Australia's financial system is well placed to handle a challenging and uncertain global environment, but it remains important to be prepared for potential shocks, said the Reserve Bank of Australia (RBA) in a Wednesday report.

RBA noted that global financial stability risks are elevated in a rapidly evolving international environment, increasing the risk that international developments will interact with existing vulnerabilities and affect financial stability in Australia.

Global financial markets have been volatile following the escalation of conflict in the Middle East, but risk premiums have remained low, while global private markets have continued to grow, though conditions remain challenging, the RBA added.

Instability in the Chinese financial system is unlikely to have a direct impact on financial stability in Australia as the financial links between China and Australia are limited, but a shock to the Chinese financial system could affect the rest of the world and Australia indirectly, via increased risk aversion in global financial markets, the central bank said.

The RBA said that the financial position of most households and businesses is strong, and cash flow pressures have eased relative to mid-2024 as inflation and then interest rates declined.

The central bank added that cost pressures remain a challenge for some Australian businesses, as evident from higher insolvency rates in some industries, but risks to the financial system from business lending appear low.

Australian banks remain well placed to support the economy even if a sharp economic downturn were to occur, as banks' credit quality and collateralization remain strong and they hold large reserves of liquid assets, which, importantly, can be quickly converted into cash in a liquidity stress event.

Non-bank lenders have increased the availability of credit for both housing and business borrowers, but risks to financial stability remain contained, the central bank added.