The Australian Prudential Regulation Authority has proposed to relax its guidance on how banks assess their mortgage customers' ability to manage their repayments, a move likely to increase the maximum borrowing capacity for a given borrower.

APRA proposed removing its guidance that requires banks to assess whether borrowers can afford their repayment obligations using a minimum interest rate of 7%. Instead, banks would be allowed to review and set their own minimum interest rate floor for use in serviceability assessments, the regulator said.

APRA also proposed that banks' assessments include an interest rate buffer of 2.5%. Currently, banks are expected to assess loan serviceability using the higher of either an interest rate floor of 7% or a 2% buffer over the loan's interest rate.

APRA decided to review the current guidance in light of the changes in the operating environment for banks since the guidance was introduced in 2014. "With interest rates at record lows, and likely to remain at historically low levels for some time, the gap between the 7 percent floor and actual rates paid has become quite wide in some cases," said APRA Chair Wayne Byres.

The changes will likely increase the maximum borrowing capacity for borrowers and give banks greater flexibility to set their own serviceability floors, Byres added.

APRA will close a four-week consultation on the proposed changes on June 18 and will release a final version of the amended norms shortly afterwards.