A war for small business borrowers appears to have erupted between Australia's major banks after Westpac revealed a sharp increase in SME lending in the December quarter.Pillar 3 disclosures lodged with the ASX on Monday show that the group's credit risk exposure to small business customers grew sharply in the three months to the end of December, rising more than 19 per cent on the previous quarter.Westpac had total credit-related exposures to small businesses of just A$27.48 billion at the end of September but that ballooned by more than $5 billion to $32.7 billion by 31 December.The regulatory crackdown on mortgage lending practices across the banking industry resulted in a decline in Westpac's exposure to housing borrowers to $540.4 billion from 542.6 billion at the end of September.Total credit risk exposures across the bank's operations still rose by $13 billion to slightly more than $1 trillion in the quarter thanks mostly to the soaring SME borrowing and solid growth in corporate loans (up $2.9 billion).The disclosure from Westpac might be a harbinger of how the other major banks will try to grow profits this year as investment activity in the residential property market slows.Around half of the $5 billion increase in small business lending was attributable to APRA's new lending rules that applied to investment borrowers from June last year. Westpac revealed that $2.6 billion of loans previously classified as residential mortgages were restructured as business loans during the quarter.The bank also said that the flow of investment mortgages slowed considerably during the period, growing by only 5.1 per cent - well below the 10 per cent cap set by the regulator.Interest-only mortgages accounted for 22 per cent of home loans, comfortably below the 30 per cent limit imposed by APRA.Westpac said it was on track to meet the prudential regulator's "unquestionably strong" capital targets, despite a slide in several of the bank's key capital ratios in the December quarter.The Pillar 3 disclosures show that Westpac's common equity Tier 1 (CET 1) ratio fell to 10.1 per cent at the end of December from 10.6 per cent in September.APRA has directed each of the major banks to maintain CET 1 ratios of at least 10.5 per cent by 1 January 2020.The bank attributed the fall to the impact of the final 2017 dividend payment and the overall increase in lending activity.If the surge in business credit activity continues this year at Westpac and the other banks, capital management could emerge as a challenging theme for the sector owing to the higher capital risk weights attached to such lending.Westpac told investors that it was aiming to restore its CET 1 ratio above 10.5 per cent by the end of March."Westpac will seek to operate with a CET 1 ratio of at least 10.5 per cent in March and September under APRA's existing capital framework and will revise its preferred range once APRA finalises its review of the capital adequacy framework," the bank said in a presentation to investors.The Pillar 3 report