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The Reserve Bank of India’s move to increase provisioning norms for advances to the commercial real estate sector can be viewed either as part of a prelude to a tighter money policy or as a mere cautionary measure. The RBI offers explanations for both even while it places its monetary stance against a need for tightening. As a specific regulatory measure the restoration of the standard asset provisioning of one per cent for commercial real estate loans is a safety no rm since the value of loans restructured in the recent period in the sector has risen far above the average level. The aim therefore is both to protect banks against spurts in their non-performing assets by tempering robust lending to this sector and to prevent asset prices overheating. It is doubtful if either aim will succeed unreservedly.

The degree to which commercial real estate activity gathers speed depends to a large extent on the robustness in economy activity. So far, fresh capacity expansion in the real economy has yet to pick up but, when it does, the demand for fresh commercial real estate stock will generate demand for bank credit. The higher provisioning norm, even if it is merely a return to the standard, will doubtless lead banks to raise interest rates. As the RBI’s own experts have pointed out, banks are quicker to respond to signals for upward revisions in interest rates than they are to signals for a downward movement. Coupled with the fact that most banks adopt variable interest rates around their Benchmark Prime Lending Rates, lending to this sector may not necessarily dampen on account of higher provisioning. Assuming the average interest rate for the sector does move up — and the State Bank of India chairman feels it will — most borrowers will want to factor the higher cost of funds into their asset prices; given the existing opacity in their formation, the end result may be quite the opposite of the RBI’s stated objective of correcting, that is lowering, asset prices. Self-restraint in lending to this sector may help banks guard against default risks. Alternatively, the RBI could raise key rates in which case more than the commercial real estate sector will feel the pinch.

As far as real estate asset prices are concerned, tinkering with the volume of funds will not work in the absence of measures to make the market more transparent. The still evolving housing price index is a step in the right direction as is the draft model legislation for the regulation of the real estate sector.

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