APRA's new capital rule ignores FSI recommendation on LMI 22 July 2015 3:04PM John Kavanagh The lenders mortgage insurance industry has failed to persuade the banking regulator to give mortgage lenders a capital benefit for using LMI.On Monday the Australian Prudential Regulation Authority announced that authorised deposit-taking institutions using the internal ratings-based approach to credit risk (the Big Four plus Macquarie Bank) would have to increase the capital required to cover their residential mortgage exposures.The average risk weight on Australian residential mortgage exposures will rise from around 16 per cent now to at least 25 per cent.In its submission to the Financial System Inquiry, LMI provider QBE said: "Currently, lenders using the advanced methodology [internal ratings-based] for calculating capital requirements for credit risk receive no capital benefit for the use of LMI, despite the fact that the LMI providers are required to hold significant capital for the risk that is transferred."QBE recommends that capital relief be provided to IRB lenders that utilise LMI. LMI provides an additional layer of capital that assists in diversifying risk across lenders."APRA made no mention of LMI in its announcement.In a study that accompanied Genworth's FSI submission, Deloitte Access Economics said the outlook for the lenders' mortgage insurance market in Australia was "problematic" unless there is capital relief for all lenders using LMI.Some lenders agree. Westpac's FSI submission said: "Regulatory settings currently provide a disincentive for further take-up of loan insurance. "Westpac believes there is merit in the Inquiry considering concessional capital treatment across residential lending, irrespective of IRB or standardised treatment for the use of LMI on residential mortgage lending."The FSI final report said the risk weight gap between large and small lenders could be narrowed in a variety of ways. "In determining the approach, APRA should seek to maintain as much risk sensitivity in the capital framework as possible and recognise lenders mortgage insurance where appropriate," it said.The Insurance Council of Australia put out a statement yesterday saying the lack of recognition of LMI in internal ratings-based capital models may lead high loan-to-valuation loans being sold without LMI coverage. "This could increase the system's susceptibility to significant stress events," said ICA chief executive Rob Whelan.Whelan's comment echoes Genworth's submission to the FSI, which said: "The non-recognition of LMI for advanced banks encourages them to adopt bank risk retention programs to cherry pick high LVR loans, waive LMI and charge a higher interest rate to the borrower."