The banking watchdog says there has been a drop in interest-only mortgages in the past six months to well below the 30 per cent benchmark it set last year to tame investor demand.

Australian Prudential Regulation Authority chairman Wayne Byres said interest-only loans are running at about 20 per cent of all new lending, and banking institutions of all sizes are conforming.

‘We are comfortable with the way the industry has adapted to that benchmark,’ Mr Byres told a Senate hearing on Thursday.

The curtailing of interest-only loans was one of several actions undertaken by APRA in the past couple of years to restrain investor demand at a time when Sydney and Melbourne house prices were ballooning.

However, a recent review of the financial sector by the Productivity Commission found the clamp-down on interest-only applications may have actually provided a windfall for the banks and a cost to taxpayers.

It argued the action by APRA has resulted in the banks charging higher interest rates on new and existing investment loans, and because interest is tax deductible on such mortgages, it has resulted in taxpayers having to bear the cost which it estimated could be up to $500 million a year.

Mr Byres wasn’t about to challenge the commission’s calculation but said its view was oversimplified and believed there were other drivers at work.

‘We are going to talk some more with the Productivity Commission about this,’ he said.

He said every time interest rates move because of a regulatory change by APRA or by the Reserve Bank changing the official cash rate, the interest expense people incur will change and the tax-deductible amounts they have, either through negative gearing or other interest reductions, will change as well.

‘I don’t think there is any way you can design something to avoid that,’ he said.

APRA’s package of macroeconomic policies has seen demand for investor loans more broadly ease to an annual pace of three per cent compared with almost 11 per cent in mid-2015, according to Reserve Bank figures released on Wednesday.

New figures on Thursday also showed house prices have softened further, falling 0.3 per cent nationally in February to two per cent annually.

Sydney housing prices declined 0.6 per cent in the month to be down 0.5 per cent over the year, sharply down from around a 20 per cent increase in late 2015.

It was the first annual fall in five and a half years, according to Commonwealth Securities.

Mr Byres told the hearing APRA did not have any particular target for house prices.