Stemming the Loan Largesse

There's good news and bad news for home loan or personal loan seekers. Though the Reserve Bank of India's latest Credit Policy has left the influential repo and bank rates untouched, it has increased the provisioning required from 0.4 per cent to 1 per cent on housing loans above Rs 20 lakh (Rs 2 million), commercial real estate advances, loans for capital market related activities and personal loans.

For every Rs 1 lakh (Rs 100,000) of such loans given, banks will have to set aside Rs 1,000 from their earnings as provisioning instead of the earlier Rs 400.

Credit Policy highlights

�                     Bank rate, reverse repo rate, repo rate, CRR unchanged

�                     Provisioning increased on personal loans, loan against shares, commercial property and home loans above Rs 20 lakh to 1 per cent from 0.4 per cent

�                     Risk weight up on commercial property to 150 per cent from 125 per cent

�                     Ceiling rate on NRE deposits up to 1 per cent over libor from 0.75 per cent

�                     GDP growth projection for 2006-07 at 7.5-8 per cent (earlier 7.0-7.5 per cent)

�                     Inflation for 2006-07 to be containe dat 5-5.5 per cent

"The RBI wants to make sure banks with adequate capital are in the mortgage market, since the provisioning would reduce the retained earnings, requiring higher capital," says Puneet Chaddha, head, retail assets, HSBC. This may result in a rise in rates, as it will impact bank's bottomlines.

The RBI move has been sector specific and it has increased interest rates only for some borrowers, not all. This shows its concern over the risks involved in these sectors.

Housing/real estate

Over the past two years, non-food credit has been growing at over 30 per cent, and the RBI feels its time to slow the pace. The increase can be attributed to housing, commercial real estate and personal loans, which accounts for over a third of incremental credit in 2005-06.

The RBI is apparently concerned over the increasing exposure to capital markets and real estate, which could be speculative. In several countries across the world, the housing boom is flattening out and this can set off a chain reaction in terms of slowing down consumption and real wage growth.

Such an abrupt cooling would take away a major support to world demand. For instance, the exposure to mortgage by commercial banks in the US stands at 44 per cent and at 20 per cent in South East Asia and this could lead to a hit on profitability of banks in the event of a reversal in this trend, leading to increase in delinquencies.

In India, mortgages account for only 3 per cent of the GDP compared to 51 per cent in the US, so the situations are hardly comparable. Also, bank exposures to mortgage and real estate are only 13 per cent and 2 per cent respectively. This is not an overly skewed figure, although it is growing at a faster pace.

Housing loans rose by 30 per cent and real estate advances almost doubled in the last year. The RBI feels these needs to be moderated. "These funds could be diverted to productive rather than consumption-led activities," adds Reddy. This means more emphasis on sectors like agriculture, small medium industry. (See below: Credit Policy Highlights).

The markets were, however, expecting a more critical announcement on the housing sector. Pranay Vakil, chairman, Knight Frank, feels the RBI recognises the fact that all the money borrowed for housing loans may not be applied for buying a house for self-use, but could be for speculative investment. The policy announcements were aimed at checking this and making the scrutiny process more stringent.

People borrowing less than Rs 20 lakh will not be affected. Such loans would mainly cover sub-metros, Tier-II and Tier-III cities. Loans over Rs 20 lakh would be largely taken for properties in Tier-I cities where speculation is maximum. This is where real estate is becoming an alternative investment to stocks or debt.

Impact on Loans

The banking fraternity seems to have mixed opinions on the immediate effect of the move. On personal loans, which form 50 per cent of retail credit, the healthy margins the banks enjoy would partially offset the increase in provisioning.  

Numbers Speak: 2005-06

�                     Loans to commercial estate up 84.4 per cent

�                     Housing loans up 29.1 per cent

�                     Personal loans up 27.9 per cent

�                     Advances to industry up 15.6 per cent

Explains a senior official of a private sector bank: "Personal loans are interest-rate insensitive and are comfortably priced for banks to earn good margins." RBI's previous move of hiking the provisioning norm from 0.25 per cent to 0.4 per cent (in October 2005) did not have much of an impact on either the pricing or demand for loans.

Moreover, the pricing of a personal loan is dependent on various factors -- like the borrower's creditworthiness -- given its unsecured nature. Also, these loans seem to be a surrogate means for diverting monies to real estate or the capital markets and the boom in the capital markets has increased the perceived risks, which is not reflected in investor sentiments. So RBI has stepped in with precautionary measures.

The rate-cut spree in housing loans had started to ebb last year itself. After a phenomenal drop from 13 per cent in 2000 to 7.5 per cent in 2004, interest rates have started to inch upwards but are still modestly priced at 8.5-9.0 per cent for floating rate loans.

"The increase in provisioning of 0.6 per cent on loans above Rs 20 lakh may not lead to rates going up substantially due to tight competition in this space and also because most banks have recently re-priced these loans upwards,' says Romesh Sobti, executive VP, ABM Amro Bank. For banks like IDBI the average size of home loans is Rs 10 lakh (Rs 1 million), with only 20-30 per cent loans crossing Rs 20 lakh. "The default rate too is higher in the lower loan bracket compared to higher," says G V Nageswara Rao, CEO, IDBI Bank. Besides provisioning, banks also factor in the delinquency for pricing of loans, which is low for the above Rs 20 lakh bracket.

The Impact: Industry players do not see any immediate pressure on rates as of now, but in the medium term, one must be prepared to see a rise of 0.5 per cent in lending rates. Investors looking to buy a house on loan on the conservative side could look at locking themselves in a fixed-rate loan or a flexi-home loan (fixed rate for the first 3-5 years and then floating). But since home loans are for a longer tenure (15-20 years), one can ride through the interest rate cycle.

Deposit Rates

There has been a general uptrend in short-term deposit rates in the past six months. Liquidity overhang in the system after SBI [Get Quote] IMD redemptions, advance tax outflows, etc. led to an increase of more than 16 per cent in short-term deposits.

The higher interest paid on shorter deposits would not be sustainable over the long run and could have an adverse consequence on profitability.

With the increase in provisioning, any upward move in lending rates would also increase the deposit rates. Centurion Bank of Punjab [Get Quote] has already increased their medium to long-term deposit rates by 0.25-1 per cent. They are now quoting at 5.75-8 per cent.

And with RBI having increased the ceiling on NRE term deposits by 0.25 per cent to 1 per cent over and above the Libor (6.31 per cent), it would add to a stable long-term deposit portfolio for banks and benefit depositors.

The Outlook

The RBI governor did mention that maintaining the rates in this policy was a hard decision. One may see them going up in the next policy (July 2006), driven largely by global policies, rising crude prices and rising commodity prices.

These factors could affect the inflation level leading to a general rise in interest rates. With the US Federal Reserve increasing rates for the 15th consecutive time since June 2004, one can surely tell that there will be no stopping the RBI, if the situation warrants hikes.

"The Reserve Bank's pronouncements suggest that the direction is up, and not down or even steady in respect of inflation, economic growth and interest rates," says Bhaskar Ghose, MD, IndusInd Bank [Get Quote]. So if its non-interest measures don't succeed in restraining credit growth, the RBI may step in to increase the interest rates.

The apex bank feels that home loans and real estate advances, which rose by more than 30 per cent and 100 per cent respectively last year, need to be moderated.