However, the outlook of the AA- ratings of the major banks were left unchanged as the agency assessed these institutions would benefit from a high level of government support in an adverse situation. But the major bank's ratings had already been placed on negative outlook in July after the agency took action on Australia's sovereign AAA rating.

The major banks' credit ratings, too, could come under threat, if the agency took the view that new "too-big-to-fail" frameworks, adopted globally to ensure taxpayer support for future bail-outs was limited, was adopted in some form.

S & P said private sector debt as a percentage of GDP had grown to 139 per cent from 118 per cent in 2012, an average increase of 5.2 per cent, while property prices had increased by 5.3 per cent, after adjusting for inflation.

"Consequently, we believe the risks of a sharp correction in property prices could increase and, if that were to occur, credit losses incurred by all financial institutions operating in Australia are likely to be significantly greater; with about two-thirds of banks' lending assets secured by residential home loans, the impact of such a scenario on financial institutions would be amplified by the Australian economy's external weaknesses, in particular its persistent current account deficits and high level of external debt."

S & P director Sharad Jain said rising property prices and increased debt levels could persist because the conditions that had given rise to these occurrences remained in place.

These included historically low interest rates, a benign economic outlook and a supply and demand imbalance in many regions.

But he said the apartment construction boom, and a tightening of underwriting standards, gave them some confidence of a "cooling effect" in household leverage and property price growth. More recent data also pointed to a moderation.


The rating agency's warning on property prices comes ahead of Tuesday's Reserve Bank interest rate decision.

The central bank is expected to hold the cash rate at 1.5 per cent, as governor Phil Lowe recognises the trade-off between meeting its inflation target and creating threats to financial stability by further lowering interest rates.

In 2012, S & P developed a global framework for prescribing credit ratings to financial institutions that factored in the economic risk, industry risk and the "stand-alone" quality of the individual institution.

The agency recognised Australia still had one of the safest banking systems in the world, along with Singapore, Canada, Switzerland and Hong Kong.

Mr Jain said Australia's banks had a track record of profit growth, which he said showed the "ability to price risk", which would support system credit quality.

But he expressed some concern that pressures from politicians and the public might "impede their ability to price risk and push them into risk taking".

S & P analysts told investors there were a number of factors that could impact the future credit ratings of the banks.

A worst case scenario, which would lead to a two notch ratings downgrade to A, would be a lowering of S & P's economic risk score, reduced government support and a sovereign credit rating downgrade.

But the agency said increased capital buffers and an improvement in the banks' earnings assessments had the potential to offset a downgrade.