The Reserve Bank's latest stress test imagined a recession, soaring unemployment, a higher cash rate and a one-fifth slide in property prices, and found the banking system's core capital ratio would fall by less than one percentage point.

Stress tests are designed to answer an uncomfortable question: what happens to the banks if almost everything goes wrong at once? In its October 2026 Financial Stability Review (FSR), released on 1 October, the Reserve Bank put Australia's banking system through a severe adverse scenario and measured how much of its capital buffer would be used up.

The headline result was that the system's Common Equity Tier 1 (CET1) ratio, which stood at 12.4 per cent in June 2026, would fall to "around 11.6 per cent" under the scenario. For a test built around a deep downturn, that is a comparatively modest decline.

The scenario the banks were put through

The adverse scenario combined several shocks, each well beyond current conditions:

  • a 3 per cent fall in GDP;
  • the cash rate rising to 5.6 per cent;
  • the unemployment rate climbing to 6.3 per cent;
  • a 20 per cent fall in both housing and commercial property prices.

It is worth placing those assumptions next to today's settings. The cash rate target is 4.60 per cent, so the scenario assumes a further full percentage point of tightening on top of the four rises already delivered in 2026. Governor Michele Bullock said on 29 September that unemployment had risen to 4.6 per cent; the scenario assumes it climbs to 6.3 per cent. Rather than growth, the scenario has the economy contracting. Measured from the 3.60 per cent setting that applied before the Monetary Policy Board's February increase, a 5.6 per cent cash rate would represent two full percentage points of tightening in all.

The scenario is a hypothetical exercise, not a forecast. Bullock said of recession on 29 September: "That is not our central base case at this moment."

What CET1 measures, and what the result means

CET1 capital is the highest-quality form of bank capital, made up mainly of shareholders' equity and retained earnings. The CET1 ratio compares that capital with a bank's risk-weighted assets. The higher the ratio, the more losses a bank can absorb while continuing to operate.

In the stress test, the system's ratio falls by about 0.8 of a percentage point, from 12.4 per cent to around 11.6 per cent. Put another way, the scenario erodes only a modest part of the system's starting ratio. The FSR estimates that provisions in the scenario would amount to "around 0.7 per cent of total credit outstanding".

The significance lies partly in what banks could still do after the shock. The FSR's media release said banks are well positioned to keep lending in a downturn. In general terms, that matters because a banking system that has to pull back sharply on credit during a recession can make the downturn worse. A system with capital to spare can keep supporting households and businesses.

The household data in the review provide useful context for the scenario. Fewer than 1 per cent of borrowers are currently in negative equity, and the FSR estimates that under a further 20 per cent fall in housing prices "only around 5 per cent of mortgages would fall into negative equity". It also estimates that the median borrower is able to cover over a year of scheduled mortgage payments from offset and redraw buffers.

Beyond the banks

The FSR also looked at parts of the financial system outside the major lenders.

Non-bank lenders account for "around 6 per cent of financial system assets", and the RBA assesses that they pose limited system-wide risk. Private credit makes up around 10 per cent of business debt and less than 2 per cent of system assets.

Superannuation is much larger, at around one-third of financial system assets, with about half of APRA-regulated fund assets invested offshore. The RBA tested a scenario in which members switch to cash at "four times the quarterly volume observed at the start of the COVID-19 pandemic". It found funds could largely meet those calls by selling international equities, without needing to fire-sell domestic assets.

On the operational side, the FSR noted that outages at common third-party service providers could disrupt much of the super sector. It pointed to APRA's operational risk standard CPS 230, introduced in July 2025, and to an APRA letter on AI-driven cyber threats issued on 30 April 2026.

The risks the RBA is watching

A strong stress test result does not mean the RBA is relaxed. The FSR media release said that while the system is resilient, "global and operational vulnerabilities continue to mount". It listed elevated threats from geopolitical tensions, vulnerabilities in global financial markets, advances in artificial intelligence and disruptions to critical service providers. It urged institutions to keep building resilience and strengthen their crisis preparedness.

The household and business backdrop is also shifting. Mortgage arrears of 90 days or more have risen slightly, though they remain around pre-pandemic levels, and the FSR noted that business insolvencies "remain elevated in some industries, particularly hospitality, construction and transport". Business credit growth has been "above its post-GFC average for a couple of years". Discussing bond markets on 29 September, Bullock said "the bond markets are reacting in an orderly way", adding: "not alarmed, but we are alert to it."

These conditions sit against a monetary policy setting aimed at bringing inflation down. Headline inflation was 3.9 per cent over the year to the June quarter and the monthly CPI indicator showed 4.0 per cent for August, while underlying trimmed mean inflation was 3.6 per cent in the June quarter.

The bottom line

The RBA's October stress test asked the banking system to withstand a recession, a higher cash rate, unemployment above 6 per cent and a 20 per cent fall in property prices. Under that scenario, the system's CET1 ratio slips from 12.4 per cent to around 11.6 per cent, and the RBA judges banks would remain well positioned to keep lending.

That result is reassuring about the system's starting point, but it is a test of resilience rather than a prediction. The RBA's own message is that vulnerabilities, particularly global and operational ones, continue to build, and that financial institutions should keep strengthening their defences.