The RBA has indicated it could cut the cash rate if price pressures remained subdued.

The Reserve Bank has warned banks against trying to hit ''unrealistic'' profit targets. Photo: Reuters

THE Reserve Bank has warned banks against trying to hit ''unrealistic'' profit targets through ''indiscriminate'' cost-cutting and weaker lending standards that could sow the seeds of future problems in the financial system.

The comments came as a senior Reserve official last night called for a debate on the size of bank profits, saying a public perception that earnings were too high could erode trust in the sector.

After the big four's profits topped $11 billion in the latest half, the central bank says weaker credit growth and higher funding costs are likely to drag on future earnings, which could entice banks to lower their lending standards.

There was no evidence of banks becoming less prudent but the Reserve warned the industry against excessive risk-taking to gain market share and boost earnings.

''While banks' profitability is expected to remain high, a continuation of the modest credit growth environment and higher funding costs is likely to constrain future profit growth,'' the Reserve's Financial Stability Report said yesterday.

''The challenge for the industry in this environment will be to avoid taking on unnecessary risk or cutting costs indiscriminately in a bid to sustain unrealistic profit expectations, as this could ultimately sow the seeds of future problems.''

In another blunt message to the industry, an assistant governor, Guy Debelle, told a conference bank profits needed to be accepted by the public if the battered level of trust in the financial sector was to be revived. ''The rate of profitability in

the financial sector is also a debate society needs to be having,'' Dr Debelle said in Melbourne.

''If financial institutions are perceived to be earning too high a rate of profitability, particularly if the institution is enjoying a degree of support from the public sector, that too will impede the restoration of trust.'' Amid continuing worries for the eurozone's health, the Reserve's review said Australia's financial system remained in a ''relatively strong position''.

Global funding pressures on the big banks had eased, with the cost of raising new debt falling to levels not seen since mid-2011, before the latest outburst of eurozone turmoil.

The relative strength of the Australian banks compared with other countries had allowed them to raise $50 billion on money markets, most of it cheaper unsecured debt.

Despite the improvement on credit markets, however, the big banks were continuing to obtain a larger share of their funds from domestic deposits, which was pushing up their costs. With more than half of bank funding coming from deposits, up from 40 per cent in 2007, the Reserve said funding costs and slow credit growth had slowed bank profit growth in recent quarters.

Credit demand from households was likely to remain subdued as people continued to pay down debt quickly and save, the Reserve said, which would pressure bank earnings growth.