An oversupply of residential property developments has now become a key domestic risk to Australia's financial system according to the Reserve Bank.
While real estate investment has softened over the past six months, the Reserve Bank is worried about a "significant and geographically concentrated" growth in supply of new apartments in Sydney, Melbourne, Brisbane and Perth.
The RBA says with demand for apartments softening particularly in Brisbane and Perth, risks are rising that "settlement failures might increase" for investors who have bought from developers off-the-plan.
"A downturn in apartment markets could weaken the financial health of these developers," the RBA warns in its half yearly Financial Stability Review released this morning.
The RBA suggests an oversupply of apartments may weigh on prices and rents over the next few years and the option of selling up to service debt might be difficult.
"If that occurs, investors will need to service their mortgages while earning lower rental income," the RBA warns.
"Any households having difficulties in making repayments may not be able to resolve their situation easily by selling the property."
The RBA review also points concerns about a buildup in property investment by Chinese investors and how Australia could be exposed to a downturn if off the plan purchases turn sour.
"These apartments are popular with investors and foreign buyers and any concern over settlement risk and/or a slowdown in demand for Australian-located property by Chinese and other Asian residents could lead to difficulties," the Review warns.
In addition to residential property, the RBA is also concerned about financial exposure to the resources sector given the end of the mining investment boom.
While the RBA says the exposure of Australian banks to the mining sector is "small", it warns that foreign banks operating in Australia have a higher share of total lending to mining.
The RBA says despite household debt increasing, most households now have a buffer through mortgage offset facilities which would help in any shock.
Noting record low interest rates around the world, the RBA says Australia remains exposed to developments beyond the local horizon.
"A large global shock could be difficult for overseas policy makers to address which could have spillover effects on the Australian economy".