* APRA drops 7% interest rate serviceability floor
* Expects measure would boost borrowing capacity
* Regulatory u-turn a moral hazard- Deutsche Bank (DE:DBKGn)
* Measure coincides with expected RBA rate cut
* UBS expects measure would increase borrowing capacity by 8% (Recasts to include RBA speech, updates shares, adds analyst reax)
By Paulina Duran and Byron Kaye
SYDNEY, May 21 (Reuters) - Australia's prudential regulator said on Tuesday it plans to relax some of the norms banks use to determine how much they can lend to customers, sending stocks in the sector higher on expectations the move would boost borrowing.
The change would remove the minimum 7% interest rate banks are currently required to use in their stress tests of customers' loan applications and instead propose a 2.5% buffer above the bank's loan rate to assess serviceability.
The proposed easing of the borrowing limit, first introduced in 2014, comes amid a sustained drop in house prices, record-low credit growth and came hours before the central bank signalled it might cut interest rates from 1.5% as soon as next month. interest rates at record lows, and likely to remain at historically low levels for some time, the gap between the 7 per cent floor and actual rates paid has become quite wide in some cases, possibly unnecessarily so," Australian Prudential (LON:PRU) Regulation Authority (APRA) Chair Wayne Byres said in a statement.
The proposal also marks a slight softening of APRA's more strident position on mortgage regulation that followed a scathing year-long public inquiry into banking sector misconduct .
That inquiry put forward dozens of recommendations including a strict interpretation of current lending rules and tests before signing on home borrowers.
After the inquiry, Australia's banking sector has faced significant market headwinds, not only from the regulatory environment but also a broader slowdown in the economy.
"Conditions must be far worse than what is apparent in the public data," Deutsche Bank banking analyst Matthew Wilson said in a note, which called the proposal "an about-turn from APRA's previous stance".
Bank shares surged, pushing the broader market higher and adding to the previous day's rally when a surprise conservative election win removed concerns about drastic regulatory changes.
Shares of the country's biggest lender, Commonwealth Bank of Australia CBA.AX , jumped 3% before easing to close 2% higher. Shares of No. 2 lender Westpac Banking Corp WBC.AX were up 2.7%, while the third largest, Australia and New Zealand Banking Group ANZ.AX , jumped as much as 5% at the open before closing up 2%. The benchmark index .AXJO was 0.37% higher.
The announcement signals "that the housing regulatory environment has passed its maximum point of tightening," Goldman Sachs (NYSE:GS) analysts wrote in a note.
CUT ON THE CARDS
The relaxed lending standards, coupled with a likely Reserve Bank of Australia (RBA) rate cut, is expected to provide support to the country's A$1.9 trillion ($1.31 trillion) housing market, which has slowed significantly.
RBA Governor Philip Lowe said on Tuesday the central bank would consider cutting interest rates at its next policy meeting in June, its clearest signal of a cut yet.
He added prudential tweaks would complement any easing in monetary policy.
"If APRA does remove the floor, some will borrow more and some will take advantage of that and that will help, but that is not a substitute for lower interest rates," Lowe said in Brisbane.
Australia's average mortgage rate for new loans is about 4%. But the current serviceability floor means banks only approve new loans if borrowers can repay "comfortably above" the regulator's 7% minimum. Banks have typically interpreted this to be 7.25%.
Relaxing that rule to only a 2.5% buffer above the average loan rate would mean mortgagees would be assessed on their ability to repay loans at a 6.5% rate, 75 basis points below the current minimum floor.
According to UBS, the drop would let home buyers borrow up to 8% more.
"We're giving power back to the banks to use whatever rate they see fit," said Nathan Bell, a portfolio at fund manager InvestSMART.