Australia’s banking system faces growing risks amid a sustained decline in dwelling prices and increasing pressures on the housing market, with experts warning that recent government tax measures and rising interest rates may exacerbate financial instability. The issue comes as Treasury experiences internal challenges, complicating efforts to address emerging economic concerns.

Banks hold approximately $2.58 trillion in dwelling mortgage assets, and many are currently reassessing the value of their housing collateral. Due to varied regional impacts, some property valuations have fallen by less than 10 percent, while others have dropped by as much as 30 percent, prompting banks to evaluate their loan-to-valuation ratios (LVRs) carefully. Though banks have not yet indicated the need for additional capital injections, economists and forecasters caution that the pace of housing price declines could accelerate further.

The Reserve Bank of Australia (RBA) has raised interest rates four times this year, with a fifth increase under consideration, contributing to downward pressure on housing prices. At the same time, federal government policies, particularly tax measures introduced under the guidance of Treasury secretary Jenny Wilkinson and Treasurer Jim Chalmers, have been criticised for further dampening the property market. The combination of elevated domestic interest rates and rising international borrowing costs has increased banks’ funding expenses, while tighter lending conditions imposed by nervous banks are limiting borrowing and discouraging property transactions.

A significant backlog of unsold homes has emerged due to sellers’ reluctance to accept prevailing market prices, which in turn suppresses prices further. Analysts warn that another 10 percent decline in property values could pose serious challenges to banks’ LVR ratios and financial stability.

This housing market weakness coincides with a sharp increase in business failures. In August, business insolvencies were reported to be 23.2 percent higher than the same period the previous year, partly influenced by the collapse of Bathla, a major company. The RBA’s Financial Stability Review noted that insolvency rates may not yet fully reflect deteriorating economic conditions.

State governments, largely reliant on stamp duty from property transactions for revenue, face fiscal pressure as housing market activity slows. Except for Western Australia, which receives substantial subsidies from other states, most governments are ill-equipped to offset the revenue shortfall. This has raised concerns about the capacity of states to manage rising National Disability Insurance Scheme (NDIS) costs, with critics pointing to the unintended consequences of federal tax policies on state budgets and the banking sector.

Regulators, including the Australian Prudential Regulation Authority (APRA) under chair John Lonsdale, are monitoring the situation closely. Some analysts call for Treasury and government officials to reconsider or delay recent tax changes, particularly those related to negative gearing, to mitigate further market declines.

Reserve Bank Governor Michele Bullock has acknowledged that higher interest rates are suppressing housing prices but has not publicly addressed the impact on banks. Observers suggest that credit conditions should be carefully managed to avoid triggering a self-reinforcing downturn.

Although the sharemarket currently remains stable, experts warn that continued sharp falls in residential property values could escalate risks to the banking system and broader economy. Past crises have seen governments guarantee bank deposits to restore confidence, a move that remains a potential option should instability increase. The unfolding situation underscores the need for coordinated action between Treasury, the RBA, and regulatory authorities to safeguard financial stability and support the housing market.