War in the Middle East has potential to spillover into a “severe international shock” that flows through to Australia’s economy, the Reserve Bank warns.
International risks were “high and rising”, said Brad Jones, an assistant governor at the central bank, as it released its twice-yearly health check of the Australian financial system on Thursday.
Already concerned over stretched valuations and high volatility in global equity markets, the US-Israeli attack on Iran and its impact on global energy markets has exacerbated RBA fears over risks to the financial system.
While Australia’s financial system is relatively well placed – most households have built up financial buffers and banks are well-capitalised – geopolitical pressures are intensifying.
“In terms of financial risk, volatility has risen sharply in response to the conflict in the Middle East and further shocks could lead to markets becoming somewhat disorderly,” Dr Jones said.
“In terms of non-financial risk, there is heightened risk of disruptions from operational, cyber and security incidents at present.”
The closure of the Strait of Hormuz – through which about one-fifth of oil supplies transit – and attacks on oil and gas infrastructure in the Middle East have sent crude prices sky-rocketing above $US110 a barrel.
Elevated geopolitical tensions could “spillover into a severe international shock”, RBA staff noted in the bank’s financial stability review.
“The conflict in the Middle East could trigger a larger shock that destabilises the global economy, particularly if supply disruptions to oil and other commodity markets are prolonged,” the report said.
“Tensions among major global powers also have the potential to escalate, hostile cyber and other actions are intensifying, and strains in the international rules-based order are increasing alongside the risk of global geoeconomic fragmentation.”
Even after the “SaaSpocalypse” sell-off in tech companies in early 2026, as traders panicked that artificial intelligence would make existing software companies obsolete, risk premiums in global equity and credit markets had remained fairly low by historical standards, the bank warned.
There remained a potential for a “sharp revision of the outlook for AI-related investments”.
“Should expectations around the productivity benefits of the surge in AI-related investment be reduced, it could lead to a significant downgrade in profitability forecasts and asset valuations,” the report said.
“Negative consequences for asset quality in the financial system and investment plans in the real economy could result.”
Growing fault lines in the domestic financial system were on the Reserve Bank’s mind as well.
Banks were well-positioned to absorb significant loan losses in an economic downturn, the RBA said, but a “disruptive adjustment” in international financial markets could challenge Australia’s financial stability.
High loan-to-valuation lending to first-home buyers had increased, following the federal government’s expansion of the five per cent deposit guarantee scheme – a sign risky lending had picked up – the bank found.
But because up to 15 per cent of the value was guaranteed by the taxpayer, the broader financial system would be mostly insulated in the case of a rise in defaults.
Banking regulator APRA on Monday announced changes to lenders’ liquidity and capital requirements, which would allow them to write more loans for property development and infrastructure, boosting productivity.
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