Merrill Lynch analysts (full report below) have sprung the banks on another method they use to expand the amount of money they can lend to anyone and everyone. From Banking Day:

The long-standing use by banks of the poverty line as a proxy for living costs is the subject of a fresh, but sceptical, review by a team of Merrill Lynch banking analysts.

The sell-side analysts at Merrill Lynch assessed the living costs used by major banks in Australia to work out the maximum loan a borrower could afford (taking into account other criteria such as the loan size, deposit and property valuation).

Merrill Lynch reverse-engineered the home-loan calculators used by banks – available on their websites – to work out the cost of living banks must use in assessing loans.

The analysis suggests that while banks, in theory and, according to them, in practice, make use of the Henderson poverty line for most cases, they may actually apply even lower living costs.

“Surprisingly, the average bank cost-of-living assumption is seven per cent lower than the poverty index, 14 per cent lower than our barebones budget, and even more for our adjusted [living costs, based on] ABS survey [data], says the report.

“From discussions with bank management, their cost of living assumptions should reflect the poverty index.”

The actual scorecards banks use in assessing loan applications must differ from those available to customers researching their loans.

Stephen Ries, senior manager of media relations at ANZ said, in an email, “There are several factors that we consider when assessing lending. Just because an online calculator provides an indicative amount it does not mean a customer will be automatically approved for that amount.”

Steve Batten, senior media adviser at Commonwealth Bank said the bank “uses baseline affordability criteria – as does the industry as a whole – to ensure that customers can service the loan, and apply buffers on interest rate and expenses over and above basic expenses, which provides for some contingency should interest rates rise.”

The Merrill Lynch analysts argue in their report that “the banks, using low default living costs, are able to artificially inflate the level of debt they can provide to borrowers.

“In our view, living at the poverty index would be unsuitable for mortgage borrowers, and the banks’ default living costs are even below the poverty index and well below any other comparable budget. We believe the banks’ default living assumptions underestimate the real cost of living for mortgage borrowers. While it might be plausible for a borrower to keep within such a low budget for the short-term, we question if it is sustainable.”

Using alternative and higher levels of living costs, modelled by Merrill Lynch, the researchers found that for a couple with one dependent a big bank’s “approval in principle” for a loan (and subject to a range of assumptions) would fall from the mid $400,000 level to less than $400,000 using what they term “normal” costs.

The maximum loan approval would fall by more than half, to around $200,000, using a higher level of living expenses that makes more realistic assumptions and is based on surveyed household living costs, and which makes adequate allowance for entertainment.

The relevance of using the Henderson poverty line (a relative measure compiled by the Melbourne Institute) attracted regulatory scrutiny from the Australian Prudential Regulation Authority in 2006 and 2007, but has not been raised publicly as an issue since then.