances are 90+ days in arrears. Around 0.5% of loans in arrears are estimated to be in negative equity.

The share of floating-rate owner-occupier borrowers estimated to have had essential expenses and scheduled mortgage repayments exceed their income, leading to an estimated cash flow shortfall, has remained around 5%.

If inflation was to remain high for longer than forecast, the share of borrowers most at risk of being unable to service their debts would increase only slightly, the review found. A larger-than-expected increase in unemployment would lead to greater financial stress though risks to the broader financial system would likely remain contained, it said.

The semi-annual review identified Australia's massive superannuation sector as an area of risk to the financial system, given its rapid growth in recent years and increased exposure to margin calls.

Other areas of risk include:

• Operational vulnerabilities from digitization of the financial system

• Low risk premia in global credit and equity markets leaves them vulnerable to a disorderly adjustment

• Imbalances in China's financial sector could spill over to the rest of its economy, and to Australia and the world, through trade and global risk aversion channels

2024 Bloomberg L.P.