A severe hypothetical scenario in the October 2026 Financial Stability Review, with property prices down 20% and unemployment at 6.3%, would lower banks' core capital ratio from 12.4% to around 11.6%, according to the RBA's estimates.

What would happen to Australia's banks if house and commercial property prices fell by a fifth, unemployment jumped and the economy contracted sharply? That is the question at the heart of the bank stress test published in the RBA's October 2026 Financial Stability Review (FSR), released on 1 October.

The short answer, according to the RBA's estimates, is that banks' core capital ratio would decline by less than one percentage point. The longer answer involves understanding what a stress test is, what this one assumed, and what it does and does not tell households.

What the adverse scenario assumed

A stress test is a "what if" exercise. It applies a deliberately severe set of conditions to banks' balance sheets to see how much damage loan losses and weaker income would do. It is not a forecast, and the RBA is not predicting these conditions.

The adverse scenario in the FSR combined several shocks at once:

  • unemployment rising to 6.3%
  • the cash rate rising to 5.6%
  • housing and commercial property prices falling 20%
  • a severe contraction in GDP.

For context, the actual cash rate target is 4.60%, after the Monetary Policy Board's 25 basis point increase on 29 September 2026, and unemployment was 4.6% in August. The scenario therefore pushes both well beyond current settings. A cash rate of 5.6% would sit a full percentage point above today's target, and unemployment of 6.3% would be 1.7 percentage points above August's rate.

What happened to bank capital

The key measure is the Common Equity Tier 1 (CET1) ratio. In plain terms, CET1 is banks' highest-quality capital, mainly shareholders' equity and retained earnings, expressed as a share of their risk-weighted assets. It is the first line of defence against losses.

According to the FSR, banks' CET1 ratio was 12.4% in June 2026 and is "estimated to decline to around 11.6 per cent" under the adverse scenario. That is a fall of around 0.8 percentage points.

Other balance sheet features help explain that result:

  • Provisions. Banks hold provisions of "around 0.7 per cent of total credit outstanding", set aside against expected losses.
  • Security on problem loans. As at June 2026, over 90% of non-performing housing loans and over 50% of non-performing business loans were well secured, meaning collateral is expected to cover much of what is owed.

Why property slumps don't automatically sink borrowers

The stress test looks at banks, but households sit on the other side of those loans. The RBA's assessments of borrowers point in a similar direction.

The minutes of the Monetary Policy Board's September meeting record that very few borrowers are in negative equity, owing more than their home is worth, and that this was likely to remain so even if housing prices fell 20%. The FSR puts the current share in negative equity at "less than 1 per cent of borrowers".

Other indicators from the FSR:

  • The share of variable-rate owner-occupier borrowers in cash-flow shortfall "increased a little over the first half of 2026, but remains relatively low at around 2 per cent".
  • The median borrower can cover over a year of scheduled mortgage payments at current interest rates, counting offset and redraw balances.
  • Housing arrears of 90 days or more have "increased a little over the year to date but remains around pre-pandemic levels".

The minutes also record staff scenario analysis indicating that "even relatively large falls in housing prices would have only modest direct effects." Housing prices have in fact fallen in most capital cities, and the minutes say staff judge the cumulative fall is likely to be greater than assumed in August.

Beyond the banks, and the limits of the exercise

The FSR's financial stability assessment states: "The Australian financial system has a good degree of resilience". Its accompanying media release adds that global and operational vulnerabilities are growing.

The review also tested other parts of the system. Superannuation funds, which hold around one-third of financial system assets, were stress-tested against members switching "from risk assets into cash at four times the quarterly volume" seen at the start of COVID-19. The RBA found funds could largely meet this from international equity portfolios without fire sales of domestic risk assets.

Non-bank lenders account for around 6% of financial system assets, and the RBA's media release says their risks are "contained by their relatively small size". Private credit is less than 2% of financial system assets, with banks' drawn exposures at an upper limit of 2.8% of bank assets.

The RBA's recommendations include keeping lending standards sound, maintaining operational resilience including at critical service providers, strengthening superannuation liquidity risk management, and improving risk management, scenario analysis and crisis simulations.

Stress tests have limits. They depend on the scenario chosen, the models used and the assumptions about how banks and borrowers behave. A different combination of shocks, or one that unfolds faster, could produce different results. The FSR itself lists global threats such as rising sovereign debt in some large economies, leveraged investors in bond markets, AI-related expectations and financing as a potential trigger for sharp repricing, low risk premia and operational risk.

A resilient banking system also does not mean every household or business is comfortable. Insolvencies are around their longer-run average overall but elevated in hospitality, construction and transport, and the FSR notes smaller businesses and energy-intensive or cyclical sectors are more vulnerable to cost pressures. Individuals with questions about their own borrowing may wish to seek licensed professional advice.

The bottom line

The RBA's stress test suggests Australia's banks could absorb a severe, simultaneous shock that includes a 20% fall in property prices, with the system's CET1 ratio estimated to fall from 12.4% to around 11.6%. Provisions, well-secured problem loans and low negative equity among borrowers all support that result. The exercise is a test of resilience, not a forecast, and the RBA continues to flag growing global and operational risks.