Further hikes to the cash rate by the Reserve Bank of Australia (RBA) in the coming months could potentially trigger talks on the likelihood of the Australian Prudential Regulation Authority (APRA) easing the lending buffers currently in place.

The scenario has already happened in the UK, where the Bank of England (BoE) scrapped its mortgage stress test buffer that requires lenders to assess borrowers at a rate that is three percentage point higher than the advertised one.

BuyersBuyers co-founder Pete Wargent said the stress test was “far too stringent”.

“From this month, the UK stress test rules have now been eased, so that lenders only need to assess for a minimum stress buffer of one percentage point, although rising power bills will also still need to be factored in,” he said.

The change comes at a time when the BoE’s base rate is expected to increase further after being stuck at 1% or lower since 2009.

“This may appear to be contradictory, but the bank is now already some 165 basis points into its hiking cycle, so as the rate hikes flow through it means that a rigid buffer would mean stress-testing for an unrealistically high terminal rate, starving the market of funds, making refinancing unfeasible for many mortgagors, and unnecessarily pricing out many first-home buyers,” Mr Wargent said.

Should APRA follow suit?

BuyersBuyers CEO Doron Peleg said Australia’s interest-rate environment has already changed drastically over the past few months, rising from 0.10% to 1.85% in August — a further 50bps increase to 2.35% could potentially put the current stress test under scrutiny.

“With the cash rate set to rise to 2.35% next month, such a stringent stress test would no longer makes sense, especially with the banking system so well capitalised, and with the regulator confirming that sound lending standards continue to be applied overall,” he said.

The APRA raised the lending buffer to 300bps in October last year, a move that was deemed prudent in addressing the systemic risks of the low-rate environment. This meant that lenders assess loan applications at a rate that is three percentage higher than the advertised rate.

“A buffer of, say, two percentage points would be far more appropriate now, not least because the current rules make it far too difficult for many borrowers to switch lenders, often leaving them trapped on unattractive mortgage rates and poor terms,” Mr Peleg said.

Potential shock?

Talks about the amendments on lending buffers could, however, be negatively perceived.

Mr Wargent said changes to lending standards must be communicated well to the media to avoid misinterpretation and misreporting.

“For example, even a reduction in the lending buffers to 2.5 percentage points would inevitably be perceived by many media outlets as increasing the risks to financial stability, whereas in reality the opposite would be true,” he said.

“The ability of existing borrowers to refinance is a critical safety valve for the housing market and for financial stability.”

Mr Wargent said it is crucial to understand that under realistic assumptions, the cash rate target is extremely unlikely to increase to anywhere near the implied 5.35% if the buffer is applied.

“Assessing borrowers at for such extreme outcomes would thus be unnecessary, at a time when Australia is close to experiencing full employment, and rental vacancy rates are tracking at near 20-year lows,” he said.

Photo by @89Stocker on Canva.