Much needed alignment for housing finance companies

By Sawant Singh and Aditya Bhargava, Phoenix Legal

Housing finance companies (HFCs) have traditionally occupied a staid corner of the financial sector, providing loans to homeowners and for the development of the housing industry. As a sector, housing finance has also been a “safe investment” as loans secured against mortgages are considered among the least risky assets. However, adverse liquidity conditions for non-banking financial companies (NBFCs) and the crisis at Dewan Housing Finance led to stakeholders reconsidering their views of HFCs. A key consideration was regulatory arbitrage in that NBFCs are stringently regulated by the Reserve Bank of India (RBI), while the perception was that HFCs are subject to a somewhat lighter form of supervision. It was thought appropriate to align the regulatory regimes applicable to NBFCs and HFCs.

Sawant Singh Phoenix Legal housing finance
Sawant Singh
Phoenix Legal

Before 2019, to avoid dual regulation, HFCs were exempted from complying with the RBI’s regulations for NBFCs, and were subject only to supervision by the National Housing Bank (NHB). To enable the RBI to regulate HFCs, the National Housing Bank Act, 1987, was amended by the Finance (No 2) Act, 2019. These amendments came into effect in August 2019 and were followed by a press release from the RBI that it would prescribe changes to the regulatory framework for HFCs.

On 17 June 2020, the RBI placed on its website for public comments changes that it was considering for the regulation of HFCs. To avoid disruption, the changes propose that where NBFCs and HFCs share common ground for regulation, the existing regulations governing NBFCs will be extended to HFCs and fresh regulations will be introduced where there is no commonality of regulation. The proposals intend to align the definitions of regulatory capital (tier I capital and tier II capital) for NBFCs and HFCs, by allowing HFCs to include perpetual debt instruments for the purposes of determining regulatory capital. As with NBFCs, the proposed changes contemplate classifying HFCs as either systemically important or non-systemically important based on criteria such as asset size. Non-deposit taking HFCs with assets greater than ₹5 billion (US$66.3 million) would be considered as systemically important, and non-deposit taking HFCs with a lower asset size would be classified as non-systemically important. All deposit taking HFCs, irrespective of asset size would be treated as systemically important. The minimum net-owned fund requirement of an HFC is also proposed to be increased from ₹100 million to ₹200 million (US$2.54 million) in a phased manner over two years to strengthen the capital base of HFCs.

Aditya Bhargava Phoenix Legal housing finance
Aditya Bhargava
Phoenix Legal

Currently, the phrases, “providing finance for housing”, and “housing finance”, are not defined by regulation, and are used as in general parlance. The changes propose to define this as obtaining financing for the purchase, construction, reconstruction, renovation, or repairs of residential dwelling units, and would include loans to individuals or groups of individuals for the purchase, construction and renovation of dwelling units, loans for slum improvement initiatives, loans to public agencies for construction of residential dwelling units, and loans to builders for the construction of residential dwelling units. Loans for furnishing dwelling units, and loans by way of mortgage of property for any purpose other than those prescribed will be considered as non-housing loans. The concept of “qualifying assets” is also proposed to be introduced, where at least 50% of the assets of an HFC would need to be in the form of housing finance, and at least 75% of such housing finance loans would be to individuals. An HFC that fails to comply with these criteria would have to change its registration from an HFC to an NBFC. These proposals will be implemented in a phased manner over two years ending in March 2024.

Possibly to limit conflicts of interest that can arise in groups with diversified real estate holdings and to limit the incidence of double financing, it is proposed that an HFC can only either lend to a group company that is engaged in real estate business or lend to retail individual borrowers who propose to buy homes from such a group company. Further, such loans to retail individual borrowers must also follow arm’s length principles in letter and spirit.

The proposals by the RBI are welcome and have been well received by financial sector stakeholders. Alignment and harmonization of regulation are always welcome, and the absence of multiple regulatory frameworks prevents regulatory arbitrage and also fosters much-needed confidence in the system. While HFCs have developed under the NHB’s supervision, the RBI’s maturity and expertise in governing financial institutions over eight decades are expected to bring improvements in governance for HFCs.

Sawant Singh and Aditya Bhargava are partners at Phoenix Legal. Sristi Yadav, an associate, assisted on the article.

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