Banks being kept under a watchful eye

It is vital that Australia’s banks maintain their ability to support themselves in the case of another financial downturn.

a woman

Amidst growing fears of a property bubble in Australia, the major banks have been urged to not let their lending standards slip whilst it has also been suggested that they should be forced to set aside extra capital as protection against financial shocks.

Lending standards

The Australian Prudential Regulation Authority issued the banks with a warning following signs that banks were letting their standards slide in order to gain a larger share of the mortgage market from competitors.

For instance, National Australia Bank (ASX: NAB) is offering $1,000 to customers who switch their mortgages from rival banks – which amounts to around $4 per week over the average life of a mortgage. Meanwhile, Westpac (ASX: WBC) is offering an increased discount on home loans over $250,000 for the spring months.

Although borrowers may be able to repay their debts at the current interest rate, it is vital that they are able to repay their loans when rates ‘inevitably’ increase.

Capital

On top of the warning regarding lending standards, the banks were also cautioned against paying out excessive dividends.

A property bubble has also been described as “inevitable” due to the low interest rates and slow credit growth environment. As such, it has been suggested that it is “simple and logical” that banks should be forced to set aside extra capital, according to Melbourne University professor Ross Garnaut. This is particularly important given that housing prices nationally could rise by up to 18% in 2014, based on the predictions of SQM Research property analyst Louis Christopher.

While banks are required to set aside a certain amount of capital as protection against economic downturns, they do not have to set aside as much for mortgage loans as they do for riskier loans. However, in terms of the risks currently facing the economy, it seems like a very viable option to increase the capital requirements.

Another suggestion has been to implement what is known as ‘macroprudential’ measures, whereby heavier limits could be set on lending to higher-risk home buyers, as seen in New Zealand.

Interest rates

Whilst there have been suggestions that the Reserve Bank could cut interest rates lower, it is looking very unlikely given that lower interest rates would further encourage aggressive competition in the mortgage market.

Foolish takeaway

It is vital that Australia’s banks maintain their ability to support themselves in the case of another financial downturn. Although profits have been sky-high this year, if borrowers are unable to repay their debts there will be an enormous crisis to deal with.

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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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