The Australian Prudential Regulation Authority requires residential mortgage lenders to apply a serviceability buffer of “at least” 3 per cent above the loan rate, but that is not how it has been working in practice. APRA reported in its latest ADI statistical update that the weighted average variable interest rate for new housing loans increased by 65 basis points to 5.09 per cent in the December quarter. The weighted average interest rate applied by ADIs to serviceability assessments rose by 80 bps to 7.93 per cent. That means the interest rate buffer being applied during the September quarter was 2.69 per cent (when the average loan rate was 4.44 per cent and the average rate applied to serviceability assessments was 7.13 per cent). During the December quarter the buffer rate was 2.84 per cent (when the average loan rate was 5.09 per cent and the average rate applied to serviceability assessments was 7.93 per cent). Is the regulator falling down on the job? APRA said that for certain loan products, such as fixed-rate loans and interest-only loans, ADIs apply the buffer to the revert rate that applies at the expiry of the fixed-rate or interest-only term. It said another factor that would explain the difference between the expected and actual buffer rates is the timing between loan approvals and drawdowns. In its recent assessment of macroprudential settings, APRA said: “The objective of the serviceability buffer is to ensure that banks make prudent lending decisions, lending to borrowers that are able to repay their loans in a range of scenarios. “The buffer provides a contingency not only for rises in interest rates over the life of the loan, but also for any unforeseen changes in a borrower’s income or expenses.” Its view is that there are heightened risks to serviceability, with the potential for further interest rate rises, high inflation and risks in the labour market.  The buffer was increased from 2.5 per cent in late 2021.