Westpac Banking Corp (ASX: WBC) has announced that it will stop lending to foreign property buyers in a move that could see apartment prices tumble.

Developers have previously warned that any withdrawal of bank lending could lead to a self-fulfilling fear of an apartment collapse. One developer has told Fairfax Media that an increasing number of clients were being turned away from the banks, even though they had been pre-approved to buy apartments.

Westpac says its new rules will apply to all pre-approved loans that have not been issued from April 26, and applies to all its subsidiaries including St George Bank, Bank of Melbourne and BankSA.

The reasons for the restrictions are several.

Australia and New Zealand Banking Group (ASX: ANZ) started refusing applications in March where income was 100% foreign sourced, following evidence of incomplete applications, missing passport pages, salaries from obscure offshore companies and crudely translated foreign supporting documentation. The move was also designed to prevent fraud and money laundering, amid allegations of mortgage rorting by foreign buyers.

Commonwealth Bank of Australia (ASX: CBA) followed suit shortly after, withdrawing loans to temporary Australian residents with foreign currency income.

Only National Australia Bank Ltd (ASX: NAB) has yet to announce any moves to limit lending to foreign buyers or temporary residents.

The other concern is that there is a glut of apartments, particularly in Australia’s three major cities on the east coast, Sydney, Melbourne and Brisbane. A flurry of construction activity over the past year or so has coincided with a huge influx of foreign buyers, particularly Chinese, into the property market and almost exclusively into new apartments in major capital cities.

A large number of apartments are due to settle from around 2017, and the risk is that foreign buyers who are unable to access funding are likely to default on payment, leaving the developers holding the bag. That could turn into a virtuous spiral, with apartments being sold at huge discounts, forcing other buyers to pass on paying up inflated prices and forcing apartment prices even lower.

The banks have also been under pressure to limit lending growth to a maximum of 10% to property investors by the banking regulator, APRA. This is another lever they can pull to slow investor-led growth.

Foolish takeaway

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.