SYDNEY, Nov 21 (Reuters) - Australia may make buy now pay later (BNPL) providers follow responsible lending laws, including mandatory background checks of borrowers, a government paper published on Monday said, pushing the sector closer to full regulation.

Consumer advocates fear lenders have outgrown borrowing laws and "the rapid growth of the BNPL industry may be contributing to poor consumer outcomes", the Department of the Treasury discussion paper said, published at the start of a review of the sector.

The department was considering varying degrees of BNPL regulation, from strengthening an industry-backed code of conduct to forcing BNPL providers to comply with existing credit laws that require companies to hold a license and run background checks on borrowers.

Applying credit laws to BNPL would amount to Australia's toughest measures yet for the industry, which surged in popularity during the pandemic thanks to government stimulus payments and ultra-low interest rates.

Until now, BNPL has avoided regulations that apply in Australia to credit card providers since BNPL providers make most of their revenue collecting merchant fees, rather than interest payments.

BNPL "is operating outside the normal credit laws and a lot of people are getting into hot water", financial services minister Stephen Jones told Channel Nine media earlier on Monday.

"We want to ensure that this product is operating safely (and that) it's operating within the normal guardrails that operate with other credit," he added.

The Australian Finance Industry Association, a body that runs a BNPL "code of practice", said it welcomed the discussion paper and supported regulation "but it needs to be right-sized and it needs to reflect how things really work and how customers are actually using it".

A spokesperson for Afterpay, Australia's biggest BNPL provider that was bought this year by Twitter founder Jack Dorsey's Block Inc, said the company looked "forward to the consultation process with Treasury and continuing to advocate for an option that will protect consumers and innovation."

Cynthia Scott, Australia managing director of Zip Co Ltd , owner of U.S.-based Quadpay, said the company already had a credit license and supported "fit for purpose regulation under the Credit Act." (Reporting by Byron Kaye; Editing by Sam Holmes)