THE International Monetary Fund has warned Australia's prudential regulator to increase the stress-testing of the major banks to ensure the sector could withstand deeper shocks caused by the global financial crisis.

The Washington-based economics agency revealed in research on the Australian economy, that the national banks had escaped the worst of the financial system upheaval that has claimed some of the world's largest banks.

However, it warned that deteriorating asset quality and growing arrears from both retail and business customers could lead to higher banking distress over the next two years.

It also said the Australian Prudential Regulation Authority should look to increase the range and size of stress tests carried out on the major banks.

APRA regularly tests the banks on liquidity and capital requirements but keeps the results confidential.

"Analysis of banks' exposure to the corporate and household sectors shows that banks are able to withstand potential losses from sizeable shocks to their loan portfolios," the IMF says in the report.

"These results should be interpreted with caution as they are not rigorous stress tests. APRA has regularly stress-tested the banking system but it would be advisable to undertake more extreme stress-test scenarios than applied in the past and include Australia's overseas subsidiaries."

APRA said it believed the testing carried out now was extensive enough and the Australian banking sector had weathered the banking crisis in strong shape. Australia now has four of only 11 AA-rated banks left in the world.

"As part of its regular supervisory activities for the banking, insurance and life industries, APRA routinely conducts stress-testing scenarios to ensure that regulated entities are adequately capitalised and well-placed to manage a range of adverse developments," a spokesman said.

"Many APRA-regulated entities also conduct their own stress-testing and APRA reviews the results as part of its regular oversight of these entities."

Australian Bankers Association chief executive David Bell said it was a positive signal for the Australian banks that the IMF said, despite the need for more testing, that the sector could withstand deeper losses as part of the economic recovery. "We're not directly involved in these stress tests," Mr Bell said.

"It is prudent for banks and their regulators to undertake stress-testing across a range of standard and also hypothetical scenarios. These exercises are resource intensive but give additional insights into the resilience of our institutions."