Banks and other lenders should not consider lenders’ mortgage insurance (LMI) an alternative to due diligence on borrowers, the Australian Prudential Regulation Authority (APRA) warns.

Although LMI protects lenders “the risks are not fully transferred to that LMI provider”, the regulator says in a draft prudential guide on residential mortgage lending.

A lender needs a clear understanding of an insurer’s specific requirements at loan origination “for ongoing monitoring and servicing and for collection actions on loans covered by an LMI provider”.

“Good practice is for internal audit and/or risk management functions to periodically test and confirm an authorised deposit-taking institution’s compliance with the requirements of an LMI provider,” APRA says.

A lender should not rely on an audit by the LMI insurer, and should have its own hindsight review and audit regime.

APRA Chairman John Laker says credit standards for home lending are a major focus of the regulator’s supervision of lenders, particularly in a strong housing market with active competition between lenders.

“In this environment APRA is seeing increasing evidence of lending with higher risk characteristics and it does not want this trend to continue,” he said.

“The draft prudential practice guide reinforces the importance of maintaining prudent lending standards when competitive pressures may tempt otherwise.”