RBA Cautions Borrowers Against Excessive Debt When Interest Rates Drops

Even though Australia's financial system has demonstrated resilience despite high inflation, the country's central bank has issued a warning regarding the risks of excessive borrowing when interest rates decrease.

In its semi-annual Financial Stability Review, the Reserve Bank of Australia (RBA) stated that it expected households pressures to ease when lending standards drop, but also warned borrowers about excessive debts, which may lead to a downturn.

The report also pointed to a rising number of mortgage holders, who were defaulting on home loans and more people opting to sell their homes to escape repayment, Reuters reported.

"Domestic vulnerabilities could increase if households respond to any easing in financial conditions by taking on excessive debt," the RBA warned in a 45-page review.

The review report has, however, highlighted the resilience shown by households, banks and businesses to beat decade-high interest rates and inflation. Supported by a steady labor market, they have been improving real incomes, and are expected to strengthen their financial stability with the easing of inflation and decrease in interest rates.

Only 2% of the borrowers were experiencing financial strain and just 0.5% of loans in arrears were in negative equity, the report stated.

However, a major economic downturn, especially a sharp drop in jobs combined with external threats like geopolitical tensions in Ukraine and the Middle East, and climate change risks were adding to the vulnerabilities impacting the global financial system, besides a weak Chinese economy.

The report also included the upcoming American elections that could add to "further geopolitical fragmentation."

The report was released after the RBA retained the interest rate at 4.35% for the seventh time since November. Since the RBA also did not consider increasing the cash rate for the first time, experts forecast a rate cut in the next meeting, The Guardian reported.

The weakening real estate market in China is expected to affect the economy and financial system. Treasurer Jim Chalmers, who was visiting China, was expected to meet his counterparts on Thursday and Friday.

"The key channels of transmission of financial stress in China to Australia would likely be via increased risk aversion in financial markets, a sharp slowing in global economic activity, lower global commodity prices and reduced Chinese demand for Australian goods and services," the report stated.