Pedestrians walk past a logo of the Westpac Bank Corp on display in a window of a branch located in central Sydney, Australia, July 2, 2016. Reuters/David Gray

Westpac was facing allegations for breaching responsible lending practices. According to the Australian Securities and Investments Commission (ASIC), the financial services provider was not able to properly assess repayment obligations of the borrowers between December 2011 and March 2015. The watchdog will bring the case to the Federal Court.

ASIC claimed that Westpac did not use the actual expenses declared by prospective borrowers to assess loan repayments. Instead, the financial services provider used statistical benchmark figures from ABS Household Expenditure Survey. ASIC said that monthly shortfalls occurred when the financial services provider relied on the benchmark figures leaving the borrower in deficit.

The financial services provider confirmed that benchmarks were used as part of its credit approval. However, it clarified that it did not rely on it solely. The company said that the Household Expenditure Measure published by the Melbourne Institute for Social Economic Research was used as the company's benchmark. "Importantly, 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," Frazis said.

Westpac pledged that it would defend the legal action and take the responsible lending obligations seriously. "It is not in the bank's or customers' interests to put people into loans that they cannot afford to repay. It goes hand-in-hand that we have robust credit approval processes while helping customers purchase their home," Westpac consumer bank head George Frazis said in a statement.

Frazis said that the company's credit policies were informed by their deep understanding and experience of the mortgage market. He added that customers' specific circumstances were taken into consideration. The circumstances included the previous repayments history, income and expenditure and the overall customer relationship.

The company will deal with a political process before initial court hearing takes place. On Thursday morning, ASIC commissioners including Greg Medcraft will appear before the Senate. Next Wednesday, Westpac chief executive Brian Hartzer will appear before the standing committee of the House of Economics.

An anonymous mortgage broker said that other lenders would be watching the case closely. He added that it was a tougher situation for both lenders and borrowers due to the regulatory pressures applied to lenders. On the other hand, some mortgage brokers claimed that it would lead to the tightening of lending criteria. Jessica Darnbrough from Mortgage Choice said that everyone has been tightening up and it would encourage mortgage brokers to go harder still.