"Government should restore the general prohibition on direct borrowing by superannuation funds by removing Section 67A of the SIS Act on a prospective basis," the report stated.

"This section allows superannuation funds to borrow directly using limited recourse borrowing arrangements."

However, the report stated the exception of temporary borrowing by superannuation funds for short-term liquidity management purposes should remain.

While the FSI acknowledged the level of borrowing is currently relatively small, the report suggested if direct borrowing by funds continues at current growth rates, it could pose a risk to the financial system.

The report stated this recommendation seeks to prevent the unnecessary build-up of risk in the superannuation system and the financial system more broadly.

In addition, the recommendation seeks to fulfil the objective of superannuation being a savings vehicle for retirement income rather than a “broad wealth management vehicle”.

The report noted that lenders can charge higher interest rates because of the higher risks associated with limited recourse lending, and “frequently” require personal guarantees from trustees.

It also pointed to the likelihood of borrowing to concentrate the asset mix of the fund, thereby reducing its diversification and increasing its risk exposure.

“Further growth in superannuation funds’ direct borrowing would, over time, increase risk in the financial system,” the report stated.

“Borrowing, even with LRBAs, magnifies the gains and losses from fluctuations in the prices of assets held in funds and increases the probability of large losses within a fund.”

In relation to superannuation more broadly, the FSI has recommended the government seek broad political agreement for, and enshrine in legislation, the objectives of the superannuation system and report publicly on how policy proposals are consistent with achieving these objectives in the long term.

The report also called for consistent policy settings across the accumulation and retirement phases.

"Consistent policy settings across the accumulation and retirement phases would meet the retirement income needs of Australians more efficiently and effectively. It would also assist Government in implementing policy settings that are well targeted and sustainable over the long term," the report stated.

The FSI stressed that the super system needs to adapt to changing circumstances but to avoid unnecessary or ad hoc changes that cannot be sustained over time.