Fitch has developed two measures of banking system vulnerability. The Banking System Indicator (BSI) measures banking system quality and strength. The Macro Prudential Indicator (MPI) meanwhile, which looks at the extent to which credit growth, asset prices, and the real exchange rate render the banking system potentially vulnerable to asset price and exchange rate corrections and the consequent economic fall out.

The indicators are then pooled to create a Systemic Risk Matrix, which gives an overall picture of the health of the banking system. Stronger systems are able to withstand shocks, but in weaker systems, even a modest shock or increase in stress could cause a full-blown systemic crisis that will exhaust much or all capital in the system and will require financial support from either the government or shareholders.

Fitch found that the majority of global banking systems show few signs of vulnerability to MPI, but Fitch's early warning model has concerns for Australia. The pace of private sector credit growth is above trend in Australia and significantly above the real interest rate. While the rises are not critical, Fitch said there is potential for future problems unless there is a moderation in credit growth.

But beyond the credit issue, Australia's banking sector is classed as “very high quality”, an accolade shared with the US, UK, Luxembourg and the Netherlands. The worst performing major economy was Japan, whose system is classified as “low quality”. Only 11 systems are deemed worse — all from emerging markets.

“Banking crises have affected almost 100 countries in the past 25 years and can have a major impact on sovereign and bank ratings,” said Richard Fox, senior director in Fitch's sovereign group. “This new methodology will help identify potential problem situations which could lay countries open to future systemic distress.”

Stuart Fagg is the Editor of Risk Management magazine, Lawyers Weekly’s sister publication.