A Reserve Bank of India (RBI)-appointed panel’s recommendation that banks offer home loans carrying fixed interest rates for at least 7-10 years, with a reset provision for the remaining tenure, deserves serious consideration. Currently, more than three fourths of retail home loans are made at floating rates. Even the so-called fixed rate offerings usually have a reset clause after 3-5 years. Loans with fixed interest till maturity are not just rare, but have few takers due to their being priced substantially higher than floating rate loans. Banks, in turn, blame it on the fact that over two-thirds of their deposits are of below two years and creating very long-term assets out of these – home loans are typically for 15-30 years – exposes them to interest rate as well as liquidity risks during the tenure of such loans. To address the resulting asset-liability mismatch, the banks have, then, sought to pass on the entire risks to the borrowers – leading to sudden rise in equated monthly instalments (EMI), or 20-year loans turning into one of 35-year long duration.
The RBI committee’s proposal to introduce loans with a minimum period of 7-10 years before interest rates can be reset, makes sense when seen in the context of its other suggestion – that banks do more to mobilise fixed deposits with tenors of above five years, besides raising resources through long-term bonds. But these require complementary initiatives from the Government. There is no reason, for instance, why only up to Rs one lakh of bank deposits made for a minimum of five years are now eligible for tax exemption. Raising this limit will enable banks to extend reasonably priced long-term fixed rate loans to not just home borrowers, but even infrastructure developers. Similarly, while banks could float long-term bonds by linking their pricing to that of Government securities for up to 30-years tenor, there has to be simultaneous policy action to encourage insurance firms, pension funds, and provident funds to invest in them.
But ultimately, the country would require the development of a secondary market in financial instruments with underlying retail mortgage assets. This is difficult to achieve unless there are supplementary measures of reform such as moderate tax rates on secondary market transactions in real estate; well developed market for title insurance; more realistic methods of enforcing financial claims on securitised assets, etc. Such measures will spur term institutions to purchase securitised mortgages from banks, and also, participate vigorously in the secondary market for transactions in these assets. A healthy growth of the housing sector requires long-term resources from institutional investors to flow into mortgage-backed securities. Banks can continue to be loan originators, but expecting them to bear the risks of keeping loans on their books forever would be too much to hope for.