Here’s a warning for investors in bank shares. ANZ chief Mike Smith is preparing for more borrowers to fall behind in their repayments.

Australia and New Zealand Banking Group (ASX: ANZ) has warned that the number of bad loans will rise as the domestic economy softens. That comes a week after National Australia Bank (ASX: NAB) increased its bad-debt provisions by $250 million, amid warnings that a slowing Australian economy could have an impact on earnings.

Bank of Queensland (ASX: BOQ) doubled its bad-debt provisions last week to $401 million, and has taken stringent steps to rein in its bad debts. It has reduced the amount it will lend in certain parts of Queensland, where house prices have fallen sharply, and will stop paying commissions on loans that are more than 180 days late. The company reported the first full year loss by an Australian bank since ANZ and Westpac Banking Corporation (ASX: WBC) were hit during the recession of 1992.

From next year, banks around the world will be forced to substantially increase the amount of equity capital they hold. The new rules are designed to protect taxpayers and depositors in the event of a banking collapse, with shareholders forced to wear much of the loss. While Australian banks are well capitalised compared to their global peers, a substantial fall in property prices could place any or all of them at much higher risk of significant profit reductions.

Although the big four banks in Australia have been labelled “too big to fail”, should one of them collapse, the bank would likely be taken over by the government – potentially leaving shareholders with nothing. And if you think that’s unlikely, just ask investors in UK banks like Lloyds and Royal Bank of Scotland (RBS). Both were rescued by the UK government in 2008, at a cost of £66 billion. RBS’s share price has fallen 94% since 2008.

The Foolish bottom line

Australian bank shareholders may have been lulled into a false sense of security, as the banks survived the GFC, and the steady stream of fully franked dividends that have flowed out of their coffers to investors over the last 20 years. Foolish investors need to be aware that there is a risk, albeit small, that what happened in the UK could happen here. At the very least, bad news for the banks could mean sub-par returns for shareholders

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned. The Motley Fool’s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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