LESSON 16

HOUSING FINANCE: NHB, REGULATORY FRAMEWORK,

REFINANCE

LESSON OBJECTIVES: TO KNOW THE REGULATORY FRAMEWORK

FOR HOUSING FINANCE, UNDERSTAND THE
WORKING OF NHB.
TO UNDERSTAND THE SYSTEM OF REFINANCE.

INTRODUCTION
The National Housing Bank, being apex body for regulating the housing finance,
controls all housing finance institutions and companies. Let us study the NHB first to
understand its working.

NATIONAL HOUSING BANK (NHB)

The NHB was established in 1988 under the NHB Act, 1987 to operate as a principal
agency to promote housing finance institutions both at local and regional level, and to
provide financial and other support to them. The HFIs include institutions, whether
incorporated or not, which primarily transact or have as one of their principal objects
the transacting of the business of providing finance for housing, either directly or
indirectly.
The NHB is an incorporated body, with powers to establish it offices, branches and
agencies at any place in and outside India (subject to RBI approval). Its is a 100%
subsidiary of RBI with a fully paid up capital of Rs.350 crores. Its capital can be
increased up to Rs. 2000 crores with a restriction that at least 51% of the paid capital
will be held by RBI / Government / Public Sector banks or Public sector financial
institutions.
The management of the NHB is with a Board of Directors, headed by the Chairman
(or Chairman and Managing Director). The other members of the board are Two
Directors, experts in any field which is useful for NHB, Two Directors, experienced
in running financial institutions, Two Directors elected by shareholder, other than
RBI/ Central Government, Two directors from out of the RBI directors, Three
Directors from amongst the Central Government officials and Two Directors from
amongst the State Government officials.

BUSINESS OF NHB
The NHB has the powers to get involved into various business activities, subject to
provisions of NHB Act. Main activities of NHB are as following:
(a) Promoting, establishing, supporting / aiding in the promotion / establishment/
support of HFIs.
(b) Making of loans and advances or rendering any other form of financial
assistance, whatsoever, for housing activities to HFIs, banks, state cooperative
agricultural and development banks or any other institutions / class of
institutions notified by the Government.
(c) Subscribing to / purchasing stocks, shares, bonds, debentures and securities of
every other description.

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 (d) Guaranteeing the financial obligations of HFIs and underwriting the issue of
stocks / shares / bonds/ debentures/ other securities of HFIs.
(e) Drawing, accepting, discounting / rediscounting, buying/ selling and dealing
in bills of exchange/ promissory notes, bonds/ debentures, hundies, coupons
and other instruments.
(f) Promoting/ forming/ conducting or associating in promotion/ formation/
conduct of companies / mortgage banks / subsidiaries/ societies/ trusts/ other
associations of persons it may deem fit for carrying out all/ any of its
functions under NHB Act.
(g) Undertaking research and surveys on construction techniques and other
studies relating to / connected with shelter / housing and human settlement.
(h) Formulating scheme(s) for purposes of mobilization of resources and
extension of credit for housing.
(i) Formulating schemes for economically weaker sections of society which may
be subsidized by Government or any other sources.
(j) Organizing training programmes / seminars/ symposia on matters relating to
housing.
(k) Providing guidelines to HFIs to ensure their growth on sound lines.
(l) Providing technical / administrative assistance to HFIs.
(m) Coordinating with the LIC, UTI, GIC and other FI in the discharge of its
overall functions.
(n) Exercising all powers and functions in the performance of duties entrusted to
it under the NHB Act or under any other law in force for the time being.
(o) Acting as agent of the Central / State Government/ The RBI or any authorities
as may be authorized by the RBI.
(p) Any other kind of business which the Government may, on the
recommendations of the RBI, authorize.
(q) Generally, doing of all such matters and things as may be incidental to or
consequential upon the exercise of its powers or the discharge of its duties
under the NHB Act.

BORROWING AND ACCEPTANCE OF DEPOSITS:

For purpose of carrying out its functions, the NHB may
(a) Issue and sell bonds and debentures with or without the Guarantee of Central
Government, ins such manner and on such terms as may be prescribed;
(b) Borrow money from the Central Government, banks, financial institutions,
mutual funds and from any other authority or organization or institution
approved by the Government on such terms and conditions as may be agreed
upon;
(c) Accepting deposits repayable after such period and on such terms as may
generally or specially be approved by the RBI;
(d) Borrow money from the RBI (i) by way of leans and advances and generally,
obtain financial assistance in a manner specified by the RBI; (ii) out of the
National Housing Credit (Long-term Operations) Fund established under
section 46-D of the RBI Act;
(e) Receive, for services rendered, remuneration, commission, commitment
charges, consultancy charges, service charges, royalties, premium, license fees
and any other consideration of whatever description;

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 (f) Receive gifts, grants, donations or benefactions from the Government or nay
other source.
The Central Government may guarantee the bonds and debentures issued by
the NHB as to the repayment of principal and the payment of interest at rates(s) fixed
by the Government.

POWERS OF NHB
Being an apex institution for housing finance, the government has given it exclusive
powers in the NHB Act. A brief description of the powers is following:
Powers to transfer rights: The rights and interest of the NHB in relation to any loan/
advance made or any amount recoverable may be transferred by it wholly or partly in
any form. Notwithstanding such transfer, the NHB may act as a trustee for the
transferee in terms of Sct. 3 of the Indian Trusts Act, 1882.
Power to Acquire rights: The NHB has the right to acquire, by transfer/ assignment,
the rights and interest of any institution in relation to any loan / advance made /
amount recoverable wholly or partly by the execution / issue of any instrument or by
the transfer of any instrument or in any other manner in which the rights and interest
in relation to such loan/ advance may be lawfully transferred.

Power to recover dues as land revenue.

Power to impose conditions: To protect its interest, the NHB may impose any
conditions on HFIs.

Power to call for repayment before agreed period: In order to protect its interest NHB
can call for prepayment of loans from borrowing institutions.

Access to Records: The NHB has free access to all such records of the institutions /
persons availing of any credit facilities from it, the perusal of which may be necessary
in connection with the provisions of finance or other assistance to the institution /
refinance of any loan/ advance to such person by the institution.
Power to inspect

Power to Collect and publish credit information.

PROVISIONS RELATING TO HOUSING FINANCE INSTITUTIONS:

Now let us discuss the provisions related to HFIs.

Registration and Net Owned Funds: To commence and carry on business, every HFI
set up as a company should obtain a certificate of registration from the NHB and have
net owned funds of Rs. 25 lakh or such higher amount as may be specified by the
NHB from time to time.

Cancellation of Registration: The registration of a HFI can be cancelled by the NHB

if it (a) ceases to carry on business, (b) has failed to comply with any condition
subject to which the registration was issued (c) at any time fails to fulfill any of the
conditions laid down for grant of registration (d) fails to comply with any directions
by the NHB.

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Maintenance of Percentage of Assets: At least 5 percent or such higher percentage,
not exceeding 25 percent, as specified by the NHB from time of deposits outstanding
at the close of business on the last working day of the second preceding quarter of a
HFI should be invested in unencumbered approved securities valued at a price not
exceeding their current market price.

Reserve Funds: A reserve fund should be created by the HFIs by transfer of a sum not
less than 20% of net profits every year before the payment of any dividend.

Issue of Prospectus / Advertisement: If considered necessary in public interest, the

NHB by general / special order – regulate / prohibit by any HFI of any prospectus /
advertisement soliciting deposits from the public and (b) specify the conditions
subject to which it can be issued.

Determination of Policy and issue of Directions: In public interest and to regulate the
housing finance system of the country, NHB may determine the policy and issue
direction, within the overall policy framework of the Government.

Collection of information about deposits and issue of direction.

Power of the NHB to prohibit Acceptance of deposit.
Powers to file winding up petition.
Powers to Inspection.
Power to order Repayment of Deposits
Power to appoint recovery officers for recovery of funds due to HFIs registered with
NHB.

Power to impose penalties: In case any HFI fails to furnish or furnishes any wrong
information, than NHB can impose penalties as per the provisions of NHB Act.
Power to make rules & Power of Board of Directors of the NHB to make regulations:
In consultation with government and with prior approval of RBI, the NHB may make
rules and regulations, not inconsistent with the NHB Act to provide for all matters for
which provision is necessary / expedient for the purpose of giving effect to the
provisions of the NHB Act.

NHB’s HOUSING FINANCE COMPANIES DIRECTIONS

As the principal housing finance company, the NHB is authorized, in public interest,
to give directions to housing finance companies, which primarily transact or have as
their principal object the transacting of business providing finance for housing
whether directly or indirectly. We discuss herewith, main elements of the NHB
directions to HFIs.

Registration: Every HFC accepting public deposit, having minimum net owned funds
of Rs. 25 lakh should be registered with NHB. The registration is subject to following
conditions:
(i) That the HFC is/ would be in a position to pay its present/future depositors in
full as and when their claims accrue.
(ii) That its affairs are not being / are not likely to be conducted in a manner
detrimental to interest of its present/ future depositors.

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 (iii) That the general character of its management/ the proposed management
would not be prejudicial to public interest / the interest of the depositors.
(iv) That it has adequate capital structure and earning prospects.
(v) That the public interest would be served by the grant of certificate of
registration to it.
(vi) That the grant of certificate of registration would not be prejudicial to the
operation and growth of the housing finance sector of the country.
(vii) Any other condition, fulfillment of which in the opinion of the NHB, would
be necessary to safeguard the public interest or the interest of the
depositors.

Acceptance of Deposits:
The HFCs can accept deposits from public, subject to NHB Act provision.
Public Deposits and Minimum Credit Rating:
Any HFC having NOF of Rs. 25 lakh and above can accept public deposits if it has
obtained credit rating for fixed deposits not below Grade A from any of the approved
rating agencies. The duration of deposit could be 12 to 84 months. In case credit
rating of the HFC falls below Grade A, it is directed to stop immediately accepting
fresh public deposits. It has to maintain a register of deposits with all necessary
information about the deposit. An HFC with NOF of up to Rs. 10 crore can accept
public deposit to the tune of 10 times its NOF. Each HFC has to pay interest on all the
public deposits it accepts. The rate of interest cannot exceed the overall limit
prescribed by the NHB from time to time.

Housing Finance companies can pay interest on overdue deposits. But this interest
will be subject to provisions of the directions given by NHB. If the HFC fails to pay
deposit along with interest on due date, it would pay amount along with interest on
the overdue time portion of the deposit on a future date. NHB has also given direction
for repayment of deposits. No public deposit can be repaid within three months from
the date of acceptance. And if, a deposit is repaid prematurely, interest on that has to
be reduced as per the norms prevailing at that time.
HFC can grant loan against public deposit accepted by it. Such loan amount should
not exceed 75% of the deposit and interest rate charged should be at least 2% above
the interest payable on the deposit.

SPECIAL PROVISIONS:
NHB has also provided some special provisions for HFCs. Lets discuss these
provisions.

Maintenance of Minimum Liquid Assets: Every HFC should is required to invest in

India in approved securities at market price, not less than 6 percent and up to 25
percent of the public deposits outstanding at the close of business on the last working
day of the second preceding quarter. HFCs are required to maintain in India in an
account with a bank or NHB or by subscription to bonds issued by NHB, a sum not
less than 12.5% of public deposits, together with investment in approved securities.
The HFC should entrust to one of the banks designated by it on that behalf, in the
place where its registered office is situated, the approved securities required to be
maintained by it.

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Reserve Funds: Every HFC should create a reserve fund and transfer therein at least
20% of its net profit every year, before any dividend is declared. Any special reserve
created by HFC in terms of Section 36(I)(viii) of the Income Tax Act, may take into
account any sum transferred by it for the year to such special reserve for the purpose
of this reserve.

Employee Security Deposit: A housing finance company receiving any amount in

ordinary course of its business as security deposit from any of its employees for due
performance of his / her duties, should keep it in a joint account with the employee in
a bank or in a post office.

MISCELLANEOUS PROVISIONS
These provisions relate to submission of balance sheet, Directors’ report, Auditor’s
Certificate, returns to NHB by HFCs and advertisement.
A. The HFCs are required to deliver to the NHB an audited balance sheet as on
the last date of each financial year and audited profit and loss account in
respect of that year as passed it in general meeting together with a copy of the
report of the BOD within 15 days of such meeting as also a copy of the report
and the notes on accounts furnished by its auditors.
B. The HFC should also furnish to the NHB a copy of the Auditor’s report to the
BOD and a certificate from its Auditors, being members of the ICAI in the
prescribed format containing all necessary information.
C. Every HFC should submit to the NHB a return furnishing the specified
information with reference to its position as on the specified date. Also, every
HFC should, within one month from the commencement of business, deliver
to the NHB a written statement containing list of names and designation of its
principal officers, their complete postal address and contact information,
specimen signatures etc.
D. Every HFC accepting public deposits is required to comply with the
provisions of the NBFC and Miscellaneous NBC (Advertisement) Rules,
1977.

PRUDENTIAL NORMS:
The NHB guidelines to HFCs on prudential norms for income recognition, accounting
standards, asset classification, provisioning for bad and doubtful debts, capital
adequacy and concentration of credit/ investments are discussed hereunder.
Income Recognition: For the policy on income recognition to be objective it should be
based on recognized accounting principles. Income from NPAs should be considered
to have accrued and be recognized only when it is actually received. Interest on NPA
should not be booked as income if such interest has remained outstanding for more
than six months.
Accounting Standard: All accounting standards and guidelines notes issued by the
ICAI dealing with lease accounting/ depreciation/ income recognition and so on may
be followed by an HFC.
Accounting for Investment: All investments in securities should be bifurcated into
current investments and long-term investments. A current investment is an investment
that is by its nature readily realizable and is intended to be held for not more than one

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year from the date on which such investment is made. A long-term investment is an
investment other than a current investment.
Quoted current investments should be valued at cost or market value whichever is
lower. Unquoted current investments should be valued at cost or breakup value
whichever is lower. Long term investments should be valued in accordance with the
accounting standards issued by ICAI.

ASSET CLASSIFICATION:
The HFCs should classify their loans and advances and any other form of credit into
four broad groups: (a) standard assets (b) sub-standard assets (c) doubtful assets and
(iv) loss assets. Following definitions can be used for classifying assets:

Standard Assets: A standard asset is one in respect of which no default in repayment

of principal or payment of interest is perceived and which does not disclose any
problems nor carry more than normal risk attached to business. Such an asset in not
an NPA.

Substandard Asset: A standard asset is one which has been classified as NPA for a
period not exceeding two years. Such an asset would have well-defined credit
weakness that jeopardize the liquidation of the debt and are characterized by the
distinct possibility that the HFC would sustain some loss, if deficiencies are not
corrected.

Doubtful Assets: A doubtful asset is one which has remained NPA for a period
exceeding two years. Term loans, where installments of principals have remained
overdue for a period exceeding two years, should be treated as doubtful asset. A loan
classified as doubtful has all the weaknesses inherent in that classified as sub-standard
with the added characteristics that the weakness may make collection/liquidation in
full, on the basis of currently known facts, conditions and values, highly questionable
and improbable.

Loss Assets: A loss assets is one where loss has been identified by an HFC on
internal/ external auditors/ the NHB inspection but the amount has not been written
off, wholly or partly. Such an asset is considered un-collectable although there may be
some salvage or recovery value.

PROVISIONING:
The HFCs are required to provide for loans and advances assets as follows:
Loans, Advances and other Credit Facilities including Bills purchased and
discounted: Taking into account the time lag between an account becoming doubtful
of recovery, its recognition as such, the realization of the security and erosion over
time in the value of security charged, the HFC should make provisions against sub-
standard, doubtful and loss assets in respect of loans advances and other credit
facilities including bills purchased and discounted as under:
Loss Asset: The entire asset should be written off. If they are permitted to remain in
the books for any reason, 100% of the outstanding balance should be provided for.

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Doubtful Asset: 100% provision to the extent amount is deemed to be unrecoverable.
For others, 20-50% of the secured portion depending upon the period for which the
asset is considered to be doubtful.
Sub-standard Asset: A general provision of 10% of the total outstanding should be
made.

CAPITAL ADEQUACY NORMS:

The HFCs should achieve a minimum capital adequacy norm of 10% of the risk
weighted assets and off-balance sheet items by March, 2001 and 12 percent by March
31, 2002. The total of the Tier-II elements should be limited to a maximum of 100%
of total of the Tier-I elements.
Reporting: The HFCs should furnish half-yearly return, in duplicate, indicating (a)
capital funds and risk asset ratio (b) calculations of risk weighted assets and off-
balance sheet exposures and (c) certain other data. The return should be signed by the
Chief Executive of the company or in his absence, his authorized representative and
be certified by the auditors of the company and submitted within a period of two
months from the close of the half-year.
Concentration of Credit / Investment: The HFCs should not lend / invest more than 15
percent of their owned funds to any single party / in shares of another company and
more than 25% to a single group of parties / in shares of single group of companies.
They should not lend and invest (loans/investment taken together) more than 25% of
owned fund to a single party and more than 40% to a single group of parties.
Loans against HFC’s own shares prohibited: No HFC should lend against its own
share, any kind of loans / advances or credit whatsoever.

REFINANCE SUPPORT TO HFC’S

The NHB has issued guidelines to HFCs who desire to avail of refinance facilities
from the NHB for their growth on sound lines and to be healthy, viable and cost
effective. The main elements of the guidelines for extending refinance support to
HFCs are discussed hereunder.

Organisation and Main Activities: An HFC which desires to avail of refinance facility
from the NHB should, inter alia (a) be a public limited company (b) provide long term
finance for construction or purchase of houses in India for residential purposes and (c)
invest 75% pf its ‘capital employed’ by way of long-term finance for housing.
Minimum Paid-up capital and listing requirements: The HFC should have a
minimum-paid up capital or NOF of not less than Rs.10 Crores or such other amount
as may be stipulated from time to time by the NHB and/or the SEBI for listing shares
on recognized stock exchange(s). The promoter’s contribution in their share capital
would be as per the SEBI requirements from time to time.

Submission of Application: The HFCs should submit their application for refinance
support in such form and furnish such information / statements and so on as may be
required by the NHB for its considerations.
Name of the Company and Promoters: The HFC should also comply with following:
They should not (a) bear a name resembling / similar / akin to the name of any
construction company with which the promoters of the HFC may be associated, (b) be
a subsidiary of a construction company, (c) have/ promote, as subsidiary, a

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construction company, (d) indulge in construction activities of any kind, either
directly or indirectly. The Chairman, MD or any whole-time director of any HFC
should not hold the offices of Chairman, MD or whole time director in a construction
company with which the promoters of the HFC may be associated or vice-versa.

Board of Directors: The AOA of the HFC should contain necessary provisions for
appointment of nominee directors by the NHB. The appointment of CEO of HFCs, if
deemed necessary, should be made in consultation with the NHB.
The HFC seeking refinance facility should comply with the Provisions of Housing
Finance Companies (NHB) Directions, 1989. It should lend money only at the rates
prescribed by NHB from time to time. The HFC must follow the Prudential norms
and guidelines issued by the NHB.
The refinance facility is at sole discretion of the NHB and cannot be claimed as a
matter of right. It would be also subject to refinance policy and exposure norms
adopted by the NHB from time to time.

EQUITY SUPPORT TO HFCs:

For the growth of HFCs on sound lines and to be healthy, viable and cost effective,
the NHB extends equity support to them. Now let us discuss the NHB guidelines in
respect of equity support to HFCs.
Organization and main activity: The HFCs desirous of availing of equity participation
from the NHB should, like the scheme for availing refinance, be a public company
and fulfill other criterion like the refinance scheme.
Minimum Paid-up capital and listing requirement: The HFC should have a minimum
paid up capital of Rs. 5 crores or such other amount as may be stipulated from time to
time b the NHB and / or the SEBI for listing their shares on recognized stock
exchanges. The promotees’ contribution in share capital should be as per the SEBI
requirement from time to time. They should get their shares listed on recognized stock
exchange(s) in India as may be stipulated by NHB. They should conform and / or
comply with all other rules, regulations, instructions, guidelines or orders issued by
the NHB or any other authority empowered in that behalf. The NHB’s participation in
equity in any case would not exceed 10% of the paid up capital of an HFC or Rs. 1
crore, whichever is lower.

Other procedures/formalities like Submission of application, Name of the Company

and Promoters, Board of Directors, are same as the formalities for refinance scheme.
Credit Rating: The HFC before approaching the NHB for equity support, should
obtain credit assessment rating of themselves or equity grading by one of the four
credit rating agencies namely – CRISIL, ICRA, CARE or DCR India. A minimum
rating of CARE three or ICRA six or CRISIL six or equivalent rating or DCR India
would be necessary for them to become eligible for equity support from the NHB.
Shareholder’s Agreement: The HFCs should enter into a shareholder’s agreement
with the NHB laying down covenants regarding substantive issues like undertaking of
new business, amalgamation, mergers, takeovers, flotation of subsidiaries,
appointment of nominee directors and so on. The covenants would also include ‘buy
back’ of shares and the method of valuation of shares which would be market value of
shares at the stock exchange, or net asset value/ intrinsic value of shares or earning
per share or cost of investment plus interest agreed rate, whichever be the highest.

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Pricing of Shares / Cost of Investment: In the case of new HFCs without track record
of profitability and dividend making, first public issue of equity shares would be
subscribed by the NHB at par, and in the case of existing companies, price would be
determined and approved by the BOD of the NHB.
The equity participation by the NHB would be at the sole discretion of NHB and not
claimed as a matter of right.

Housing finance industry - an overview

Highlights
• Significantly, there has been no dearth of demand for housing and
consequently for finances for the same have been abundant.
• Market dynamics play a pivotal role in determining the lending rates.
Considering the same, the housing finance industry has been in a slump in
recent times.
• The entry of banks into the housing finance sector has posed a serious threat to
already existent players in the field.
• The housing sector is witnessing a clash between major players. Foremost
amongst this is the ICICI and HDFC imbroglio. The later is giving sleepless
nights to HDFC.
• Tax sops provided by the Government of India is a significant step towards
upholding the future prospects of this industry.
Sector Comments
Nearly 25 lakh houses are built every year in India. However, the nation’s
requirement is around 65 lakh houses per annum. The housing sector in India is facing
an estimated shortage of 4.1 crore houses and according to the Ninth Plan, the
demand-supply gap in urban housing is 3.3 crore houses. In case, all these urban
housing dwellings were to be built, it would require an investment of Rs. 150,370
crore.
Traditionally, the housing finance business has been yielding a margin of around 2
per cent. The skill of the players is in converting their advances that have a maturity
period of 15-30 years with the deposits that mature within three years. Though, the
National Housing Bank (NHB) refinances housing loan up to Rs. 2 lakh disbursed to
the lower income group, this is just a negligible proportion of advances to the major
players. The primary sources of funds are fixed deposits, debentures, private
placement of bonds and borrowings from banks and financial institutions. Thus,
efficient financial management has a key role to play in this industry.
Lending rates are predominantly market-driven and in view of the same, the housing
finance industry has been in a slump in recent times with there being low demand
from builders and investors alike. Furthermore, the entry of banks into the housing
finance sector has also not augured well for the industry. Most housing finance
companies cater mainly to the higher income group having reasonably assured
creditworthiness. In a scenario marked with the absence of speedy foreclosure
regulations, most companies prefer to stay away from rural and the Low-Income
Group (LIG). However, it must be noted that demand for housing in the Middle-
Income Group and High Income Group segments has also recorded a steady rise
lately.
Market profile

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The Indian housing finance sector is crowded with players of all sizes and nature:
government organisations, insurance companies, banks, housing finance companies
and co-operative organisations like HUDCO and NHB. Major players in the Industry
are HDFC, LIC Housing Finance, Dewan Housing, Can Fin Homes, SBI Home
Finance and Gujarat Rural Housing. The youngest entrant into the Industry, which is
penetrating rapidly, is ICICI. Interestingly, both Can Fin Homes Limited and its
parent Canara Bank are into housing finance. It is the same with quite a few banks,
for example, SBI and SBI Home Finance Limited, Bank of Baroda and BOB Finance,
Vysa Bank and Vysyabank Housing. Though HDFC and ICICI also have their
banking arms, they compete with each other in personal loans, but not housing loans.
The industry comprises of nearly 383 housing finance companies although
disbursements from only the leading 26 institutions are eligible for re-finance from
National Housing Bank, which is the regulatory body for these companies. These
Housing Finance Companies (HFCs) constitute nearly 95 % of the total disbursement
by the industry. However, owing to the slump in real estate market over the last few
years, the industry posted a fairly low disbursement growth.

Market trends
The housing sector is witnessing a clash between major players. HDFC had ruled this
sector with a lion’s stranglehold. It was smooth sailing for HDFC all these years and
it seemed that its monopoly was there to stay forever. However, out of the blue
emerged ICICI Home Loans, when this financial institution decided to clash arms
with HDFC on its home front. Within a year of its launch, ICICI Home Loans is
giving the industry leader, HDFC, sleepless nights.

Undercutting in the interest rates is all in the game and so is every other trick in the
book. HDFC is gathering its wits to beat its competitor at its own game. It launched
an aggressive hoarding campaign designed in the style of ‘follow the leader’. HDFC
has launched its website propertymartindia.com as a joint venture with the Mahindras.
Following suit, ICICI too, launched its home portal www.indiahomeseek.com. So the
war rages on both at the retail level and also in the form of a cyber war. ICICI has
lowered its prime lending rates on short and medium term loans from 13 per cent to
12.5 per cent. Thus, bringing the interest on housing loans at par with the foreign
exchange loans.

HDFC also reduced the interest rates on its housing loans from 13.25 per cent to 13
per cent. It went an extra mile to woo the borrowers of loans up to Rs. 1 crore by
allowing them the facility to either opt for a fixed interest rate of 13 per cent or a
floating interest rate of 12.5 per cent. As the name indicates, a borrower opting for the
first choice will have to repay the loan at an interest rate of 13 per cent irrespective of
any future hike or cut in the rates. Those choosing the second option would be subject
to the vagaries of the interest market and may gain or lose in the bargain. The
company has also reduced the interest on loans borrowed by non-resident Indians.
These loans repayable within five years will attract an interest rate of 11.5 per cent
per annum while loans with a term of 6-10 years will be charged interest at 12.5 per
cent.
The above rates are under the fixed interest rate option. Similar floating rate loans
would be charged at 5 per cent less interest. Originally, only the commercial banks

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offered housing loans on floating interest rates, now that HDFC is offering loans at a
12 per cent floating rate, ICICI also has a floating rate home loan in the pipeline.
Price sensitivity factors
• Noteworthy fact here is that NHB refinance to the HFCs comprises a mere 7%
of the loans disbursed. In other words, most HFCs have to arrange for a major
part of the disbursals from their own resources. Thus, low spreads,
mismatched asset and liability, competition posed by banks with recent
regulations requiring commercial banks to invest 40 per cent of their advances
towards the priority sector, etc. pose problems for the lending division.
• The first housing finance company to cut down its interest rate after RBI
slashed the PPF interest rate by 1 per cent on January 14, 2000 was HUDCO.
When the National Housing Bank, the refinancing agency of all housing
finance companies, slashed its rates by up to 50 basis points, it triggered off a
virtual interest war in the industry. HDFC, ICICI, LIC Housing Finance, PNB
Housing Finance Limited and a host of others followed suit. In a game of one-
upmanship, the companies have been vying with one another to offer the best
deal in a rapidly growing market.
• CRISIL has forecast an increase in the interest rates in the second half of this
year. This will be due to the demand of funds by the Centre and also the
corporate exceeding the supply. The Central Government has projected a Rs.
31,000 crore higher borrowing this year than last year’s figure of Rs. 86,000
crore. The State Government borrowings would add up to a further Rs. 27,500
crore and the corporate demand would be higher by Rs. 11,000 crore. As
compared with the supply, CRISIL expects the short fall to be around Rs.
15,800 crore. To make up this short fall, even if there is a 1 per cent cut in
CRR, interest rates are still bound to increase.
• The Union Budget 2000-01 has given a shot in the arm to the industry by
raising the exemption applicable to individual borrowers on the interest paid
on housing loans to Rs. 1 lakh. The existing tax rebate of 20 per cent under
section 88 of the Income tax Act of 1961, covered repayment of housing
loans, subject to a maximum of Rs. 10,000. The same has now been doubled
to Rs. 20,000. This, coupled with the lowering of the interest rate would
enable a borrower to enjoy tax exemption upto a loan of Rs. 7.5 lakh for a 15-
year term. He can now have access to better tax planning options on account
of the exemption and a lower Equated Monthly Instalment (EMI) due to
longer term of repayment. Furthermore, individuals who already own a house
can now invest in a new house and yet claim exemption from capital gains on
the sale of the asset. The tax exemption on the interest paid on housing loans
has also been extended up to the year 2003. This move will benefit the salaried
employees, especially the middle-class populace. A dream of providing 25
lakh rural houses has been envisaged in the budget. Out of these, 12 lakh
houses will be built under the ‘India Awas Yojana’ and another one-lakh
houses would be provided under the ‘Credit-cum-Subsidy’ scheme for
families with an annual income below Rs. 32,000. Moreover, around 1.5 lakh
houses to be constructed under the ‘Golden Jubilee Rural Housing Finance
Scheme’ will be eligible for refinance from the NHB.
• The industry has found new avenues such as securitisation, which are
expected to be launched in the market very soon. This mechanism would

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 require a pool of assets (mortgages), which would be sold by the HFCs to
NHB. These assets in turn would act as a Special Purpose Vehicle (SPV) and
would be sold as pass through certificates to investors, which initially would
be from groups earning pension funds, mutual funds, financial institutions,
commercial banks and other trusts or institution which require monthly fixed
income.
• The mortgages would be for loans up to a period of 10 years, on which HFCs
would earn 16 % from borrowers. The spread is to be passed back to the
concerned HFCs in the form of premium at purchase of mortgages or service
charge over a period of time. It is expected that with the success of
securitisation the circulation of funds would increase coupled with cash flows
generated by these funds. Furthermore, a secondary market for mortgages
would become feasible for HFCs.

Outlook
The industry is witnessing a boom at present boosted by the generous budget sops and
rock bottom real estate prices. The demand is a result of genuine individual needs for
housing. The prospects of the industry would be further strengthened on the
amendments to the Rent Control Act and repealing of the controversial Urban Land
Ceiling Act. Thus, the housing finance industry is on solid ground and has interesting
prospects ahead. As for the small players, they will have to take the harsh decision to
either exit the industry or merge with bigger entities. It is also amply clear that in the
future, industry leader HDFC will have to share the spoils with the aggressive young
turk - ICICI. Notwithstanding the competition, the customer has nothing to lose as he
can choose the best loan scheme from the ICICI and HDFC fold, with minimum
interest and a nil processing fee.

Conclusion
Despite the abovementioned factors, several bottlenecks still exist in the industry,
which have to be taken care of before any of the above can bring about an
improvement in the prospects of the industry. From an overall viewpoint demand for
housing is ever rising and the same would be reflected on the demand for funds.
Hence, the profitability of the industry should commence on the positive track in the
future.

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