Global stock markets are likely underpricing heightened risks from geopolitical tension and cyber threats, leaving financial systems vulnerable to a violent correction, the Reserve Bank of Australia warns.
The central bank identified international shocks from stretched equity valuations, digital operational vulnerabilities and longstanding weakness in the Chinese system as the biggest threats to financial stability in its biannual review of the sector’s resilience.
Despite the risk of a global trade war still bubbling away, share market valuations have continued to rise, “increasing the risk for a disorderly price correction”, the bank said in its Financial Stability Review released on Thursday.
Given heightened interconnectedness of financial markets, a sell-off in global bonds and equities was likely to spill over to Australia.
Additionally, the growing reliance on digital technologies left the financial system vulnerable to cyber attacks or technology failures, such as the outage of stock exchange operator ASX’s settlement system in December.
Ongoing weakness in China’s property and banking sector were also of concern. Instability in Australia’s largest trading partner could spill over as a result of lower commodity prices and a drop in demand for Australian exports.
While this week’s US government shutdown occurred too late for the bank to take it into account in its report, it provided another example of how elevated international uncertainty could impact financial markets.
Australia was still in a relatively good position, with the vast majority of households keeping up with mortgage repayments and banks in good financial nick with strong levels of capital and liquidity.
“Our overarching assessment is that Australia’s financial system is well-placed to navigate a period of elevated international risks,” said RBA assistant governor Brad Jones.
Households and businesses maintained strong savings buffers, while the amount of mortgage holders in negative equity had declined significantly from before the pandemic.
Stress test modelling showed that even under a dramatic scenario in which unemployment surged to 10 per cent and house prices tumbled by 40 per cent, less than four per cent of borrowers would fall behind on repayments.
The majority of those would still be able to sell their home and repay loans in full.
Superannuation funds could amplify a shock in the financial system, given the size and dominance of the sector in Australia.
While super funds have traditionally acted as a shock absorber because their long-term mandate allows them to invest counter-cyclically – essentially, buying the dip – super funds also pose a risk to financial stability because of their high concentration of bank bills.
A liquidity crunch could force funds to sell off bank bills simultaneously, raising funding costs for the banking sector and exacerbating financial stress.
It was important lending standards remained sound and financial institutions continued to beef up protections against operational shocks, to safeguard Australia’s financial resilience, Dr Jones said.
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