Australia’s regulators have been warned to prepare “contingency plans for a severe collapse in the housing market” that could lead to a “crisis situation” in one or more financial institutions.

The Organisation for Economic Co-operation and Development’s (OECD) latest in-depth assessment of Australia maintains that while the “current trajectory” of house price declines “would suggest a soft landing … some risk of a hard landing remains”.

The Paris-based global forum recommends the Reserve Bank begin raising the cash rate from its record low as soon as possible to prevent “imbalances accumulating further”.

The RBA last cut the cash rate to 1.5 per cent in August 2016, following an earlier cut to 1.75 per cent in May. There has not been an official cash rate increase since November 2010.

“Australia’s housing market is a source of vulnerabilities due to elevated prices and related household debt. A direct hit to the financial sector from a wave of mortgage defaults is unlikely,” the report says.

“However, if house prices collapse consumer spending could suffer, via negative impact on wealth, including from exposures to bank shares, which would encourage deleveraging. Together with reduced housing-related expenditures, this would put pressure on the whole economy.”

It comes as CoreLogic data shows house prices in Sydney fell another 0.5 per cent in the first week of December, bringing the total decline to 10 per cent from the peak in July last year.

That surpasses the previous record set during the last recession between 1989 and 1991 when prices fell 9.6 per cent, making it the worst decline since the firm began collecting data in 1980.

Meanwhile, auction clearance rates are expected to come in below 45 per cent for the sixth consecutive week, compared with around 60 per cent one year ago.

While describing the housing market slowdown as “welcome” after a period where prices were overvalued by 5 to 15 per cent and noting current evidence pointed to a soft landing, the OECD said its research in the past “has found soft landings are rare”.

The OECD report recommends contingency plans in the form of “a loss-absorbing regime in the case of financial-institution insolvency”, including controversial “bail-in provisions”.

“Stress tests conducted by APRA (Australian Prudential Regulation Authority) show banks’ capital remains above regulatory minimum levels under a scenario centred on a housing-market downturn,” it says. “Nevertheless the possibility of financial-institution crisis should not be discounted entirely.”

The OECD notes, unlike in the US or EU, the law does not include provisions that would automatically convert some unsecured senior bonds and deposits from other banks into equity in the event of a crisis.

“The absence of explicit bail-in provisions could slow down the speed of resolution and risk encouraging financial institutions to gamble for resuscitation,” it says.

At this point, however, the OECD says its “resilience indicators” show no signs of a looming recession that would end Australia’s 27 years of uninterrupted growth. “Some low-probability, but potentially dramatic, tail-end scenarios are nevertheless listed,” it says.

In addition to a “dramatic house price correction”, they include a “renewed plunge in global iron ore and coal prices, possibly in relation to global environmental policy”, and an “acceleration in global trade disputes or pronounced slowdown in China’s economy”.

Last week, gross domestic product figures for the third quarter dramatically undershot expectations at just 2.8 per cent, partly as a result of softer consumer spending.

In a subsequent speech, RBA deputy governor Guy Debelle raised alarm by suggesting the next move in rates could be down, not up, and floated the possibility of controversial money printing policies known as quantitative easing in the event of a crisis.

Treasurer Josh Frydenberg said the OECD report, which predicts “robust” economic growth of 3 per cent, proved the Government’s “economic plan is delivering a stronger economy”.

But he seized on the house price warnings to again attack Labor for its proposed changes to negative gearing and capital gains tax breaks for property investors if it wins next year’s federal election.

“The OECD notes house prices have gradually cooled, stating ‘the current trajectory would suggest a soft landing’, but warns, ‘a large drop in house prices could cut household consumption, prompt collapse in the construction sector, increase mortgage defaults and freeze back lending to businesses’,” Mr Frydenberg said in a statement.

“Labor’s housing tax policies will do just this. They will damage Australia’s housing market and destroy the equity that people hold in their homes, increasing the risk of financial instability and lower economic growth.”

He noted the OECD’s comment that the country “faces economic challenges that, if not handled well, could see an end to its strong track record”. “Australia cannot risk a return to Labor’s high tax and reckless spend approach,” Mr Frydenberg said.

Shadow Treasurer Chris Bowen told reporters on Monday the OECD report supported Labor’s position in calling for “ongoing tax reform”.

“There’s only one party going to this election with a tax reform agenda and that’s the Labor Party,” he said. “Tackling the unsustainable and unfair tax concessions in our system, seeking a mandate for important tax reforms, as the Liberal-National Morrison Government simply engages in silly scare campaigns.”

Mr Bowen also seized on the report’s call for “clarity and stability” in Australia’s climate change energy policy.

“This of course comes as the chief executive of Origin Energy, Frank Calabria, announced and said that his firm would be very concerned about undertaking further investments while the Government’s divestment policy stays on the table,” he said.

“This is a fundamental point. The Liberal and National Party failures on energy are having a real impact now. Big energy companies saying that they can’t invest with this policy uncertainty. As the Labor Party warned.”

frank.chung@news.com.au