Bradley Wallis has told the commission he and his wife felt like they were being held to ransom by the bank.

Bank of Melbourne lent Mr and Mrs Wallis $516,000 to buy a bed and breakfast property outside of Port Macquarie in NSW, but provided a residential rather than business loan.

The inquiry heard the bank then pressured the couple to put $100,000 from the sale of an investment property into a term deposit that couldn't be withdrawn until the B&B loan was changed to a commercial one.

That was so the bank could cover a security shortfall, as it had lent a higher amount than it should've.

A senior Westpac executive admitted its Bank of Melbourne subsidiary should not have withheld the money.

"We shouldn't have done it," Westpac's general manager of commercial banking Alastair Welsh said on Friday.

"We got this wrong and passed that on to our customer, and that was a bad call by us."

Mr Wallis said the couple felt "we were being held for ransom essentially" and they had to agree to get the mortgage on the investment property discharged.

Mr Welsh agreed with senior counsel assisting the commission Rowena Orr QC that the bank retained the $100,000 as a bargaining chip to get Mr and Mrs Wallis to agree to restructure the loan.

He said the B&B should have been valued as a commercial property.

Mr Welsh agreed the local business manager was keen to get the deal done and stood to gain financially through bonuses if the loan was approved as a residential property due to its higher value.

The inquiry heard Mr Wallis believed the bank did not have the legal authority to withhold the money.

Mr Welsh said Westpac's lawyers maintained the bank could do so but conceded the clauses it relied on were too complex for customers to understand.

Australian Associated Press