Presentation by Sunando Roy
Reserve Bank of India 2005
Trends in Growth of Housing Finance
Individual housing loan segment, which witnessed a frenetic growth in 2003-04 maintained its momentum in 2004-05 and 2005-06. Housing loans in absolute terms have increased by Rs. 44,827 crore in 2004-05, and their share in the scheduled commercial banks’ total loans and advances increased from 10.4% as at 31st March 2004 to about 11.9% on 31st March 2005. Housing loans registered a growth of 50% as against a growth of 33% in the overall loans and advances of the banking system. The same trend continued in the first three quarters of 2005-06 (April – December 2005) where the individual housing finances grew at a rate of 25.3% as against 18.1% increase in gross advances. Consequently, the share of housing loans to total credit increased to 12.6% as on 31st December 2005. This share is more than 25% in respect of three big banks, one in the private sector and two foreign banks.
Real Estate exposure other than individual housing loans also showed a significant increase between March 2004 and August 2005. The high growth in real estate exposure during 2004 which increased by Rs. 13,280 crore (74.2%) continued in the first half of 2005-06, when it increased by Rs.8,696 crore (27.9%). The share of real estate exposure other than individual housing loans increased from 2.1% of gross advances in March 2004 to 3.4% in August 2005.
Data Limitations
The growth in housing loans is not restricted only to the banks’ portfolios. The housing finance companies and subsidiaries of other financial sectors like insurance are also important players in the housing loan market, the data pertaining to which is not available with the Reserve Bank of India as they are out of its regulatory ambit. Further, reliable data on real estate prices are also not available with the Bank. Information regarding household balance sheets is also not available.
Reasons for Growth in Housing Finance
The growth in the housing loan segment can be attributed partly to the favorable Govt. policies in terms of tax benefits for individual housing loans coupled with lowering of interest rate. RBI has been promoting this area through bringing in a part of the individual housing loan portfolio of the banks under priority sector lending. Housing loans also attract lesser risk weight as compared to other loans and advances. Further, as asset impairment is low in this sector and also underlying collateral provides a greater degree of comfort to the banks, this sector has found favour with banks in recent times. The decline in industrial credit between 2000-2003 (though there has been a reversal of trend currently) had also aided the growth of home loans in recent years. In view of the increased competition for granting housing loans the borrowers in fact have a choice of products offered and are obtaining good service and competitive rates. Recent years have also seen a mushrooming of advisory services in the real estate sector which has positively aided the growth in individual housing loans.
Housing Finance – Risks Involved
The overall impairment of the housing loan portfolio worked out to 2.1% in December 2005 (2.08 % in March 2005 and 1.9% in March 2004) and compared quite favorably with Gross NPL ratio for the entire loan portfolio, which was 4.1% (5.2% in March 2005 and 7.2% in March 2004). However, the disconcerting feature in the asset quality of housing loans portfolio is that while overall NPA ratio in the industry has been consistently coming down, NPA ratio for housing finances, though not very substantial as to warrant immediate concern, are more or less stagnant. This points to the need to exercise caution by the banks in all aspects of retail loans administration.
Experiences in other countries show that any increase in real estate prices is generally preceded or accompanied by a boom in banking credit and/or expansionary monetary policy or easy liquidity conditions. A subsequent tightening and/or a collapse in the market prices may lead to increased credit risk. The relationship between the real estate prices and housing loans is required to be monitored closely. In fact though globalization has brought down the commodity prices, the high asset prices, of which real estate prices is a major component, appears to be here to stay.
The long-term nature of the mortgage loans, coupled with very low interest rates, may also affect banks heavily if the interest rate goes up significantly. Significant positive asset liability mismatches (positive gap) in the longer end is fraught with interest risk and the banks require to pay attention to their ALM policies. Further, increased competition may lead to adverse selection, which, in the event of a fall in the real estate prices may expose the banks to higher levels of risk.
Regulatory Initiatives and Inherent Safeguards
As part of the Reserve Bank’s initiatives in adopting best international practices for monitoring the stability of Financial System in India, the Bank has been compiling macro-prudential indicators (MPIs) from March 2000 onwards. The growth in retail segment with particular reference to housing loans is being monitored on a half yearly basis in our MPI reviews. As the NPA levels in home loans segment is still low it has not yet thrown up any systemic concerns. Stress tests on the housing loan portfolio of banks, however, have not been carried out till date.
In recognition of the inherent risks in high growth of retail credit, particularly the housing and personal loan segment, the Reserve Bank cautioned banks about the need to sharpen their risk assessment techniques so as to guard against any adverse impact on credit quality. As a counter cyclical measure, risk containment measures were prescribed on housing and consumer loans, and the risk weights in the case of housing loans were increased from 50 per cent to 75 per cent in the Mid-term Review of Annual Policy for the year 2004-05. Furthermore, keeping in view the sharp increase in credit to real estate, banks were advised in July 2005 to put in place a Board approved policy with regard to exposure to the real estate sector and to submit disclosures to the Reserve Bank in separate returns. NPAs in the housing loan segment are currently at a low level of around 2 per cent. Such loans, unlike corporate sector loans, do not involve any large losses on any single commitment. Therefore, if banks put adequate risk monitoring and management systems in place, there should not be much cause of concern for the future, although past performance may not always be a good guide.
Internationally, a view has been emerging that Loan-to-Value Ratio (LTV) being a dominant indicator of default probability of housing loans, loans with high LTV (say above 80%) could be assigned higher risk weight. The suggestion is based on empirical evidence from some countries. However, the likelihood of default and the gross severity of loss in the event of default are positively correlated with the LTV, only when all other factors are held equal. Therefore, a more risk sensitive capital allocation framework would suggest that LTV should be considered as the risk indicator of an individual loan in conjunction with overall credit quality which is a function of many aspects such as quality of credit appraisal, installment to income ratio, trends in prices of real estate, efficacy of foreclosure laws, purpose of purchasing/constructing a house i.e. whether as an investment or for living. The LTV in India is expected to be lower than the international levels and may not warrant such differential risk weights.
The penetration level in housing in India is still one of the lowest in the world. The mortgage to GDP ratio is around a measly 3%; this compares to 51% in the U.S. and 12 to 20% in more economically comparable countries. This implies a potentially manifold increase in the existing level of mortgage in the country. Also, thanks to the affordability, there is an increasing trend with more and more customers opting to buy a house rather than renting one. According to a housing survey, if the present rate of growth of population continues, then by 2010 India would require 2.5 to 3 million additional dwelling units every year.
Conclusion
Most of the emerging market economies have witnessed an unprecedented boom in the stock market and housing in the recent times. Inflation in most countries has been well under control. Yet the conventional premise that a benign inflationary outlook portends a state of relative stability for the financial system is seriously under threat.
The biggest dilemma facing the central banks every where today is not how to control inflation, but how to respond to runaway increases in asset prices in order to prevent a systemic threat to financial stability? The burning question BIS should attempt an answer for in today’s context is: should monetary authorities respond to asset prices even if inflation seems under control? The belief that monetary policy focused on inflation and growth is the best way to achieve economic stability seems no longer valid as demonstrated by unbridled rise in asset prices, which could actually be a bubble in the making with all the painful consequences it entails when the bubble inevitably bursts.
Here again, presuming such out of whack rise in housing and equity prices are not sustainable – and indeed, not desirable – in the long run, BIS could attempt to come out with a mathematically tractable framework to identify such bubbles in the emerging markets. For, one can never be sure that what looks like bubble is really a bubble.
Another question BIS should be trying to address is whether it is safer to wait for a bubble to burst by itself and then to ease monetary policy to soften a downturn – a strategy adopted by Ms Greenspan et al in handling the U.S. boom and bust cycle. What seems to have worked in U.S. economy may not necessarily be replicated in case of emerging and developing economies like India, China, Korea, Malaysia etc on account of vast structural differences in their economies and those of western ones. And we are not sure whether this indeed was a good strategy for the U.S. too, given the huge imbalances left behind in the US economy (current account deficit and negative savings etc.) in the wake of pursuing such an approach.
It is time BIS focused on the fact asset-price inflation can be as harmful as conventional inflation. A sudden collapse in share or house prices can trigger a deep downturn. And surging prices can distort price signals and cause a misallocation of resources – by encouraging too little savings (already in India, signals of slowing savings rate are visible), or to much investment in housing, so reducing future growth. This is why BIS and central banks need to pay closer attention to asset prices.
(Source: Off-site returns furnished by banks (domestic).Trend and Progress of Banking in India 2004-05)
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