A wrong way to boost credit to housing

S Kalyanasundaram | Updated on December 08, 2020

Boosting housing, boosting jobs   -  REUTERS

It is illogical to remove the criterion of quantum of loan from the risk weight calculation. Other methods are preferable

In continuation of the Monetary Policy Statement announced on October 9, 2020, the Reserve Bank of India decided on some changes in the risk weighted norms for housing loans.

The risk-weighted asset is a bank’s asset weighted according to risks. The RBI said that under the extant regulations, differential risk weights are applicable to individual housing loans, based on the size of the loan as well as the loan-to-value ratio (LTV). Given the crucial role of the real estate sector in generating jobs and reviving the economy, it decided to rationalise the risk weights and link them to LTV ratios only for all new housing loans sanctioned up to March 31, 2022. The RBI further informed that this measure is expected to give a fillip to the real estate sector.

Earlier, the risk weight was based on the quantum of the loan as well as loan-to-value ratio for housing loans. As per this new directive for calculating risk weightage, only LTV matters and not the quantum of loan.

Such loans shall attract a risk weight of 35 per cent where the LTV ratio is less than or equal to 80 per cent, and a risk weight of 50 per cent where the LTV ratio is more than 80 per cent but less than or equal to 90 per cent, the RBI said in its policy statement. Developers and lenders expect that this would play a significant role in boosting demand for the housing sector.

The rationale

As claimed by the RBI, the tinkering of the risk weight norms was done to give a fillip to the real estate sector. But what was the original purpose of the risk weighted norms for various loan assets of banks?

Until the prudential norms on income recognition for banks, banks used to charge interest in all the loan accounts and take it to income account. The actual recovery was immaterial for recognition of interest as income. This system enabled banks to window-dress the actual position. During the 1990s, at various stages, the RBI set income recognition norms in the backdrop of adoption of Basel norms.

As a part of these norms, various stipulations on the actual recovery were made to ensure that only in respect of performing assets, the amount of interest can be taken to profit and loss account and based on various risk perceptions, provisions are to be made in the balance sheet.

Capital adequacy norms have also been prescribed to ensure that the banks are adequately capitalised to face the challenges. The capital adequacy ratio is the minimum capital requirement of a bank and is defined as the ratio of capital-to-risk-weighted assets.

Categorising accounts as performing or non-performing, income recognition and capital adequacy norms provide necessary disclosure to the different stakeholders who are dealing with the banks to know the health of the banks.

Hence the prescription of assessing the magnitude of risk with necessary weightage for different exposures was to enable the banks to make adequate provisions to cover the risk and to reflect the true financial position of the banks.

Wrong tool

It is erroneous to use the tool of risk weight to increase or decrease flow of credit to any sector. This will defeat the purpose for which the risk weights are prescribed. Moreover, the risk undertaken by the banks will be commensurate with the quantum of loan and higher the loan exposure higher will be the risk. It is illogical to remove the criteria of quantum of loan from the risk weight calculation.

There are other tools available to increase or decrease credit flow to any particular segment, which can be used by the RBI.

As far as the housing sector is concerned, this is already under the priority sector credit. The RBI will be perfectly justified in changing the target under this with necessary sub-targets if necessary. Even margin and interest rate can be prescribed for housing loans so as to increase or decrease exposure.

It is also possible to open necessary refinance window to enhance flow to any particular segment.

Long ago, the RBI had used ‘Selective Credit Control’ to avoid speculation in selective commodities by prescribing higher margin, higher interest and restricted exposure against select commodities. The same method can be suitably adopted (in reverse order) to enhance credit flow to the housing sector, if required.

A tool should be used only for the purpose for which it was created and not to meet some other agenda. Wrong usage will only be counterproductive.

The writer is a retired banker

Published on December 08, 2020

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