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Financial stability review: September 2014

23 Sep 2014

Provides the Bank's assessment of the current condition of the financial system and potential risks to financial stability.

The global financial system continues to be buoyed by strong investor risk appetite. International financial markets have been remarkably stable for much of the past six months, with historically low volatility and ‘search for yield’ behaviour evident in many asset classes amid highly expansionary monetary policy. This environment has supported economic growth and an ongoing improvement in most banking systems. Nonetheless, a significant reassessment of risk could lead to a sharp repricing of assets, particularly if markets are less liquid than
anticipated. Potential triggers for such a reappraisal include revised expectations for monetary policy in advanced economies. Up to this point, however, market prices have reacted remarkably little to credit and geopolitical events that might have been expected to affect investor risk appetite.

Risks surrounding European banks and sovereigns have lessened but not disappeared, given the slow growth environment. European banks have made some progress with balance sheet repair in the lead-up to the release of the European Asset Quality Review, though if the results are unexpectedly negative, it could impede these banks’ ability to raise additional capital. Conditions in many emerging markets have stabilised since early 2014. However, credit and property prices have grown strongly in some emerging economies, including China, which may have made these economies more sensitive to adverse shocks.

Financial system stability in Australia is being underpinned by the continued strong financial performance of the banking system. Australian banks have improved their resilience to future shocks by increasing capital ratios, and their profitability remains robust, aided by further declines in bad and doubtful debt charges. They are also benefiting from improved wholesale funding conditions globally. This in turn has put downward pressure on deposit pricing and fostered an environment of stronger price competition in lending. Non-banks are also benefiting from the lower funding costs, with issuance of residential mortgage-backed securities by a wider range of entities (including mortgage originators) picking up and associated spreads narrowing.


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