Banks warned not to relax lending standards

APRA has issued a warning to the banks with the fear that some customers may not be able to repay their debts.

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Australian banks have been warned by the Australian Prudential Regulation Authority (APRA) not to relax their mortgage lending standards in light of increasing competition and record low interest rates, stating that customers must be able to repay their loans when rates “inevitably” increase.

Following a major review of loan approving standards – which revealed a number of shortcomings such as incomplete mortgage documentation – the APRA has confirmed that it will be contacting a number of lenders to ensure they would not let their standards slip.

Interest rates are currently sitting at a low of 2.5%, and whilst many have predicted that the next change in rates will be an increase, a number of analysts have also suggested there could be another rate cut to come. In this environment, there is greater demand for loans and, as such, the level of competition between banks such as Westpac (ASX: WBC), ANZ (ASX: ANZ), NAB (ASX: NAB) and Commonwealth Bank (ASX: CBA) is increasing in order to capture customers.

Westpac, for example, is offering a discount of up to 0.9% on new loans above $250,000 as part of a ‘spring home loans campaign’, which is designed to attract more customers away from its competitors.

Whilst APRA has simply warned banks not to let their standards fall, other countries have gone to more extreme measures to control the likelihood of a housing boom. New Zealand, for instance, considered setting a limit on mortgage lending with a high loan-to-value ratio to “dampen excessive house price growth in periods when credit growth is boosting housing demand beyond housing supply”, as reported by The Australian Financial Review last month.

Many analysts in Australia suggested that this could be a good option for Australia to follow too, although APRA has not yet pointed to macro prudential action as being the likelihood. Such action would be difficult to implement in Australia, given the presence of non-bank lenders such as Aussie Home Loans who are competing against the big four banks.

Foolish takeaway

Whilst the major fear is that a situation similar to the 2008 sub-prime crisis could be realised, the banks must adhere to their strict standards and lend only to those who will be able to repay their debts when interest rates go up.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned in this article.

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