As the real estate sector has evolved over the last decade so has been the financing need of the sector.

Traditionally, banks have been serving the needs of the sector towards the construction of real estate projects, whereas non-banking financial companies (NBFCs) have contributed on a wider basis and played a very important role as a supplemental channel of credit intermediation alongside traditional banking channels.

Over the years, NBFC funding towards the real estate sector has undergone considerable evolution in terms of size, complexity, and interconnectedness with the financial sector.

NBFCs have undergone a systemic change post the crisis of September 2018, triggered by the collapse of IL&FS, after which many of them faced an existential crisis, and some could not recover as well. Many of those NBFCs have been very active in the real estate sector up until then.

NBFCs have been funding real estate developers across the lifecycle of a project, and their value addition has been primarily during the initial stages of a project, where the existing regulatory guidelines barred banks from extending financing. In the view of the regulator, it may have construed that NBFCs were taking a disproportionately higher risk, which seems fair seeing the way sector got impacted post the NBFC crisis.

Therefore, the Reserve Bank of India, vide its circular dated April 19, 2022, has stipulated that NBFCs have to ensure while approving loans involving real estate that the borrower has been granted all requisite permission from the government/other regulatory authorities for the underlying projects.

The above guideline has come into effect from October 1, 2022, and is applicable to NBFC-Middle Layer (non-deposit taking NBFCs with assets of more than ₹1,000 crore) and NBFC–Upper Layer (as published by the RBI from time to time).

Post the above notification, NBFCs are restricted from financing projects which are not approved or in simple language, projects which are at land stage. To put it further simply, this means NBFCs cannot fund either towards acquisition of land or fund, where the primary source of repayment is an unapproved project/ land.

Therefore, it will lead the sector to align as the NBFCs has thus far provided a vital cog during the lifecycle of a real estate project by being able to extend funding towards the project at its nascent stage or towards land acquisition.

RBI guidelines seem to be a step in the right direction to ensure more equity infusion into the projects while ensuring that the risks are at manageable levels for the overall system.

In conclusion, regulatory steps taken such as these are mainly to give directions to NBFCs to take prudent risk and become more bank like and at the same time to ensure that there is more skin in the game for the promoters in the underlying project through infusion of higher equity towards land acquisition and approvals.

Consequently, this would lead to better managed overall systemic risk.

(The author is Business Head - Real Estate and Urban Infrastructure, Arka Fincap Limited )