News that Westpac Banking Corp (ASX: WBC) will be putting loan applicants under a microscope may be good news for the longer-term health of the financial sector, but shareholders should make no mistake that they will be paying the price during the painful transition.
This isn't just a Westpac issue either. Its peers like Commonwealth Bank of Australia (ASX: CBA), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB) will probably have to follow suit given the widespread nature of "liar loans" where applicants under declare expenses or inflate income to secure loans they are probably not qualified to receive.
Westpac will require applicants to declare spending on everything from toiletries to pet care from next Tuesday as part of its new tougher "responsible lending" program, according to the Australian Financial Review.
The bank will also start to better verify documents submitted by applicants and has hired credit reporting agencies like Equifax to help screen applicants.
While the market has been aware of accusations that the banks have breached the law by extending loans to consumers who cannot afford them and analysts have been paring their earnings expectations on the back of mounting industry headwinds, such as slowing credit growth, I believe the sector is facing further significant downgrades this year.
Westpac's move to crackdown on liar loans could prove to be the trigger that prompts analysts to relook at their profit growth and dividend assumptions for the sector as the increased scrutiny on loan applicants is likely to have a big impact on bank profitability at a time when the industry is struggling to grow.
The "responsible lending" initiative will not only increase costs for processing each and every loan application but it will also likely severely limit consumers' capacity to borrow at a time when Reserve Bank Governor Philip Lowe is warning that the next move in interest rates is more likely to be up than down, and that the increase will "shock" some borrowers.
The argument for increased costs is also true for Afterpay Touch Group Ltd (ASX: APT) which may be forced to verify the ages of its users after accusations that underage consumers used the service to purchase alcohol.
I don't think the impact from a clampdown in liar loans has been appropriately reflected in consensus forecasts for the banking sector.
Let's just hope the clampdown doesn't cut the availability of credit by too much as that will be a drag on the entire Australian economy – not to mention the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index.
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