FINANCIAL SECTOR - MANJU FOUNDATIONS

FINANCIAL SECTOR

Credit Restrictions

7.6.49 Financing options are presently skewed
in favour of personal loans vis-à-vis developer
financing. Most housing finance companies cater
mainly to individuals in the higher income group,
who have a reasonably assured credit worthiness.
Only 5-7 per cent of the loans disbursed by these
housing finance companies go to builders and
institutional developers.
7.6.50 The high default rates among the developers
is one of the factors dissuading housing
finance companies from investing in this sector. The
legal recovery mechanism is time consuming. Lack
of a code of conduct for the industry is the other
factor that keeps investors away. Even now, developers
need to become corporatised to avail funding
from financial institutions. All this leads to builders
and developers approaching private sources of
finance at high interest rates, which ultimately leads
to higher real estate prices.
7.6.51 To attract investment into this sector, it is
imperative that the government increases the
comfort level of the existing fund providers through
appropriate legal measures and corporatisation of
real estate, besides maintaining industry discipline.
Developing a grading system among the developers
will make investors aware of the risks associated
with the projects of each developer. Grading would
facilitate the overall growth of the real estate sector
by providing the developers with incentives to conform to fair trade practices and legal requirements.
A scientifically graded project would lend
itself to a more accurate and reliable estimation of
the risks associated with the real estate project/
project promoter. This is expected to enhance the
confidence of the end users and augment the
interest of the lenders in these projects, thereby
facilitating the flow of institutional funds to the
project/project owner. With the construction sector
receiving industry status, it is expected that developers
and companies will be able to borrow from
financial institutions on priority basis.
Sources of Funds
7.6.52 Real estate mutual funds, pension funds
and insurance companies are the major investors
in the housing sector in developed countries. In the
United States, pension funds invest 5 per cent of
their reserves in real estate equity and mortgages,
whereas in India developers’ ability to get financial
help from these sources is limited. Housing finance
companies in India also need to be given access to
pension, provident and insurance funds. As the
gestation period of real estate projects is more than
five years, on an average, it is necessary that
developers have access to such long term funding
sources.
Real estate investment trusts
7.6.53 In India real estate assets are kept outside
the financial market and not leveraged for investment
purposes. India must try to make real estate
a full-fledged investment option. Real estate as an
asset class is vastly different from capital market
assets. It is a natural hedge against inflation, experiences
low volatility and hence generates positive
long-term returns. To begin, with an exclusive stock
exchange could be set up under Securities and
Exchange Board of India (SEBI) guidelines for
trading real estate stocks.
7.6.54 The Government should permit the setting
up of a Real Estate Investment Trust (REIT) which
should be regulated by SEBI in order to open the
investment floodgate for the real estate sector. The REIT would operate like a mutual fund, where
investments of individual investors are consolidated
to invest in real estate, rather than stocks of
companies. It would provide a higher level of liquidity
as well as professional advice for price discovery,
as the investor would be investing through an asset
management company. It also provides assured
returns in the form of dividends to its investors from
rental income earned on real estate assets. The
essential difference between a REIT and a mutual
fund is that investments made in REIT are traded in
real estate stocks and not invested in stock of
companies. Further the swings in this market are
in the range of 5-10 per cent, which an average
investor is in a better position to absorb than the 60-
90 per cent swings on the stock market. Mortgage market and securitisation
7.6.55 Another source of finance for housing
companies is development of the secondary
mortgage market which involves conversion of
mortgages into tradable financial or debt instruments.
Securitisation is a process popular among
housing finance companies in the West by which
the home loan assets are bundled into securities
and sold to the investors. Such securities are called
mortgage-backed securities and they help the
finance companies convert their loan assets into
cash for further loan disbursals, thus maintaining a
flow of funds from the lenders. It also helps finance
companies reduce their investment risk; the risk of
earning a lower rate of return on cash flows for prepayments
of home loans.
7.6.56 There are two pre-requisites for secondary
mortgage market:
(i) Mortgage loan insurance: The risk of default
under mortgage loan is covered under an
insurance policy for a nominal premium.,
which protects the risk of non-payment to
the lender. As a result, the mortgage loans
are risk-free and it is this reason that only
50 per cent risk weight is assigned to
housing loans under capital adequacy
norms. In India, however, such risk weight
is 100 per cent given the absence of such
insurance cover which increases the risk of non-payment/failure. The Reserve Bank
of India (RBI) has recently reduced the risk
weight for housing loans to 75 per cent,
taking into account the good recovery in
this sector.
(ii) Foreclosure: Housing loans are long-term
loans, repayable over a period of 15 to 20
years. Any default will be restricted to the
period of actual default. Under prudential
norms, the account will become a non-performing
asset after default of six monthly
instalments. Foreclosure laws will enable
the lender to call back the entire dues when
default of six monthly instalments takes
place, irrespective of the fact that the full
amount is not due. The various
agreements obtained by the lender will have
such clauses to recall the entire balance
due in case of default.
7.6.57 At present, banks and housing finance
companies find it difficult to sell their housing loan
portfolio to institutions if it does not have the remedy
of foreclosing an account. The normal procedure
for recovery of bad debts under the civil code takes
more than 10 years. Parliament passed the National
Housing Bank (Amendment) Act 2000 adding a new
chapter, V-A, to the National Housing Bank Act, 1987.
This simplifies the foreclosure norms for housing
loans and permits summary proceedings for dues
by appointing a Recovery Officer and setting up
Appellate Tribunals on the lines of the Debt Recovery
Tribunals in the case of banks. Further, the
Government has also included scheduled banks in
the definition of approved institutions, besides
housing finance companies.
7.6.58 Under these provisions, officers of approved
institutions with a legal background shall be
appointed as recovery officers of the Tribunal. If a
borrower defaults in repayment, the lending institution
may resort to foreclosure of the account and
apply to the recovery officers for sale of the property
pledged, mortgaged or assigned to it as security.
The foreclosure law can speed up the recovery
process considerably. However, the government
has to notify the rules and appoint recovery officers
before the foreclosure norms can take effect.