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Jeffrey Hutton is a Morningstar contributor.

Competition to woo new borrowers will heat up over the next two years as banks struggle to expand their loan books. But will all that competition eventually mean less choice as the big banks force smaller independent lenders out of business?

The $1.2 trillion Australian mortgage market is growing at less than 6 per cent a year - the lowest level of lending growth in more than 20 years, according to the Deloitte Australian Mortgage Report released last week.

"Price wars will likely continue in the short term," said Deloitte national banking leader Rick Porter. "However, under the current economic environment, institutions will need to strike the right balance between growth and profitability."

That might be great news for borrowers for now. But smaller lenders don't have the access to international wholesale money markets that their larger banking rivals, the big four, enjoy. If they are knocked out of the market, future borrowers may find conditions far less favourable.

At the centre of the issue is a lending sector that has to work harder to attract borrowers, as many consumers stash away savings in term deposits and repay debt and as overseas credit becomes more expensive.

Since the year 2000, the value of housing settlements has outstripped lending. But all that changed with the global financial crisis. Housing lending has exceeded the value of settlements since December 2009, with the most recent data showing the value of housing lending has ticked over $25 billion - its highest level in at least a decade - while settlements were about $5 billion less.

To expand their loan books, banks will have to accept more meagre net interest margins - the interest they earn on loans over the amount they can borrow from wholesale markets or the interest they pay on deposits. Since the global financial crisis, terms for borrowing on wholesale markets have improved.

Margins will narrow in 2012, Deloitte senior banking partner and fellow report co-author Graham Mott said.

"While major banks generally reported improvements in net interest margins in 2011, reflecting the repricing benefits across the existing mortgage loan portfolio of passing on more than the cash rate increases in late 2010, the outlook is for margins to narrow in 2012."

Overall, lending margins will fall from about 220 basis points to about 200 basis points, Deloitte says.

"This highlights the balancing major banks need to undertake to offer competitive rates to borrowers and ensure adequate returns to shareholders."

Debt and economic woes in Europe and the US may already be making debt more expensive just as banks have to work harder to find customers, even if they have the backing of the government that was extended during the global financial crisis.

Earlier this month, ING Direct sold $750 million in mortgage-backed securities of which $597.5 million - with a weighted average maturity of 2.7 years - had a coupon of 135 basis points over the bank bill swap rate.