The Insurance Council of Australia (ICA) wants the Financial System Inquiry to acknowledge the benefits of lenders’ mortgage insurance (LMI) by reducing risk weights for residential housing.

In a submission to the inquiry, ICA says LMI increases competition and innovation among lenders and helps low-income and high-risk borrowers onto the housing ladder.

It argues LMI aids financial system stability, with providers required to hold more capital than the general insurance industry, yet there is no capital relief for using the cover.

ICA fears lenders may seek alternatives, including self-insurance or holding additional risk on their books. Banks may continue to use LMI for riskier lending, but this could lead to over-representation of higher-risk loans and an unviable LMI industry.

“The exit of LMI providers from the Australian market is not unimaginable,” ICA warns.

“New Zealand, where Genworth and QBE have both wound down their operations, offers a possible precedent for what could happen in Australia.”

ICA recommends reducing risk weights for authorised deposit-taking institutions by five percentage points, bringing them into line with standardised banks.

“To maintain a strong and stable LMI industry and to continue the beneficial impact… the risk weights should appropriately reflect the additional system capital and broader credit and operational risk mitigants provided by LMI cover,” the submission says.