The Reserve Bank of India (RBI) may make borrowing more expensive for builders by asking banks to set aside more capital for loans to commercial real estate projects. A higher capital requirement will force banks to raise interest rate on such loans.
Senior bankers feel that RBI may either raise standard provisioning or risk weight on bank loans to real estate companies in the forthcoming policy on April 20. This will be aimed at protecting banks’ exposure to properties amid spiralling prices.
“If RBI does not raise cash reserve ratio and keep signalling rates like repo rate and reverse-repo rate untouched, my feeling is that it may tighten the prudential norms. A hike in risk weight, particularly on real estate loans, is not ruled out,” said SA Bhat, chairman and managing director of Indian Overseas Bank. As per the latest available data, banks exposure to commercial real estate is Rs 88,581 crore as on November 2009.
Risk weight is the capital that is set aside to calculate capital adequacy ratio, which is 9% for all banks. Banks have to set aside less capital for borrowers with higher credit rating. For a triple A clients, the risk weight is 20%, which means banks have set aside Rs 1.80 of its own capital for every Rs 100 loan to such borrowers.
But risk weight for real estate companies is 100%, irrespective of the rating; this means banks have to keep aside Rs 9 for every Rs 100 loan to builders. Chances are the regulator may raise this risk weight to 125% or even 150% in the forthcoming policy. To help builders and banks cope with the crises, RBI had lowered it to 100% from 150% during the downturn. But while doing this, RBI had indicated that these were counter-cyclical measures.
“Government and banks bailed out real estate companies by providing financing to them. The growth in this sector was higher than the overall credit growth, as a result, prices did not come off significantly.
Revival in the sector has resulted in real estate prices rising and now RBI may need to make an effort to cool down prices,” said Hemindra Hazari, head of research Karvy Stock Broking. On a YoY basis, loans to real estate sector surged 15.3% when overall credit rose 10.4% as on November 20, 2009.
Unlike personal loans, which grew only 0.7% as banks slowed down when customers began to default, they continued lending to builders. “It was financing a high-risk sector and was not justified...this resulted in real estate prices not dropping to the extent that they could have...more so, given the over supply in the market,” he added.
Some bankers think that RBI may raise standard provisioning on commercial real estate loan, which is now at 1%. It is the money that banks set aside from their earnings on standard loans to protect their books if the borrower defaults. Standard provisioning for manufacturing companies is 0.40%. Thus, on a Rs 100 loan to a real estate company, a bank has to keep aside Re 1 while only 40 paise has to be provided to a manufacturing firm.
After Lehman fell, standard provisioning on real estate was lowered from 2% to 0.40%. In November 2009, RBI raised it to 1% amid concerns that nearly 14% of loans to this sector was restructured.
In mid-term policy (October 2009), RBI had said: “Real estate prices have firmed up as has been the trend in several other emerging market economies. Increasing optimism about the recovery and high levels of liquidity are driving up real estate prices although they are still some distance away from the pre-crisis peaks.”
