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Here’s another reason why the big banks could be in trouble

Tristan Harrison
Piggy Bank in a Vice

The big banks of Commonwealth Bank of Australia(ASX: CBA), Australia and New Zealand Banking Group(ASX: ANZ), Westpac Banking Corp(ASX: WBC) and National Australia Bank Ltd(ASX: NAB) are under the spotlight again.

News Corp(ASX: NWS) ran a story yesterday outlining how the banks had been using the Household Expenditure Measure (HEM) to estimate a bare bones household budget.

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An expert gave an example that if a household’s after-tax income was $80,000 and the HEM was a $30,000 expense then the bank would calculate that household could afford repayments of $49,999.

However, the person who invented the HEM said it was alarming it was being used in this way, banks were meant to gather further information.

Underestimating expenses wouldn’t necessarily be a big problem if other parts of the household budget weren’t in bad shape. Wage growth is at a low point. Utility bills in Australia are some of the most expensive in the world.

Households have managed to solve the HEM problem in the past with decent wage growth and a very handy declining interest rate. It sure helps affording the mortgage when the repayment gets cheaper and cheaper.

According to a report done by UBS in 2017, at least 70% of all homes loans used the HEM benchmark.

The News article went on to say that a couple were considering legal action with Maurice Blackburn because they accuse Westpac of lending responsibly. Another person in the article couldn’t afford the loan he got for an investment property, but the Ombudsman said that he was responsible for his own investment decisions.

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If Maurice Blackburn is successful with that case it could potentially open up every loan where the HEM benchmark was used. For that reason, it seems less likely that it would be successful.

If people were borrowing more than they could afford then that has a big part to play in how strongly the housing market has performed over the past five years. Arguably a lot of these loans shouldn’t have been given out if a real analysis of expenditure had been done.

Foolish takeaway

I imagine there will be more and more stories like this in the coming months of people who can’t afford their loans. Before, property owners could just access the equity in their property as cash to pay for things, but now that property values aren’t going up this option has been ruled out.

If loan defaults don’t happen, then there will sadly at least be a lot of forced selling which will put further downward pressure on the housing market. Arguably you could say borrowers should have actually done their sums to figure out if they could afford the loan the bank was offering.

However, if I were a bank shareholder I’d be questioning management asking why loans were given out that potentially borrowers would not able to repay.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of National Australia Bank Limited. 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 Scott Phillips.