There is little doubt that residential lending is a major component of banks' lending activities. The current slowdown in price growth gives rise to some concern that negative equity will start re-emerging on a large scale. It has already started to appear on a small scale. What implications does this have for banks?
Firstly, it is important to note that this is not a general phenomenon. The sunshine states (those with large mineral wealth) continue to experience a boom and house prices there have not (yet) even peaked. Secondly, most banks and other lenders have limited their exposure by not exceeding 80% LVR except where LMI is used. This means that they are not exposed until at a minimum 20% of the property's value has been lost.
However, given the high propensity for people to re-mortgage and use mortgage equity withdrawals, it should be expected that a reasonable proportion of lending is towards the upper end of the LVR scale, and therefore exposed. Home lending has also become progressively less profitable for the banks as brokers, and better informed consumers, have eroded margins.
Given current capitalisation and profitability ratios I do not expect that, under any forseeable scenarios, any of the major, or regional, banks will have any serious problems. The interesting thing will be to watch for unusual movement among the smaller players in NSW, Victoria and Tasmania if the housing prices there continue to dip. Some of them may have problems and may seek to merge if things start to get ugly.