The housing market in India is funded by banks, non-banking financial companies (NBFCs), and housing finance companies (HFCs). Currently, limited economic options are available for credit risk transfer or credit risk enhancement, leading to greater reliance on equity. High dependence on equity hampers the growth prospects for lenders. To have a growing and sustainable housing market, suitable credit risk mitigants must be accessible to lending institutions.
One of the efficient tools for credit risk mitigation available to the lending institution is the Mortgage Guarantee (MG) product. It empowers the housing finance ecosystem by enabling lenders to enhance their credit box and reduce underlying risks. Lending Institutions often hesitate to discover newer geographies or segments of customers due to perceived higher credit risk. By having the backing of MG, the lending institutions can expand their credit box without increasing the risk.
Mortgage Guarantee provides a first loss default cover against a payment default by the borrower. The guarantee is invoked as soon as the loan becomes a non-performing asset (NPA), and the guarantor starts paying the EMI due from the borrower. MG can be taken on a loan-by-loan basis at the time of origination, or it can be taken on an existing pool of loans.
Some of the key benefits of MG to lenders are discussed below:
Credit box expansion
With MG cover, lending institutions can give borrowers a higher loan amount. This is possible through various measures such as increasing loan to value (LTV), extending the loan period, and considering cash and other alternate income to calculate borrowers’ income and eligibility. Higher loan amount results in greater purchasing power and affordability to the buyer, stimulating the demand for housing. A lending institution can tap into newer geographies and offer loans to emerging borrower segments such as cash-salaried employees and employees of micro/small entities.
For example, if a bank gives a loan of ₹16 lakh for the purchase of a house property of ₹20 lakh, the loan will be at 80 per cent loan to value (LTV), and the bank will have 100 per cent exposure on the loan amount of ₹16 lakh. However, if the same loan is covered with a 20 per cent MG, the net exposure of the bank will be reduced by 20 per cent to ₹12.8 lakh, while it will continue to earn interest on the loan of ₹16 lakh. The bank may even increase LTV to 90 per cent and enhance the loan amount to ₹18 lakh and still have a lower net exposure of ₹14.8 lakh.
Under the IND AS accounting, a lender is required to make provisioning on its financial assets (including loans) using the Expected Credit Loss (ECL) framework. ECL framework is based on the estimated future losses on the loans due to default or delay in repayment by the borrower.
Since MG offers a first-loss default guarantee on the loan, the expected loss on a guaranteed loan is significantly lower compared to a loan without an MG. Further, since the guarantor starts paying EMIs once the loan becomes NPA, the loss due to delay in repayment on a loan is also significantly lower for the loans covered by MG. As a result, ECL provisioning on loans is reduced due to MG cover.
MG provides regulatory capital relief to the lenders on the guaranteed loans by reducing the risk weight from 35 per cent/50 per cent (as applicable currently in India) to 20 per cent/30 per cent (based on the rating of the Mortgage Guarantee Company). The freed-up capital can further be deployed in the businesses, resulting in higher volumes and, thereby, increasing the profitability.
The writer is the Chief Financial Officer of India Mortgage Guarantee Corporation