TONY JONES, PRESENTER: After successive scandals, Australia's banks are under serious scrutiny with Labor promising a royal commission if it wins the election and the Government's new plan to beef up ASIC's powers.

Well the banks are now facing new allegations of loan fraud.

A Senate inquiry into white collar crime has heard allegations of bank staff forging signatures and exaggerating incomes on loan applications.

In one damning submission, two economists argue the problem is systematic. Echoing the theme of the hit Hollywood film The Big Short, they say lenders are routinely massaging the numbers to make borrowers look more credit-worthy than they really are.

Stephen Long has the story.

STEPHEN LONG, REPORTER: At their age, Michael Downer and his wife Kaye should be leading the good life without too many worries, except whether the fish are biting.

Instead, they're in debt and despair.

KAYE DOWNER: Anger, frustration, anxiety - everything. The whole realm of emotions because it's affected our life together. It's affected our relationship. Even just interest in a lot of things.

MICHAEL DOWNER: Our possible retirement.

KAYE DOWNER: And it's just been four years of, you know, anxiety and sleepless nights and, yeah. Yeah, it's terrible.

STEPHEN LONG: Four years ago, lured by a property spruiker, the Perth couple bought a house and land package at Zilzie near Rockhampton in Queensland on a 30-year interest-only loan.

MICHAEL DOWNER: I was 65.

KAYE DOWNER: And I was 60.

STEPHEN LONG: Westpac obtained a professional valuation which told the bank its customers were paying too much. The valuer warned that property within the estate was, "currently being marketed aggressively to non-local investors," at, "inflated prices." The valuation put the property's worth at $400,000 maximum - probably less. Despite this, Westpac lent the Downers nearly half a million dollars to buy it.

MICHAEL DOWNER: When we saw that, we thought, "Well if I'd seen that in the first place, I wouldn't have even gone ahead."

STEPHEN LONG: Michael was retrenched soon after and the Downers struggled to pay the mortgage.

KAYE DOWNER: Just going through these papers again. That's - like, your mind boggles, doesn't it, when you look at it? I mean, how much they've inflated our income.

MICHAEL DOWNER: Yep.

STEPHEN LONG: After pleading for help with no avail, the Downers demanded that the bank give them their loan documents. They were shocked by what they found. Though the Downers' pay went straight into their Westpac account, their earnings were vastly inflated on some of the forms. A statement of income prepared by the bank put Michael's gross annual salary at $93,500. He'd actually earned less than $60,000. Kaye's part-time wage of about $12,000 was more than doubled to $28,000.

MICHAEL DOWNER: We've been loyal to the bank for 20-odd years. They knew what we were earning.

KAYE DOWNER: It's just full of all different handwritings. Proof that it's been - a lot of it's been filled in at the bank - by the bank after we signed it.

STEPHEN LONG: On a page of the loan application, Kaye's signature appears to have been forged.

KAYE DOWNER: That - my signature there's certainly dodgy. I mean, that goes backwards. Mine goes forward.

MICHAEL DOWNER: It's just fraud.

KAYE DOWNER: It's fraud, absolutely fraud.

STEPHEN LONG: And it's far from an isolated case. Criminologists and consumer activist Denise Brailey has been investigating bank fraud for 15 years. She's seen a vast number of cases like the Downers.

DENISE BRAILEY, CRIMINOLOGIST & CONSUMER ACTIVIST: In all case, and I've looked at well over 2,000 cases, in each of these cases, they're unaffordable, unsustainable and unverified.

STEPHEN LONG: Jeff Morris is the whistleblower who exposed Commonwealth Bank's financial planning scandal. He says a toxic incentive system at the banks encourages loan fraud.

JEFF MORRIS, WHISTLEBLOWER: You've got brokers and lenders who are being remunerated on the loans they write, simply massaging the figures to put it through the computer system and then it spits out an approval.

LINDSAY DAVID, LF ECONOMICS: The banks have just trashed their lending standards over a prolonged period of time with significant evidence of banks massaging people's incomes in their loan application forms to make them look a lot more credit worthy than what they really are, which is essentially fraud.

STEPHEN LONG: Economist Lindsay David believes that loan fraud by banks is systemic. In an explosive submission to a Senate inquiry on white collar crime he and a colleague argue that banks have an interest in overstating the credit quality of borrowers.

Why would the banks do this?

LINDSAY DAVID: The safer your mortgage book looks, the lower it costs for you to do business. It's as simple as that. If you go and show that your borrowers are very credit worthy, you're gonna get cheaper funding costs and that's a win-win for the bank - until the whole system breaks down, obviously. ...

... So as you can see here, the Australian debt-to-disposable-household-income ratios have increased significantly. It looks like we're heading towards 200 per cent, which is ...

STEPHEN LONG: Phenomenal.

LINDSAY DAVID: It's phenomenal.

STEPHEN LONG: On just about every measure, Australia's household debt levels are the highest in the world. Property prices have kept rising, even though incomes are stagnant, with the lowest wages growth on record.

Lindsay David says the only way that banks have been able to keep lending more and more is by compromising credit quality and doling out absurd amounts relative to income.

LINDSAY DAVID: The American banking system never loaded up their citizens with so much debt like the Australian banks have done. I mean, you just gotta look at the numbers.

STEPHEN LONG: 124 per cent debt-to-GDP ratio here in Australia. The Americans didn't even crack 100 per cent at the peak of their housing bubble. That kind of tells you that, you know, if the Americans were lending recklessly, how the heck are our banks lending responsibly?

LINDSAY DAVID: If he's right, it could threaten the entire financial system. Just like in America, a lot of home loans have been bundled up and sold to investors who believe those loans are high quality.

LINDSAY DAVID: To say triple A on our mortgage books is kind of like, to me, saying, you know, "Here's a great Ferrari. Come and buy it," when essentially it's a Datsun with a Ferrari badge on it.

STEPHEN LONG: For many years, the number of borrowers in Australia who can't pay their home loans has been very low and the banks here have a solid reputation, but they're heavily reliant on funding from offshore to make new loans. So you wouldn't need a rise in the number of bad loans that was big enough to make the banks insolvent for us to have a crisis. All you'd need would be a rise that was enough to make those global funders lose confidence and the funding would dry up and we'd have a meltdown.

LINDSAY DAVID: I don't think Australians understand the risk our banks have taken in order to get house prices as high as they are.

STEPHEN LONG: But in the Downers' case, the risk was all with them.

KAYE DOWNER: Worrying about our future and how we're going to manage.

MICHAEL DOWNER: Whether we're gonna lose our own home.

KAYE DOWNER: Yeah, this is the biggest worry. And when we sell the property in Queensland, there will be a massive shortfall and this - our own home is a guarantee against the loan, so we'd have to sell this to pay the bank back. So, yeah, the future is just very uncertain.

TONY JONES: Well in a statement to Lateline Westpac said its conduct was cleared by the Financial Ombudsman's Service. Nonetheless, it said it was taking the Downers' claims very seriously and working on establishing the facts through a full investigation.