Tamal Bandyopadhyay: The RBI is barking up the wrong tree

The share of housing loans is still very small, and the profile of borrowers shows the level of speculation is low.

The Reserve Bank of India has launched a two-pronged attack to deflate the bubble in the real estate sector. The provisioning norms for standard home loans (where the borrower has not defaulted in repaying the equated monthly instalments) above Rs 20 lakh has been raised from 0.4 per cent of assets to 1 per cent. This means, instead of keeping 40 paise aside for every Rs 100 worth of standard assets, the banks will require to set aside Re 1 to create a cushion of safety. The risk weight for real estate loans, too, has been increased from 125 per cent to 150 per cent. The banks will now require more capital to build such assets. Naturally, the cost of home loans which has already started going up will rise further.

The twin-move, outlined in the annual credit policy, follows another restrictive step taken by the regulator to rein in the exuberance in the sector. A few months ago, it had barred commercial banks from lending to any real estate projects unless all necessary approvals were in place.

Real estate prices have gone up substantially over the past one year. This has brought in speculators into the market along side the genuine buyers. If there is a sudden crash in prices and the borrowers start defaulting in paying their EMIs, banks will not be able to recover the money lent even by selling the assets. Incidents of fraud, too, have been on the rise. Financial intermediaries are tying up with property builders for projects and the builders, in turn, are passing on the loans to flat buyers. There have been cases where the builders have projected their construction workers as flat-buyers to ensure quick disbursals of institutional loans for the project.

These are, however, stray cases and may not justify the RBI move that may end up dealing a body blow to the mortgage market and the dreams of millions of middle-class Indians.

The market is growing at a phenomenal pace. In the first nine months of 2005-06, ICICI Bank disbursed Rs 17,600 crore of home loans against Rs 18,874 crore in the whole of 2004-05. The Housing Development Finance Corporation (HDFC) disbursed Rs 13,805 crore during April-December 2005, against Rs 16,206 crore in 2004-05. According to one estimate, the housing finance industry has grown from Rs 28,720 crore in 2001-02, to Rs 60,354 crore in 2004-05, and is expected to touch Rs 80,000 crore in 2005-06. Another estimate by a consulting firm pegs the home loan market at Rs 1,35,000 crore in 2005, and says it has been growing at 48-49 per cent over the past five years. The report also says that banks have outpaced the housing finance companies in home loan growth.

The reasons for this growth are many "" ranging from low interest rates to tax benefits, rise in disposable income and, of course, the burgeoning middle class. According to an HDFC estimate, in 1995, the cost of a flat was 22 times the annual salary of a home buyer. It came down to 4.6 times last year. There has not been any drastic change in the scene despite the hardening of interest rates as people's purchasing power has not been dented. The interest rate on home loans came down to as low as 7.25 per cent in 2003. Since then, it has gone up to about 9.5 per cent now.

The home loan portfolio of a large private bank shows that in 2002-03, the percentage of those taking home loans in the below 30-year age bracket was 13 per cent and it was 47 per cent in the case of those over 40 years of age. Last year, the share of below 30-year age group in the total home loan pie rose to 24 per cent and that of the 40-plus age group fell to 34 per cent.

Despite such a phenomenal growth, mortgage credit now accounts for about 12 per cent of bank credit and over 6 per cent of India's GDP. In contrast, housing loans account for 12 per cent of GDP in China, 22 per cent in Malaysia, 40 per cent in Hong Kong and 65 per cent in the US. There is a huge demand and supply gap. HDFC estimates a shortage of 19.4 million housing units in the country with 12.7 million in rural areas and 6.7 million in urban India.

By rationing credit and indirectly building a case for higher interest rates, the RBI is possibly barking at the wrong tree. The regulator and the government need to jointly attack other issues to increase the supply of homes and bring down the prices. Stamp duty and service tax jointly account for about 25 per cent of any home loan deal, and go directly to the government's coffer. Even after paying this, a flat owner gets only 65 to 73 per cent of the built-up area as living space. A seller needs to pay capital gains tax unless the sale proceeds are not reinvested in another property. The rise in prices can be controlled by putting in place right policies and increasing supply of houses by repealing the Urban Land Ceiling Act and modifying zoning norms. The RBI must nurture the mortgage market with great care and not stymie its growth.