Speaking at the Securities Institute Mortgage Lending Practices seminar, Mr Charles Littrell, APRAs Executive General Manager, said the check comes directly on the heels of its recent review of claims on lenders mortgage insurance (LMI), which found that a third to half of all claims could have been adjusted or refused had the relevant providers taken a hard line on policy terms and conditions.

There is evidence that adherence to these contract requirements is poor across the regulated lending population, he said. This leads to the outcome that lenders mortgage insurance works well to cover the occasional bad loan but may not work well to cover the greatly increased claims volume attached to a property downturn.

According to Mr Littrell, the psychology of home lending in recent years has changed from a credit rationing process to a product market process.  This has led to a more competitive market for borrowers, but may have increased the risks for lenders.

APRAs health check will require Approved Deposit-Taking Institutions (ADIs) to demonstrate appropriate capital strength, foreclosure and insurance claim processes, and management plans that are capable of handling large increases in delinquent and defaulted home loans.   APRA is not forecasting any increase but wants regulated lenders to be ready in a reasonable downside scenario.

Mr Littrell said that APRA would be focussing on fundamental assumptions made by ADIs about the soundness of their loans and loan insurance, particularly the operational risks surrounding those assumptions.

Although home lending is generally safe, in APRAs view, lenders are too comfortable with these products and ADI directors should be asking their management some important questions.

First, are you relying on steadily appreciating prices to cover any home loan problems; second, are you assuming that insured lending is automatically safe  if so, are you certain that your procedures guarantee that you can foreclose on a delinquent loan and effectively claim on the lenders insurance policy; finally, do you have a plan in place to deal with a substantial increase in delinquent loans to perhaps 5 per cent of the portfolio?

He added: APRA will be making it clear that insured loans with less than robust foreclosure and claims systems do not qualify for the 50 per cent concessional risk-weighting treatment for capital adequacy purposes but are instead weighted at 100 per cent.

APRAs health check of ADIs is due for implementation during the second quarter of 2003.

A copy of Mr. Littrells speech is available on APRAs website: www.apra.gov.au