An initial court hearing will take place on March 21. But before a judge hears the allegations, the regulator and bank may be asked about more details of the case through the political process.

ASIC's commissioners, including chairman Greg Medcraft, will appear before a Senate estimates hearing in Canberra on Thursday morning. Westpac chief executive Brian Hartzer will appear before the House of Economics standing committee on economics the following Wednesday.

ASIC said its case relates to the assessment of the ability of borrowers to repay when interest only-loans flipped over to a loan where the principal and interest are repaid.

"This is a big headache," a major mortgage broker, who asked not to be named, said.

"The other lenders are going to be watching this very closely. This will 'red flag' the attention of lenders' policy makers fearful of regulatory pressure. It has made a problematic situation even tougher for lenders and borrowers because of regulatory pressures applied to lenders," he said.

ASIC alleged Westpac's "automated decision system" for mortgage applications for interest-only loans had a "servicability assessment" that used a monthly repayment figure that assumed - contrary to the fact - that repayments of principal would be made over the term of the home loan. Rather, they were only made over the residual term after the expiry of the interest-only period. This meant the servicability assessment considered a lower figure for minimum monthly repayments than would actually have to be paid.

ASIC argued that Westpac relied solely on a household expenses benchmark index that underestimated actual living expenses. It alleged that the bank approved loans where a "proper assessment" of a borrower's ability to repay would have shown a monthly deficit.

In a statement responding to the allegations, the head of Westpac's consumer bank George Frazis said the bank has "robust credit approval processes while helping customers purchase their home".


"Our credit policies are informed by our deep experience and understanding of the mortgage market," he said. "They include a consideration of customers' specific circumstances, including income and expenditure, previous repayments history and the overall customer relationship. We build into our processes a range of conservative inputs, including the addition of buffers to take into account possible future interest rate increases."

Westpac said its use of benchmarks such as the 'household expenditure measure' (HEM) called out by ASIC was a "useful input" into its loan assessment process, "in combination with our understanding of customers' circumstances."

The bank said interest-only mortgages were assessed in the same way as a standard principal and interest loan and did not increase how much a customer could borrow.

"The Australian residential market is dynamic and we are constantly reviewing and refining our credit policies," Mr Frazis said.

Mortgage brokers claim other lenders will respond to Westpac's regulatory problems by tightening lending criteria again. It is expected to lead to increased deposit sizes, more evidence of ability to repay, financial buffers to deal with unforseen circumstances and demanding interest only property buyers provide detailed explanations of when and how they intend to repay the loan principal.

"This does not come as a surprise. Everyone has been tightening up. This will spur others to tighten lending policy to keep the regulators off their back. They have already done but this will encourage them to go harder still," said Jessica Darnbrough from Mortgage Choice.

Mr Frazis said Westpac "are committed to meeting our responsible lending obligations and servicing the needs of customers, including prompt credit approval, which enables our customers to responsibly purchase their home with confidence."

While the alleged misconduct occurred before March 2015, in more recent times lenders have issued confidential blacklists of suburbs where they will restrict lending because of growing concerns about oversupply, off-the-plan sales, and, in some areas, falling prices.

Lenders also slammed the brakes on foreign borrowers. Other lenders, such as Macquarie Bank, are requiring interest only borrowers to provide detailed explanation on when and how they intend to repay the loan principal.

