SYDNEY Australia's central bank on Wednesday urged banks not to take undue risks and relax their lending standards, warning the current low interest rate environment has the potential to encourage speculative froth in the housing market.
In its 56-page Financial Stability Review report, the Reserve Bank of Australia (RBA) said the country's financial system is sound and major banks are well placed to meet higher international liquidity standards due to kick in next year.
It noted that local banks have increased their resilience to adverse shocks since the global financial crisis and their asset performance has continued to gradually improve.
"With banks' bad and doubtful debt charges now at relatively low levels, and in an environment of moderate credit growth, the sources of profit growth may be more limited in the period ahead," the RBA said in its twice yearly review.
"It will be important for financial stability that banks do not respond by unduly increasing their risk appetite or relaxing their lending standards."
One area that needed particular attention was their housing loan practices, the RBA said.
"The pick-up in lending for housing would be unhelpful if it was a result of lenders materially relaxing their lending standards," the report said.
The RBA noted that lending to housing investors was growing at a strong pace at some banks and warned this could fuel speculative demand that will in turn raise the risk of a sharp housing downturn in the future.
To be sure, the central bank said such conditions were not there yet.
"An upsurge in speculative housing demand would be more likely to generate financial stability risks if it brought forth an increase in construction of a scale that led to a future overhang of supply and a subsequent decline in housing prices," it said.
"At a national level, Australia is a long way from the point of housing oversupply, though localized pockets of overbuilding are still possible."
The central bank also stressed that continued prudent borrowing and saving are needed to underpin the resilience of households, whose gearing and indebtedness remain near historical highs.
"The recent momentum in household risk appetite and borrowing behavior, in particular, therefore warrants continued close observation."
Since late 2011, the RBA has slashed 225 basis points off its benchmark cash rate to a record low 2.5 percent. This year, it indicated that the most prudent path was for rates to remain steady for a while.
On the financial position of the business sector, the RBA said little has changed since its last review in September.
"Balance sheets are generally in good shape with gearing and interest burdens at fairly low levels," it said, noting appetite for debt remained subdued.