Recent data is pointing to an improving housing cycle. So, what would be the impact of curbing negative gearing for banks, those giants of our financial system? The initial effect that comes to mind is slower profit growth, because banks make such a large chunk of their profits by lending to property investors, many of whom are attracted by the tax breaks. But if you think about it a bit more deeply, it seems clear these effects would be modest, and would probably be outweighed by the fact we'd end up with a safer financial system. The $1.5 trillion home loan market is the engine room of Australian bank profits, accounting for about 65 per cent of all loans in the banking system.

It seems curious the banks have been absent from the public discussion about property tax. Credit:John Shakespeare Loans to property investors make up a bit over a third of all mortgages, and it's been a rapidly-growing section of the market, at least until last year's crackdown on landlord borrowers. The value of loans to property investors lifted 32 per cent, or $173 billion, in the past five years, Reserve Bank numbers show. That gain isn't far behind the $190 billion growth in owner-occupied loans over the same period, even though owner-occupied lending started from a much higher base. Few dispute that the combination of concessions on capital gains tax and negative gearing – allowing investors to deduct their interest payments against their overall income – has helped fuel the boom in property investor lending. What would it mean for banks if these tax breaks were curbed – as Labor is planning to do? (Its policy is to halve the capital gains concession and only allow negative gearing on newly-built homes).

Well, dulling the incentive for highly-levered property investment would probably make buy-to-let investment less attractive, lowering demand from these buyers. That would probably mean less growth in housing investor credit for banks. But here's a couple of reasons to think this slowdown wouldn't be severe enough to get the banks worried. For one, you'd expect that other home buyers, such as owner-occupiers or first home buyers,would step in to pick up some of the slack. This has already happened to some extent, with owner-occupier loan growth picking up since the banks took a harder line on lending to property investors last year. And since Labor's changes are "grandfathered" – they only apply to investments after 2017 – existing investors might also have an incentive to pay down their loans more slowly than otherwise, paying banks more interest in the process. That is because if they were to pay down their loans more quickly to invest in another property, they wouldn't receive a negative gearing benefit on the new property unless it was newly built.

How about the potential decline in house prices caused by tighter rules on negative gearing? What would that mean for banks? No one knows for sure what Labor's policy would do to house prices, but once again, a scenario of modest price falls is not that scary for banks. Sydney house prices have fallen for at least a couple of quarters in a row on three occasions since 2003, according to the Australian Bureau of Statistics. These falls did not harm the banks – which after all, make their money on the outstanding stock of mortgages, not the price of homes. What is more, reining in negative gearing could also have actual benefits for banks, by reducing some of the risks in the financial system. The view of global regulators – though not necessarily banks – is that housing investor debt is riskier for banks than owner-occupier loans.

Even though many property investors are well-off, the Reserve Bank of New Zealand last year argued these loans are more likely to go sour if there is an economic shock or property crash. That's because many property investors not only need to keep their own job to be able to service their debts – they are also reliant on their tenants paying a certain amount of rent. If their tenants lose their jobs, or the rental market collapses, these loans are more likely to go bad. In the jargon of central bankers, landlord investors can face "additional income volatility" in a crisis. So, there is an argument that highly-geared property investors can present a greater risk to financial stability – and therefore banks – than old-fashioned owner-occupiers. This isn't some radical view. The RBA has backed a review of negative gearing, and David Murray's financial system inquiry in 2014 said the tax treatment of property was a key reason for the boom mortgage debt, which it viewed as a risk to the financial system. Giving people less incentive to borrow heavily for property purchases could ultimately be good for banks, even if it did slow down their profit growth a bit.