* Record H1 profit of A$4 bln in line with expectations
* Flags slower home loan growth amid regulator clampdown
* Govt announces new inquiry into competition in the sector
* Industry also faces increased compliance and capital costs (Recasts, adds CEO and analyst comments)
By Jamie Freed
SYDNEY, May 8 (Reuters) - Westpac Banking Corp, Australia's No. 2 lender, booked a record first-half cash profit, helped by a drop in bad debt but flagged slowing growth in home loans as regulators seek to cool a red-hot property market.
A recent plan by the country's prudential regulator to place new limits on some types of housing loans, is, however, just one headwind faced by the mortgage-reliant banking sector, which is grappling with rising compliance and capital costs as well as stiff competition.
The Australian government also announced on Monday a new inquiry into competition in industry, following a series of scandals and public allegations against the "Big Four" banks of abuse of market power.
Westpac's cash profit for the six months to end-March climbed 3 percent to A$4 billion ($3 billion), due in large part to a robust performance from its institutional loans division as credit quality improved. The result met expectations and puts the lender on track for its best-ever full-year profit.
Chief Executive Brian Hartzer said the bank expects housing price growth will slow, especially in Sydney and Melbourne due to the regulatory clampdown and like other domestic banks, it has raised mortgage rates.
With expectations high for regulators to require banks to boost capital later this year, Westpac also offered a discount for investors to participate in its dividend reinvestment plan even though its Tier 1 capital ratio of 10 percent was above its targeted range.
"We thought this was a prudent step to increase capital further while we wait for regulatory guidance," he said.
Its net interest margin fell 7 basis points to 2.07 percent from a year ago after it increased interest rates to attract deposits, while first-half return on equity was 14 percent, down from 14.2 percent a year ago.
The new government inquiry is widely expected to target the wealth divisions of the banks.
"Those wealth businesses have caused the banks the most amount of angst over the last few years as far as customer complaints and problems," Morningstar analyst David Ellis said.
"But I don’t think the likely outcome would be forced divestments of their wealth businesses.”
Despite the headwinds, Australia's banks are some of the strongest globally.
Rivals National Australia Bank and Australia and New Zealand Banking Group both reported rises in half-year cash earnings last week, benefiting from strong credit growth driven by housing loans in Australia's booming east coast property markets.
Both NAB and the Commonwealth Bank of Australia are also expected to notch up record annual earnings.
$1 = 1.3492 Australian dollars Reporting by Jamie Freed and Rushil Dutta; Editing by Edwina Gibbs