Westpac shares have plunged to a two-year low after investment bank UBS cut the stock to a "sell" rating on concerns over the quality of the lender's mortgage book.
Internal Westpac documents released by the banking royal commission were analysed by UBS banking analyst Jonathan Mott, who said there were now questions over the quality of Westpac's $400 billion mortgage book.
"We see significantly higher risks than we had previously incorporated into our assessment of the stock," Mr Mott said in his research note.
Westpac shares were $1.11, or 3.8 per cent, lower at $28.07 at 1555 AEST on Thursday - their lowest level since February, 2016.
Investor worries extended across the heavyweight banking sector, with Commonwealth, ANZ and NAB all heavily down in the wake of the UBS report.
The released documents included banking regulator APRA's May 2017 targeted review of the big four banks' mortgage arrangements, which included an assessment that while none of the banks had particularly strong results, Westpac was "a significant outlier".
An analysis of a sample of 420 Westpac mortgages by financial advisory firm PwC was also released which found that eight out of 10 of Westpac's mortgage "control objectives" were ineffective.
Mr Mott said a UBS analysis of the data considered by PwC suggested that minimum income checks were not completed in 29 per cent of cases, 66 per cent had no itemised living expenses collected, and in 30 per cent of cases, the borrower's financial position may have been misrepresented.
In nine per cent of cases the loan would have been blocked if the mortgage application had been based on true financial information.
"We believe the royal commission is a game changer for Australian financial services," Mr Mott saiod.
On Thursday afternoon Westpac issued a statement defending the quality of its loan book, saying its mortgages were performing well with deliquencies low by industry and historical averages.
The bank also said the APRA assessment had been to a higher standard than existing regulatory and legal requirements.
Mr Mott said Westpac had moved over the past 12 months to tighten its lending assessments but still had a long way to go to fully comply with responsible lending requirements.
If banks did tighten their lending standards in response to the royal commission's concerns over compliance with responsible lending laws, there could be a "credit crunch" that would leave Westpac in a weaker situation than its peers, Mr Mott said.
"Combined with a weaker asset quality and questions over the enforceability of security in the event of irresponsible lending, we have a cautious view on Westpac and the broader Australian banking industry," he said.