AUSTRALIA could escape property bubbles if banks were forced to tether housing credit to rental values.

One of the nation's most controversial economists,Professor Steve Keen, has called for a dramatic overhaul of lending rules that would place strict limits on the size of home loans.

Under his sweeping proposals, every mortgage would be capped based on the rental value of the property it was secured against.

A lender could only issue a loan worth up to 10 times the market value of the property's annual rental income.

The academic claims that by limiting the amount banks could lend against each house, debt-driven speculation would be "much less likely".

"With this reform, all would-be purchasers would be on equal footing," he says, in a submission to the Senate inquiry into banking competition.

"The only way to trump another buyer would be to put more non-debt financed money into purchasing a property".

Professor Keen, an associate professor in economics and finance at the University of Western Sydney, rose to prominence during the global financial crisis when he forecast a 40 per cent collapse in housing prices within five years. He says Australian property prices are rising in part because "some borrowers are willing to take on more (debt) to trump other borrowers".

"The increased leverage drives prices up, feeding back into the leverage-price bubble process."

In his submission, Professor Keen - renowned for his "doomsday" view of the global economic system - warns against fuelling competition in the banking sector. He says past efforts to improve competition "have exacerbated the main problem in banking: the tendency for banks to fund speculative bubbles".

Separately yesterday, the banking industry's powerful lobby group - the Australian Bankers' Association - made its own submission to the Senate inquiry.

Lodging the submission, ABA chief Steven Munchenberg said "some of the populist regulatory ideas which have been discussed over the last few weeks would hurt consumers which they aim to help".

The group outlined a string of initiatives "to further enhance competition in the marketplace", including tax incentives to encourage more saving, which would "put downward pressure on the cost of funds".

Originally published as How to burst the property bubble