In its latest review of the financial system, APRA is seeing some signs of a pick-up in higher risk lending, particularly high debt-to-income borrowing by investors

The Australian financial system, including APRA-regulated entities across banking, insurance and superannuation, continues to be safe, stable and resilient. The system is well-placed to absorb potential adverse shocks in a rapidly changing, complex and highly interconnected operating environment. Similarly, the entities that APRA regulates are judged to be resilient if adverse shocks were to materialise, meaning they could continue providing critical financial services to the community.

To ensure this resilience is maintained, APRA is carefully monitoring developments in the international and domestic environments. Three areas are of particular focus.

Geopolitical environment

More than two-thirds of APRA’s regulated entities think geopolitical risk is a top concern.

Globally, regulators and industry are stepping up their focus on geopolitical risks. Geopolitical risks are challenging to manage because they can transmit through the financial system via many channels and trigger multiple disruptive risk events at the same time. Some of those transmission channels and risks are well understood, but others are newer and unique to geopolitical events.

In this context, APRA and the CFR agencies are strengthening the system’s resilience through a dedicated geopolitical risk work program. This is a forward-looking initiative designed to ensure industry is more aware of the wide-ranging impacts of geopolitical shocks on the financial system, and that institutions can respond to unexpected disruptions.

Housing

For almost a decade, gross debt of Australian households has been around 1.8 times their incomes, making this a key vulnerability in the financial system.

Household debt in Australia has been high by both historical and international standards for some time.

As interest rates have declined this year, APRA has observed housing price growth strengthen and an increase in investor activity. Housing lending standards have remained sound but there are signs of a pick-up in some forms of higher risk lending and heightened competition for new lending.

Given these dynamics, aggregate household indebtedness could increase further, and other housing-related vulnerabilities could build. APRA is carefully monitoring these dynamics and has been engaging with the lenders it regulates to ensure a range of macroprudential policy tools can be implemented where needed.

Interconnectedness, particularly the growing role of superannuation

The superannuation industry has doubled over the past decade, and its response in a crisis can impact the whole financial system, including banks.

There are significant interconnections in the Australian financial system, both financial and non-financial. These interconnections help the system operate more efficiently but also introduce new vulnerabilities.

The superannuation industry plays a unique role in Australia’s financial system. Historically, it has played an important role as a stabiliser when shocks occur. But with its growing size and linkages across the system, particularly with banks, the industry’s response in a crisis could also amplify stress in some scenarios.

APRA is looking closely at how these interconnections might affect the stability of the financial system if there was a severe, unexpected shock. APRA’s exploratory stress testing suggests that super funds can continue to be a stabilising force during a shock, but in some cases, their actions can also amplify the negative effect of the shock on members and the system.

The full report is here.