Changes to capital rules that may affect lenders’ mortgage insurance (LMI) could put the home loan system under stress, according to the Insurance Council of Australia (ICA).

Last week the Australian Prudential Regulation Authority announced a requirement for the big four banks and Macquarie Bank to hold more capital in reserve, to protect against mortgage losses. The average risk weight on residential mortgage exposures will rise from about 16% to at least 25% for banks that use the internal ratings-based approach to credit risk.

ICA believes a lack of recognition of LMI in internal ratings-based capital models may lead to higher loan-to-valuation ratios on a non-LMI-covered basis.

“This could increase the system’s susceptibility to significant stress events,” Mr Whelan said.

The change, designed to bring greater resilience to the market, will take effect on July 1 next year.

Mr Whelan says the regulator should consider LMI’s role as it implements changes.

He says the industry will continue working with regulators to ensure appropriate recognition of the extra system capital LMI providers make available.

ICA and QBE have campaigned for some years to gain capital relief for LMI providers, warning that otherwise the insurance, covering financial institutions against mortgage losses, could disappear from the marketplace, as it has in New Zealand.

They also argue that without LMI, many people will not be able to borrow above 80% of a property value. Lenders usually offer LMI to borrowers with a deposit of 20% or less.

QBE LMI CEO Jenny Boddington told insuranceNEWS.com.au the extra capital LMI brings to the financial system and how it provides extra stability should be recognised.

“Very simply, the cost of holding capital and/or being able to invest these funds elsewhere creates higher costs which are ultimately borne by the consumer.

“This recognition is key to ensuring consumers’ costs remain affordable, and therefore home ownership remains possible.”