analysis
A focus on responsible lending will uncover huge problems for the banks
Irresponsible lending practices are likely to be a focus of the banking royal commission and ongoing legal action. (AAP)
Investment guru Warren Buffet wasn't commenting on the Australian mortgage market when he said, "Only when the tide goes out do you discover who has been swimming naked", but it is no less relevant.
Key points:
- 42 per cent of home loan customers told banks they had incomes in excess of $500,000 last year
- Westpac is the first bank to face ASIC court action over irresponsible lending allegations
- Mortgage contracts can be voided if the bank provides credit to someone who cannot afford it
When interest rates start rising and/or if property prices fall, the market's vulnerabilities will be exposed.
The prospect of higher interest rates is considered a distant threat because inflationary pressures will take time to build.
We also know households are sitting on a mountain of property debt and one false interest rate move by the RBA could trigger a collapse with far-reaching consequences.
That isn't the only trigger.
Overstated income
The banks' Achilles heel — irresponsible lending — is shaping up as a major threat to the banks and financial system, depending on the outcome of the banking royal commission and a low-profile battle currently being waged in courts.
"Irresponsible lending is endemic in Australia," Digital Finance Analytics director Martin North said.
"More than 900,000 households are already in mortgage stress.
"We're seeing a lot of households who are actually getting loans that are five, six, seven, eight, nine times income and that is astronomically high and in my mind will lead to grief later."
Even though customers of the big four banks are representative of the Australian population, their claims about the incomes of those customers are not.
Bank disclosures suggest that 30 per cent of households with an owner-occupied mortgages have an average income of at least $200,000 a year, an extraordinarily large number of high-income earners.
It jumps to 40 per cent for those with investor loans.
UBS banking analyst Jonathan Mott has benchmarked the disclosures against the population using Census, ABS and ATO data.
His conclusion is that the bank disclosures "do not appear logical and are highly improbable".
What's more, the bank data suggests a whopping 42 per cent of customers earning at least $500,000 per annum took out a mortgage last year.
The most plausible explanation for all of this is that a vast number of borrowers have overstated their incomes.
Liar loans
UBS estimated that Australia's $1.7 trillion mortgage market could be laden with $500 billion in so called "liar loans".
Following a survey, the investment bank concluded that one-in-three people admitted to falsifying their loan applications.
And why wouldn't they? Mortgage brokers write about half the loans and the commission system hasn't changed.
The bigger the loan, the more they make and their clients, the borrowers, are gleefully able to buy homes they thought they couldn't afford.
The banks and mortgage brokers are all rowing in the same direction, incentivised by a system which rewards sales, and the bigger the better.
How else do you explain house prices approaching $1 million in the far-flung suburbs of Sydney and Melbourne, where people have modest incomes and virtually no real wages growth?
Foreign investors and a rising population does not account for it all.
ASIC takes action
The extent of the banks' direct responsibility is about to be exposed by a court case involving ASIC and Westpac.
Westpac is accused of breaching the responsible lending laws through an over-reliance on a benchmarking tool used to assess loan suitability.
In other words, the bank failed to adequately consider the borrower's unique or actual financial position.
They are allegations the bank strenuously denies.
We're only talking about a few loans here, and should the bank lose, it will probably take the best part of a week to earn the money to pay the penalty.
The threat comes from an army of borrowers who have loans that should never have been approved.
"Under the responsible lending legislation, if the bank has provided credit to someone that can't reasonably pay it back, then the whole contract can be voided," Brian Johnson CLSA's veteran banking analyst said.
"It suddenly goes from being the borrower's problem to the bank's problem," he said.
Westpac is not the only bank facing this threat.
Lenders have lifted their game, but the damage has already been done through the use of benchmarking tools.
"The free and loose lending standards that banks have demonstrated, particularly over the last decade through the use of benchmarking tools and interest only loans, has the potential to be catastrophic for the Australian economy," Maurice Blackburn lawyer Josh Mennen said.
Financial planning crisis, money laundering scandals, market manipulation … you ain't seen nothing yet.