HOUSING FINANCE By- Rahul Jain

Characteristics of housing finance Long term finance with repayments spread over years Most of the people prefer loan at fixed interest rate. The concept of variable interest rate is slowly picking up Market is becoming very competitive after the entry of banks in financial institutions in retail lending. The spreads are declining due to competition and unless long term funds at reasonable interest rates are made available, it would be very difficult to maintain bottomline.

Housing Shortage and resource requirement A. Housing Shortage India is a vast country with a population of over 1 billion people. More than 50 million people are living in slums. India has a current housing shortage of 22 million units (both in rural and urban areas). It will increase to 42 million by the end of 9th five-year plan. Rural areas are still neglected, both under infrastructure and housing, resulting in shift towards urban centres. India is far behind Asian Countries such as Singapore, Hongkong, Malaysia, Bangkok, Korea and China in fulfilling this basic human need.

Housing Loan Market in India The size of mortgage loan market is relatively very small compared to developed countries. Our estimated size of mortgage loans with HFCs is about Rs crores. In developed countries like UK and USA, the outstanding mortgage loan to GDP is above 55%, Japan 33%, Korea over 10%, in Malaysia over 20% and Hongkong over 30%. In India the ratio is just around 1.6%. After including other indirect agencies like Govt. and institutions, the percentage share will be less than 2% However, new Mortgage loans as %age of GDP is 11% in USA and 9% in U.K. I.e. about 20% of outstanding.Whereas in India it is 0.6% I.e. about 37%of outstanding.

What is Primary and Secondary market: The primary market constitutes housing loan companies (HFCs) and the borrower. The (HFCs) hold the mortgages of a borrower in their books. The participants in the secondary market are specialised institution, to whom housing loan mortgages are sold by (HFCs) at a market determined interest rate. These loans are sold in the market to interested buyers in the form of mortgage backed securities (MBS). These interested buyers could be insurance companies, pension funds, mutual funds and even individuals. By this process, the avenues for funds are increased, there is a greater participation of individuals and the housing finance company is able to raise the long-term funds from the secondary market.

A. Mortgage loan Insurance: In developed economies, the risk of default under mortgage loans is covered under an Insurance Policy for a nominal premium. As a result the Mortgage loans become risk free and only 50% risk weight is allotted on Housing Loans, which vastly improves Capital adequacy ratio. In India, in the absence of such Insurance cover, the risk of non- payment/ failure exists to a larger extent and hence the risk weight is 100%. Indians are traditionally and emotionally attached to their own house therefore, the default ratio is low. the recovery percentage is as high as 98 to 99%. Taking this factor into consideration, RBI has now reduced the Risk weight to 75% taking into account the good asset quality.

Housing Finance Company A HFC is a company which mainly carries on the business of housing finance or has one of its main object clause in the Memorandum of Association of carrying on the business of providing finance for the housing. Requirements for commencing housing finance business by an HFC under the NHB Act: For commencing the housing finance business, an HFC is required to have the following in addition to the requirements under the Companies Act, 1956: (a) Certificate of registration from NHB (b) Minimum net owned fund of Rs. 200 lakhs ( w.e.f )

Problems of long term finance in India: The mortgage loans are long term loans for years. In some countries such as Japan these are also available for years There are very limited options for availability of funds for such a long period and at a fixed interest rate The long term Debt market has not so far developed or stabilised in India. Most of the institutions are suffering from asset liability mismatch and the consequences would be felt when liabilities will mature for payment. The interest rate risk will be exposed once the interest rates start moving northwards.

B. Foreclosure Laws: Repayment of housing loan is in monthly instalment (EMI) over 15 to 20 years. Under Prudential Norms the account will become a non- performing asset if there is default in recovering six monthly instalments. The countries, where foreclosure laws are in place, the account can be pre-closed, the lender can call back the entire dues after default of 6 monthly instalments, irrespective of the fact that the amount is due to be repaid over a period of 15 to 20 years. The various agreements obtained by the lender will have such clauses to recall the entire balance due in case of default as prescribed.

SECURITISATION: Origins in the USA in the 1970s. It is now one of the most important innovations in the financial markets of developed countries. Securitisation refers to conversions of cash flows into marketable securities. The illiquid assets called Asset Backed Securities (ABS) are packaged, converted into tradable securities and sold to the third party investors, without recourse. The securities are highly tradable. In case of housing loans these are referred to as Mortgage Backed Securities (MBS).

How the system works: A financial intermediary gets repayment along with interest over a period of time. The lender who collects the periodic instalments has to wait till the final maturity of the loan to recover his full principal and interest. Securitisation allows the financial intermediary to sell its right to receive the future payments from the borrowers to a third party and receive consideration for the same up front. The proceeds are re-deployed in business. This cycle could be repeated several times leading to efficient usage of capital. Benefits of Securitisation: It is an alternative source of funding. The asset is transferred and It generates cash without any addition to borrowings, thus pressure on capital adequacy is averted.

State of Securitisation in India and related problems: The route for securitisation was cleared with the amendment in the National Housing Finance (Amendment) Act, The NHB was allowed to act as a Special Purpose Vehicle to handle securitisation. NHB has already handled two/three issues. The high stamp duty in most of states on bonds with the exception of Maharashtra, Karnataka Gujrat, Tamil Nadu and West Bengal, where the stamp is 0.1% is an obstacle. A high incidence of stamp duty makes the issue un-attractive and costly for the originator. The Companies have availed refinance from NHB and book debts are charged to it. If a Housing Finance Company wants to securitise these loans, NHB should accept pre-payment and release these securities. NHB has imposed prepayment charges on Refinance 1% on the amount for the remaining period of loan outstanding, which works out to more than 4% on the outstanding amount. If securitisation is to be successful, NHB should reconsider the levy of charges.