By Business editor Peter Ryan
The Reserve Bank has warned that Australia could be exposed to "vulnerabilities" in Asia sparked by fallout from Europe's unresolved debt crisis.
In its latest Financial Stability Review, the RBA has signaled that a slowing in the United States and China caused by "a disorderly resolution" of the Europe crisis puts Asia's banking system at risk.
"Vulnerabilities may have built up during recent credit expansions which could be revealed in the event of a significant decline in asset prices or economic activity," the RBA says.
"As some banking systems in Asia are now quite large, there is a greater chance that problems in them could have adverse international spillovers."
But the RBA says Asia's banking system has been so far "largely resilient" to the Europe crisis because of their domestic focus.
The semi-annual review confirms that the Europe crisis remains the single biggest risk to the global economy despite recent intervention by the European Central Bank to buy unlimited bonds from struggling economies.
"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 year ahead," the Review warns.
Despite the global outlook, the RBA says the Australian banking system remains "in a relatively strong position" and that it is underpinned by "robust financial, regulatory, supervisory and crisis management frameworks."
The Review also notes the pressures on wholesale fund markets have eased and that banks have restored good market access to international markets over the past six months.
But once again, the central bank is urging caution.
"While the Australian banks have little direct asset exposure to the most troubled euro area economies, they remain exposed to swings in global financial market sentiment associated with the problems in Europe."
While bad and doubtful debt charges have fallen since the peak of the global financial crisis, the Review says banks are now challenged by high funding costs, lower credit growth and slower growth in profit.
The RBA says that while the competitive pressures have not yet spurred "inappropriate risk taking" , it is concerned about lower lending standards last seen in the leadup to the financial crisis.
"A challenge for firms in the competitive banking environment will be to resist the pressure to ease lending standards to gain market shares in the pursuit of unrealistic profit expectations."
The Review says households and businesses have continued their "prudent approach" to debt.
"Many households continue to prefer saving and paying down their debt more quickly than required," the RBA says.
The RBA says the paying down of debt is "desirable" as it makes indebted households better placed to withstand future shocks such as a fall in housing prices.