Procuring bank finance for acquisition of land has always been a challenge more so for large land intensive projects
The Master Circular on Housing Finance (“Housing Circular”) issued by RBI specifically deals with the conditions on the basis of which the credit would flow to the housing sector in India. The RBI Guidelines on Classification of Exposures as Commercial Real Estate (CRE) Exposures issued on September 09, 2009 (“Guidelines”) lay down principles for classifying an exposure as CRE.
A conjoint reading of the Housing Circular and Guidelines indicate that banks may extend finance to public agencies and not private builders for acquisition and development of land, provided it is a part of the complete project. However, banks are not permitted to extend fund based or non-fund based facilities to private builders for acquisition of land even as part of a housing project. Bank finance can also be granted to individuals for purchase of a plot, when the borrower intends to construct a house on the said plot, within such period as may be laid down by the banks.
Some banks have been construing the Housing Circular and Guidelines to impose a total prohibition on banks funding acquisition of land even for activities other than housing and real estate activities. Though the Guidelines provide some clarity on the subject, a few bankers continue to remain very conservative in the interpretation thereof. The definition of Income Producing Real Estate (IPRE) in the Guidelines states that for an exposure to be classified as IPRE/ CRE, the essential feature would be that the funding will result in the creation/ acquisition of real estate (such as, office buildings to let, retail space, multifamily residential buildings, industrial or warehouse space, and hotels) where the prospects for repayment would depend primarily on the cash flows generated by the asset. Additionally, the prospect of recovery in the event of default would also depend primarily on the cash flows generated from such funded asset which is taken as security, as would generally be the case. The primary source of cash flow (i.e. more than 50% of cash flows) for repayment would generally be lease or rental payments or the sale of the assets as also for recovery in the event of default where such asset is taken as security. The Guidelines clearly state that if the repayment primarily depends on other factors such as operating profit from business operations, quality of goods and services, tourist arrivals etc., the exposure would not be counted as CRE.
The Guidelines list out the illustrative examples as to which exposures would be classified and which may not be classified as CRE. Any loan extended for business activities like construction of a cinema theatre, hotels and hospitals, cold storages, educational institutions etc., to those entrepreneurs who themselves run these ventures would not to be classified as CRE for the reason that the loans would be serviced by the cash flows generated by the businesses and not directly affected due to the fluctuations in the real estate prices. In fact, the Guidelines are liberal enough to provide that cases of developers/ owners of the real estate assets (hotels, hospitals, warehouses, etc.) leasing out the assets on revenue sharing or profit sharing arrangement and the repayment of exposure depending upon the cash flows generated by the services rendered, instead of fixed lease rentals, may not be classified as CRE exposure.
If a borrower were to set up a hospital or hotel project in the heart of one of the metro cities, the cost of land would be a substantial chunk of the project cost which may be required to be financed by the banks. The repayment of such loan would be from the revenues of the hotel/hospital business. Similarly, if there is any industrial project being set up, there is no prohibition on banks financing the land cost where the loan is going to be serviced out of the revenues from the industrial activity.
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Despite the Guidelines of 9th September 2009, some bankers continue to remain conservative towards funding the acquisition of land for business activity. These bankers have taken the view that the Housing Circular imposes a blanket prohibition on banks financing acquisition of land and the Guidelines merely provide the principles on which a particular exposure is to be classified as CRE or not. Such bankers have failed to appreciate the objective of RBI in prohibiting the funding of acquisition of land i.e. to prevent the speculation in land by private builders and developers. It cannot be the intent of RBI to prohibit banks from funding the acquisition of land for a genuine business or industrial activity.
The only circulars which restrict the funding of the acquisition of land are the Housing Circular and the Guidelines and even these merely restrict the banks from financing private builders and developers for the acquisition of land. It may be a good idea for entrepreneurs facing difficulty in getting bank finance for land acquisition to insist on their banks seeking a specific clarification from RBI on this subject.
Sandhya Iyer is a Partner and Pratyush Khurana is an Associate at law firm Vaish Associates