India - Housing Finance Companies – Proposed Changes By RBI.

8 July 2020

The Central Government had, with effect from August 09, 2019, transferred regulatory powers of the Housing Finance Companies (“HFCs”) from the National Housing Bank (“NHB”) to the Reserve Bank of India (“RBI”). It is further stated that the RBI will review the extant of regulatory framework applicable to HFCs and issue the same in due course. Until such time, HFCs were required to comply with the directions and instructions issued by NHB.[1]

Pursuant to the above and in order to increase the efficiency of HFCs, the RBI has now placed a draft of the changes proposed in the regulations applicable to HFCs for public comments till July 15, 2020, which we have briefly summarised below:

Applicable law and a new regime of registration for HFCs:

HFCs were granted exemptions from the provisions of Chapter IIIB (Provisions relating to Non-Banking Institutions receiving Deposits and Financial Institutions) of the RBI Act, 1934 (“RBI Act”) vide notification dated June 18, 1997[2].

With the transfer of regulations of HFCs to RBI, it was decided to withdraw these exemptions vide Gazette Notification dated November 19, 2019[3] and make the provisions of Chapter IIIB (except Section 45-IA (Requirement of registration and net owned fund)) of the RBI Act applicable to all HFCs.

It has now been proposed that a company proposing to carry on the business of HFC has to register itself with the RBI under Section 29A (Requirement of registration and net owned fund) of NHB Act, 1987 (“NHB Act”).

Business of Housing Finance

NHB was set up to operate as a principal agency to promote housing finance institutions and to provide financial support to such institutions, both at local and regional levels.

A housing finance company is required to be in the business of providing housing finance. However, the term ‘housing finance’ was not defined under the NHB Act. NHB relied on the definition of ‘housing finance institution’ provided under the NHB Act, which states that a housing finance institution includes every institution (whether incorporated or not) that primarily transact or has as one of its principal objects transacting in the business of providing finance for housing, directly or indirectly.

The RBI now proposes to define ‘housing finance’ or ‘providing finance for housing’ as:

“Financing, for purchase/ construction/ reconstruction/ renovation/ repairs of residential dwelling units, which includes:

Loans to individuals or group of individuals including co-operative societies for construction/ purchase of new dwelling units.
Loans to individuals for purchase of old dwelling units.
Loans to individuals for purchasing old/ new dwelling units by mortgaging existing dwelling units.
Loans to individuals for purchase of plots for construction of residential dwelling units provided a declaration is obtained from the borrower that he intends to construct a house on the plot within a period of three years from the date of availing of the loan.
Loans to individuals for renovation/ reconstruction of existing dwelling units.
Lending to public agencies including state housing boards for construction of residential dwelling units.
Loans to corporates/ Government agencies (through loans for employee housing).
Loans for construction of educational, health, social, cultural or other institutions/centres, which are part of housing project in the same complex and which are necessary for the development of settlements or townships;
Loans for construction of houses and related infrastructure within the same area, meant for improving the conditions in slum areas for which credit may be extended directly to the slum-dwellers on the guarantee of the Government, or indirectly to them through the State Governments;
Loans given for slum improvement schemes to be implemented by Slum Clearance Boards and other public agencies;
Lending to builders for construction of residential dwelling units.”

The proposed draft also clarifies that housing loans will not include loans given for furnishing dwelling units or loans given against mortgage of property for any purpose other than buying/construction of a new dwelling unit(s) or renovation of the existing dwelling unit(s).

Further, HFC is required to have a ‘principal business’ of providing housing finance. But the term is not defined under the NHB Act. RBI now proposes to define and extend the definition of ‘principal business’ similar to that used for Non-Banking Financial Companies (“NBFCs”). The RBI[4] defined the term through its press release dated April 08, 1999 saying that a company: (i) is required to have financial assets more than 50% of its total assets (netted off by intangible assets); and (ii) its income from such financial assets should be more than 50% of the gross income. It is imperative that both the above mentioned conditions are satisfied in order to determine the constituents of ‘principal business’.

However, just carrying on housing finance alone as a ‘principal business’ will not suffice. It is proposed to introduce a concept of ‘qualifying assets’. Such a test has also been provided for in respect of NBFC-Micro Finance Institutions (NBFC-MFIs).

‘Qualifying Assets’ refers to ‘housing finance’ or ‘providing finance for housing’ and will be subject to the following:

Qualifying assets should not be less than 50% of Net assets, out of which at least 75% should be utilised towards individual housing loans which are loans as stated in clauses (a) to (e) of the definition of “housing finance” or “providing finance for housing”.
“Net assets” means total assets other than cash and bank balances and money market instruments.

HFCs which do not fulfil the above stated criteria will be treated as NBFC-Investment and Credit Companies (“NBFC-ICC”) and will be required to approach RBI for conversion of their CoR from HFCs to NBFC-ICC. For those companies that do not currently fulfil the qualifying assets criteria but intends to continue as HFCs in future, the RBI will grant them a phased timeline, which is as follows

Timeline	At least 50% of net assets as qualifying assets towards individual housing finance	At least 75% of qualifying assets towards housing finance for individuals
March 31, 2022	50%	60%
March 31, 2022	–	70%
March 31, 2022	–	75%

Therefore, if a substantial part of the lending is to developers, then the HFC would have to approach RBI for conversion.

Lending to Group entities engaged in estate business

RBI proposes to regulate double financing, that is, lending to construction companies in the group and to retail individual home buyers. RBI proposes that HFC may now choose to lend only at one level. The HFC can either undertake an exposure at group level or lend to retail buyers in the projects of the group entities.

If the HFC decides to take any exposure in its group entities (lending and investment) directly or indirectly, it cannot be more than 15% of owned fund for a single entity in the group and 25% of owned fund for all such group entities. For extending loans to individuals who choose to buy housing units from entities in the group, the HFC would follow arm’s length principles.

The restriction appears cumbersome and could have implications for developers. Furthermore, this may add more trouble to the real estate sector which is currently in liquidity crisis even before the Covid-19 pandemic. Even a project level restriction as aforesaid could have a negative impact given the current situation.

Classifying HFCs into systemically important and non-systemically important entities

In order to align the regulations of HFCs with that of NBFCs, RBI now proposes to classify these as:

Systemically important HFCs – to include non-deposit taking HFCs (HFC-ND) with asset size of Rs 500 crore & above and all deposit taking HFCs (HFC-D) (irrespective of asset size); and
Non-Systemically important HFCs – to include HFCs with asset size below Rs 500 crore (HFC-non-SI).

Furthermore, there is a restriction under the HFCs (NHB) Direction 2010 dated July 01, 2019 (“NHB Directions”) in relation to the acceptance of public deposits. The term ‘public deposits’ has been defined under such directions which is similar to the definition given under the RBI Master Direction on ‘Acceptance of Public Deposits’ dated August 25, 2016 (updated as on February 22, 2019) (“Master Directions on Acceptance of Public Deposits”), except that as per the definition in NHB directions, any amount received from NHB or any public housing agency are also exempt from the definition of ‘public deposit’. For the purposes of aligning the regulations of HFCs with NBFCs, RBI now proposes to align the definition of ‘public deposits’ with the Master Directions on Acceptance of Public Deposits with an addition of exception that any amount received by HFCs from NHB or any public housing agency will also be exempt from the definition of ‘public deposit’.

Minimum Net Owned Fund (“NOF”) of Rs 20 crore

RBI now proposes to double the minimum NOF from Rs. 10 crore to Rs 20 crore to strengthen the capital base for smaller HFCs and companies seeking registration under NHB Act. Existing HFCs will get 1 year to reach the level of Rs. 15 crore and 2 years to increase it to Rs. 20 crore. It is pertinent to note that RBI has not amended the NOF requirement for NBFC-ICC which is only Rs 2 crore as compared to Rs 20 crore for HFCs.

Harmonising definitions of Capital (Tier I & Tier II) with that of NBFCs

The components of Tier I and Tier II capital are similar for NBFCs and HFCs except for the treatment of perpetual debt instruments (“PDI”). Presently PDIs are not considered as part of capital of HFCs unlike that of NBFCs. RBI now proposes to align the definitions of capital (both Tier I and Tier II) of HFCs with that of NBFCs as per Para 3 (xxxii) and 3 (xxxiii) of Master Direction on NBFC – Systemically important Non Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 (updated as on February 17, 2020)[5]. PDIs will be treated as Tier I/ Tier II capital only by HFCs-ND-SI.

Monitoring of frauds

The Master Direction on Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016 issued on September 29, 2016[6] covers classification and monitoring of frauds as well as reporting to the Board, to the police authorities, RBI, etc. In order to harmonise all instructions pertaining to fraud monitoring, RBI now proposes to make the said directions applicable to HFCs in place of present guidelines issued by NHB. However, all reports as prescribed in the formats given in the said master directions may continue to be forwarded to NHB, New Delhi.

Information Technology Framework

The master direction on Information Technology (IT) Framework for all NBFCs (with asset size above Rs500 crore (systemically important) and NBFCs with asset size below Rs 500 crore) dated June 08, 2017[7] covers IT Governance, IT Policy, Information & Cyber Security, IT Operations, IS Audit, Business Continuity Planning and IT Services Outsourcing. These directions are now proposed to be made applicable to HFCs and consequently the Information Technology Framework issued by NHB vide circular dated June 15, 2018[8] is now proposed to be withdrawn.

Securitization

All HFCs (systemically important and non-systemically important) will fall under the ambit of guidelines on securitisation transaction as applicable to NBFCs contained in Annex XXII to Master Directions – NBFC – Systemically important Non Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 (updated as on February 17, 2020) (“Master Directions on NBFC-ND-SI”)[9].

Lending against shares

There are no guidelines in place currently for lending against the security of shares by HFCs. For the sake of uniformity, it is now proposed to extend instructions applicable to NBFCs to lend against the collateral of listed shares contained in Master Directions on NBFC-ND-SI to all HFCs. Pursuant to this, (i) HFCs will be required to maintain at all times a loan to value (“LTV”) ratio of 50%; (ii) in case where lending is being done for investment in capital markets, HFCs to accept only Group 1 securities as collateral for loans of value more than Rs 5 lakh; and (iii) report on-line to stock exchanges on a quarterly basis, information on the shares pledged in their favour, by borrowers for availing loans in format as given in Annex V of the Master Directions on NBFC-ND-SI.

Managing Risks and Code of Conduct in Outsourcing of Financial Services

Outsourcing guidelines applicable to NBFC-ND-SI will be applicable to all HFCs.

Implementation of Indian Accounting Standards

The Indian Accounting Standards will be applicable to HFCs.

HFCs vis-à-vis NBFCs

There are regulatory differences between the HFCs and NBFCs, which are as follows:

a. Capital requirements (Capital to Risk Asset Ratio (“CRAR”) and risk weights) – The CRAR and risk weightage varies for HFCs and NBFCs:

For HFCs[10]

For NBFCs[11]

Minimum level of CRAR

Currently – 12%;

By March 31, 2021 – 14%; and

By March 31, 2022 – 15%

15%

Risk weighted assets

Risk weighted assets on balance sheets ranges as follows:

(i) Cash and bank balances – 0%

(ii) Investments – 0% to 100%

(iii) Current assets – 0% to 100%

(iv) Fixed assets – 100%

(v) Other assets – 0% to 100%

(vi) Domestic sovereign – 0% to 100%.

Risk weighted assets on balance sheets ranges as follows:

(i) Cash and bank balances – 0%

(ii) Investments – 20% to 100%

(iii) Current assets – 0% to 100%

(iv) Fixed assets – 100%

(v) Other assets – 0% to 100%

(vi) Domestic sovereign – 0% to 100%.

b. Income Recognition, Asset Classification and Provisioning (IRACP) norms – There are differences in provisioning norms applicable to doubtful assets, sub-standard assets and standard assets in HFCs’ books which are as follows:

Provisioning requirements in respect of loans and advances and other credit facilities

HFCs[12]

NBFCs[13]

Doubtful Assets

Depending on the period for which the asset has remained doubtful, provision to the extent of 25% – 100% of secured portion will be made in following manner:

Period for which asset has been considered doubtful	% of provision
Up to 1 year	25
1 – 3 years	40
More than 3 years	100

Depending on the period for which the asset has remained doubtful, provision to the extent of 20% – 50% of secured portion will be made in following manner:

Period for which asset has been considered doubtful	% of provision
Up to 1 year	20
1 – 3 years	30
More than 3 years	50

Sub-standard Assets

A general provision of 15% of total outstanding is applicable.

A general provision of 10% of total outstanding is applicable.

Standard Assets

HFCs have provision for standard assets in the following manner:

Standard assets in respect of housing loans at special rates	2% provision on total outstanding amounts of such loans.
Standard assets in respect of Commercial Real Estates (“CRE”) (residential housing)	0.75% on total outstanding amounts of such loans.
Standard assets in respect of all other CRE	1% on total outstanding amounts of such loans.
Standard assets in respect of individual housing loans	0.25% on total outstanding amounts of such loans.
Standard assets in respect of all other loans	A general provision of 0.4% of the total outstanding amount of loans.

NBFC (systemically important) have provision for standard assets as:

(a) 0.30% – by end of March, 2016;

(b) 0.35% – by end of March, 2017;

of the outstanding, which will not be reckoned for arriving at net non-performing assets (“NPA”).

Similarly, NBFC (non-systemically important) have provision for standard assets at 0.25% of the outstanding, which will not be reckoned for arriving at net non-performing assets (NPAs).

Norms on concentration of credit / investment

Credit concentration norms for NBFCs and HFCs are similar. However, NBFC, such as, Infrastructure Finance Companies (IFC) have an exception to exceed the concentration of credit by 10% of its owned fund in lending to any single borrower and by 15% of its owned fund to any single group of borrowers. Further, it may lend to and invest in (loans/investments taken together) by 5% of its owned fund to a single party and by 10% of its owned fund to a single group of parties.

c. Limit of exposure on an investment in CRE and capital market – HFCs can invest in land and building in CRE up to 20% of its capital fund[14]. Further, the exposure of HFCs in capital market should not be more than 40% of its net worth, out of which, direct investment or exposure of HFCs in shares, convertible bonds/debentures, equity-oriented mutual funds and all exposures to venture capital funds should not exceed 20% of its net worth.[15] However, no such limits have been prescribed for NBFCs.

While harmonising the regulations of HFCs with NBFCs as mentioned above will be carried out in a phased manner over a period of 2-3 years, until such time, HFCs will continue to follow the extant norms as prescribed by NHB.