The Australian banking system has suffered from a “sickness” of high levels of mortgage lending and a “huge glut” of credit available to borrowers, according to a new report.

The “sinkhole” of underwriting for high-risk borrowers is a problem that is not being addressed, the report by the bank regulator the Australian Prudential Regulation Authority (APRA) said.

The regulator’s interim report, which is due to be released on Wednesday, found that banks have a “critical need” to invest in new lending initiatives to support borrowers.

It said that while the sector was “satisfied with the level of lending in the economy” it did not have the capital or capacity to meet the need.

The APRA’s interim study found that a quarter of banks had raised some or all of their capital from investors since January and were “relatively confident” that they could “maintain capital ratios well into the future”.

The report found that of the total capital available to lenders, about 20 per cent of banks have raised their capital levels through a combination of “in-principle and in-force” lending.

However, it found that only about three-quarters of these loans were being managed at “adequate capital levels”.

The APSA report found: “There is an urgent need to invest significantly in new and more effective lending capacity to support the lending needs of the large number of borrowers who are at risk of financial distress.”

The APMA’s interim findings are likely to lead to further scrutiny of the Australian banking sector’s lending practices and the need to ensure lenders are providing adequate capital to meet their lending needs.

The APRA report has prompted calls for the Federal Government to introduce a capital surcharge to fund the funding of capital needs.

A spokeswoman for the Financial Services Minister, Scott Morrison, said on Tuesday that a capital charge was “not on the table”.

“There’s nothing to suggest that the Federal Treasurer will go to the extent of making a capital levy or a capital requirement, as that would be very unpopular with the community,” the spokeswoman said.

Ms Morrison has previously suggested that the government should look at the introduction of a capital tax to fund lending, and that it should include a levy on the amount of interest a bank charges on its loans.

Mr Morrison’s spokesman said the Treasurer would be “taking a look” at the issue.

“The Treasurer has been very clear that capital is a part of our national financial system and the government will continue to make sure that banks are investing in their own capital and in the investment that they do,” he said.

“But that is one of the things that the Treasurer will be looking at at the time that he has the opportunity to make a decision on capital.”

Mr Abbott said in an interview on ABC TV on Tuesday morning that the Government would not be putting a capital rise in place before the end of the year.

“There will be no capital tax increase in the Budget,” he told ABC Radio Melbourne.

If we have an economic downturn like this, it is going to be much more difficult to spend that money in the long term because the spending power of households and businesses is going in reverse, as they do in any recession.”