Housing affordability could be improved by giving capital relief to large banks that use lenders’ mortgage insurance (LMI), the Insurance Council of Australia (ICA) says.

The Australian Prudential Regulation Authority (APRA) imposes extra capital requirements on large lenders when a borrower has less than a 20% deposit, even though they switch the risk to an LMI provider.

Both parties then hold extra capital against the same risk, which may encourage lenders to not take LMI cover in some circumstances, potentially increasing premiums and borrower costs, according to ICA’s submission to a Senate inquiry on affordable housing.

Capital relief would ensure LMI continues to benefit the housing system by increasing lender competition, bolstering financial stability and improving home loan access and affordability, it says.

Smaller lenders with LMI do not have to hold as much capital as they would without the cover, but the rule changed for larger internal-risk-based banks under Basel II-related measures.

“Whereas the Basel standards require that banks should hold capital against losing 10% of a mortgage value, APRA requires double this,” ICA says.

The average LMI premium is $5500, depending on the loan size and loan-to-value ratio. Borrowers pay the sum over the life of the loan.

“With the benefit of LMI, many first home buyers are more likely to be able to afford to buy, move into and accumulate equity in their home sooner,” the submission says.

The Senate committee is due to report on June 26.