This cross-sectional study was to evaluate the levels of urinary liver-type fatty acid binding protein (u-LFABP pg/mg urine creatinine ratio) at different stages of diabetic nephropathy and to see its correlation with other clinical parameters in South Indian patients with type 2 diabetes mellitus (T2DM). A total of 65 (M: F; 42:23) T2DM subjects were divided into three groups, and were compared with 13 (M: F; 3:10) nondiabetic controls. The study groups were as follows: normoalbuminuric (n = 22), microalbuminuric (n = 22) and macroalbuminuric (n = 21). Estimated glomerular filtration rate (eGFR) was calculated using Cockcroft and Gault formula. u-LFABP levels in spot urine samples were measured with a solid phase enzyme linked immunosorbent assay. This study showed that u-LFABP levels were undetectable in healthy controls and was very low in the normoalbuminuric subjects. Elevated levels of u-LFABP are evident from the microalbuminuric stage indicating tubular damage. The levels of u-LFABP increased gradually with declining renal function. Geometric mean (95% confidence interval) for normoalbuminuria was 0.65 (0.47–0.97), microalbuminuria was 0.99 (0.55–1.97) and macroalbuminuria was 5.16 (1.8–14.5), (P = 0.005). In conclusion, u-LFABP levels were elevated in patients with reduced eGFR and showed a positive correlation with systolic blood pressure and protein to creatinine ratio in the total study subjects.