A secret report by the banking regulator shows that lax lending standards by Australian banks threatened to push the number of borrowers who could not pay their home loans to dramatic and unprecedented levels that could have caused a serious recession and a banking crisis.

Key points: APRA home loan search in 2007 found banks issuing 3.4 times more loans than they could have under previous rules

APRA home loan search in 2007 found banks issuing 3.4 times more loans than they could have under previous rules Report forecast that lower lending standards could lead to serious recession and banking crisis

Report forecast that lower lending standards could lead to serious recession and banking crisis Experts fear risks identified in report now worse, with mortgage debt doubling

Mortgage debt has doubled since the Australian Prudential Regulation Authority (APRA) carried out the confidential search in 2007, and experts fear the risks identified in the secret report are now far worse.

APRA's report, which was never published, examined the impact of lower lending standards adopted by the banks on credit growth and the ability of borrowers to service home loans, based on examination of tens of thousands of loans made in 2006.

Its modelling found that lower lending standards had allowed banks to dramatically expand credit, issuing 3.4 times more loans than they could have under previous, more conservative lending rules.

It forecast that the lower lending standards would cause a dramatic and unprecedented increase the share of "delinquent" home loans, where borrowers fell behind on repayments.

"Delinquency rates forecast by the model are substantially higher than those observed in the recent decade, which are often stated by many lending institutions to be less than 1 per cent of loan value," the report said.

"In a steady economic scenario over the next three years, the delinquency rate is predicted to reach 7.5 per cent."

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That level of arrears on home loans would have likely panicked investors and could have caused the offshore funding that Australian banks rely on to support their lending to dry up or become far more expensive, causing a credit squeeze and a home price crash.

7.30 has been told that APRA's then-chairman, John Laker, told staff that the report could not be published because it would panic investors and could undermine the banks.

"There's probably no doubt that Australia would have had a recession, increased mortgage defaults, increased unemployment, borrowing costs going up, and real pressure on the economy," Morgij Analytics chairman Graham Andersen told 7.30.

As it happened, poor lending overseas led to a global financial crisis, the Reserve Bank slashed interest rates and the Government threw stimulus money at households, averting the threat of a homegrown recession from lax lending standards.

But some say that has merely allowed the problem to get far worse, with mortgage debt doubling since APRA's alarming research was carried out.

'GFC saved us' by averting homegrown recession

Australia's total household debt has now eclipsed the entire annual output of the economy — the highest level in the world.

"In some senses you could say that the global financial crisis saved us, or were we actually just delaying the problem and not fixing it?" Mr Andersen said.

Last year, in a footnote to a speech, APRA chairman Wayne Byres revealed that Australia's big four banks and Macquarie did not have enough capital set aside against mortgages to cover loan losses in the event of a severe house price crash.

CSLA banking analyst Brian Johnson says the APRA finding was one of the most disturbing things he has ever read.

That speech got veteran banking analyst Brian Johnson, of CSLA, concerned.

"As I read the speech that APRA made I'd have to say it was one of the most disturbing things that I have ever read," Mr Johnson told 7.30.

"What they said is that the standardised banks, which are basically the regional banks, just passed.

"They said that the advanced banks, which is basically the major banks, they said that they did not pass.

"I would say 'did not pass' means fail.

"I've been instructed by one of the banks that's not what it means but it sounds like that to me.

"If my child came home and said 'I did not pass', I would say 'you failed'."

Mr Byres admitted at a Senate Committee last year that a further erosion of bank lending standards in recent years had caught the regulator unawares.

"I think we were caught a bit by surprise at how much the competitive pressures in the industry — the competitive dynamic in the industry — had led people to do things that were really, in our view, lacking in common sense," he said.

"It did seem that competition was eroding standards."

The banking regulator has been troubled by a "net income service" model, under which banks have been willing to lend amounts that leave the borrowers not much above the poverty line after making loan repayments.

It is now fighting a rearguard action to rein in bank lending, imposing new capital controls, restrictions on investor residential mortgages and tighter lending limits.