The Australian Prudential Regulation Authority (APRA) has reminded the banking industry not to grow short-term profits at the expense of adequate investment in resources to manage evolving business risks.

In a letter to chief executives, APRA stated that it has observed reductions in cost-to-income ratios being achieved, in part, through cost cutting in non-revenue generating areas.

APRA noted that it has also seen material operational losses and other errors that could be attributed to under-investment in risk management infrastructure and instances where prudent practices in the main banking group are not replicated in non-bank subsidiaries.

In response to these trends, APRA will lift its on-site visit frequency for banks; look more closely into their investment in management and control across the entire risk spectrum; and ensure that each conglomerate is maintaining good risk management practice across the whole group.

APRAs Chief Executive Officer, Mr Graeme Thompson said that Australian banks have been world leaders in generating high profit growth and returns to shareholders.

"Healthy profitability is a key contributor to bank soundness, but we are increasingly seeing signs that the pressure for continued profits growth may be risking negative consequences for soundness in the longer term," he said.

APRA also notes that since 1995, the banking sector's loans secured by residential property have increased at an average annual rate of 12 per cent, an unsustainable long-term growth rate in a low inflation environment.

Mr Thompson said that associated with this, APRA is observing some loosening in scorecard underwriting standards for individual borrowers and, in isolated cases, loans that do not meet the 50 per cent concessional capital treatment being structured to claim this concession.

"While we are not presently observing unsound loan growth in any systemic sense, we urge the industry to maintain prudent property lending practices," he added.

In its on-site reviews, APRA will look at banks attention to risks associated with sudden increases in home loan default rates (which includes observing the documentation conditions associated with mortgage insurance) and at their ability to increase resources devoted to problem loan management should property conditions deteriorate.

APRAs statistical collections and on-site visits are generating few indications that Australian banks have become overly aggressive in commercial property lending. It is, however, seeing some evidence of increasing reliance on security values rather than cash flow coverage in commercial loan exposures and it plans to discuss this directly with the relevant banks.

APRA recently issued a similar letter to credit unions and building societies on property lending practices.

APRA is the prudential regulator of the financial services industry including banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, friendly societies, and most members of the superannuation industry. It currently regulates $1.5 trillion in assets for 20 million Australians.