UPDATE 1-Australian banks warned not to ease lending standards - RBA
* RBA: banks should not take risk to meet unrealistic profit goals
* No sign yet of inappropriate risk-taking by Australian banks
* Euro zone, slower global growth pose risk to world financial system (Updates with analyst comment, market reaction)
SYDNEY, Sept 25 (Reuters) - Australian banks are well placed to cope with any shocks from abroad, the country's central bank said on Tuesday, though it also warned them against taking inappropriate risks in order to achieve unrealistic profit goals.
In its semi-annual Financial Stability Review, the Reserve Bank of Australia (RBA) highlighted Europe's debt crisis as a threat to the stability of the global financial system as well.
At home, it noted that subdued credit demand and higher funding costs had made for a highly competitive environment.
"Looking ahead, how banks respond to these obstacles to profit growth could be a key factor for financial stability over the medium term," the RBA said in a 64-page report.
"A challenge for firms in a competitive banking environment will be to resist the pressure to ease lending standards to gain market share in the pursuit of unrealistic profit expectations."
It was quick to point out there is little evidence so far that Australian banks have been "imprudently easing lending standards" to boost credit growth. But it observed that they are seeking ways to sustain profit growth, including cutting costs.
"Such strategies will need to be pursued carefully to ensure that risk management capabilities and controls are maintained," it said.
Last month, the country's major lenders including Commonwealth Bank reported flat cash profit and warned of cost pressures, raising doubts they can continue their run of record results.
The Australian dollar shrugged off the report, which had been widely expected to give the banking sector a clean bill of health. It last traded at $1.0441, a tad firmer from late New York levels.
Shares in the big four domestic banks were mostly higher led by a 0.7 percent rise in Commonwealth Bank and Westpac Bank , outperforming a slightly softer overall market .
"Generally, its a very good report card for the financial system, but contained within is a couple of pretty clear warnings," said Craig James, chief economist at Commsec.
Part of the reason for the tepid credit demand is that households are continuing to save and pay down existing debt more quickly than required, the RBA noted.
This is not a bad thing, given that it'll make indebted households better able to cope with any future income shock or fall in house prices, it added.
On the wholesale funding market, the RBA said pressures have eased since late last year and banks have reduced their reliance on it as growth in deposits has continued to outpace credit demand. Deposits now account for 53 percent of banks' funding, up from about 40 percent in 2008.
Also helping bolster their resilience to shocks, Australian banks have continued to strengthened their capital positions over recent years, the RBA noted.
Still, the central bank warned the financial sector remained vulnerable to swings in global sentiment associated with the problems in Europe.
Despite the European Central Bank's latest efforts to tackle the region's sovereign debt crisis, the RBA said there is still "significant implementation risks and many of the underlying problems in the euro area are yet to be effectively resolved."
"Given these ongoing difficulties, markets will likely remain sensitive to any setbacks in dealing with the euro area crisis," the report said.
"Along with the weaker near-term outlook for global growth, the euro area problems will continue to pose heightened risks to global financial stability in the period ahead."
Outside the euro area, the RBA sounded more relaxed saying banking systems of advanced countries were still recovering gradually from the global financial crisis, while those in Asia have largely been resilient to Europe's debt woes, partly because of their domestic focus. (Reporting by Ian Chua; Editing by Eric Meijer)