On June 17, 2020, the Reserve Bank of India [RBI] released the ‘draft framework’ for the regulation of Housing Finance Companies [HFCs]. The proposed framework introduces some major changes in the HFC regime by clearly differentiating housing loans from non-housing loans, defining the ‘principle business’ of the HFCs, doubling the net owned fund threshold, and prohibiting the HFCs from simultaneously lending to the group companies and individual homebuyers. In this article, the authors will examine all these key changes introduced by the RBI and evaluate the regulatory impact on the HFCs.
Understanding the Context
Initially, the power to regulate the HFCs vested with the National Housing Bank [NHB]. The NHB acted as the refinancer and the regulator for the HFCs which resulted in a conflicting and difficult situation. Thus, on August 9, 2019, the central government amended the National Housing Bank Act, 1987 [NHB Act], and transferred the regulatory powers of the HFCs to the RBI. Pursuant to the conferment of powers, RBI conducted a review of the existing guidelines and decided to regulate the HFCs as a category of the Non-Banking Financial Company [NBFC]. Accordingly, the NBFC Master Directions and Chapter IIIB of the RBI Act, 1934 (provisions governing the NBFC) were made applicable to the HFCs. Furthermore, RBI has made it mandatory for companies to obtain Certificate of Registration [CoR] under Section 29A of the NHB Act. But, the companies already registered as HFC are not required to re-apply for fresh CoR. Thus, the draft framework streamlines regulation, takes out uncertainty, and eliminates the hassle of re-registering the entity under RBI.
Filling the Gaps – Defining ‘Principle Business’ of providing ‘Housing Finance’
Under the NHB Act, to register a company as HFC, the company must have the ‘principle businesses’ of providing ‘housing finance’. However, the term ‘housing finance’ and ‘principle business’ was never formally defined. The draft framework introduced by RBI proposes to define both the terms in detail. This would eliminate the uncertainty and help to determine whether the company qualifies as an HFC or not.
1. What is Housing Finance?
The RBI proposes to define ‘housing finance’ as “Finance for purchase/ construction/ reconstruction/ renovation/ repairs of residential dwelling units”. Such ‘finance’ would include loans advanced to individuals, co-operative societies, public agencies (including state housing board), and corporate sector for the purpose of construction of new dwelling units, purchase of old or new dwelling units, and development of townships, etc. The draft framework further clarifies that loans provided for furnishing of dwelling units or extended against mortgage of property for any purpose other than buying or construction of new dwelling units, are to be treated as non-housing loans.
Such classification of the activities under the definition of ‘housing finance’ is extensive and inclusive. It helps to clearly demarcate the ambit of housing loans from non-housing loans. Furthermore, a precise definition of ‘housing finance’ will also allow the HFCs to diversify into other segments since HFCs have to operate within the prescribed limits of the framework. Moreover, the aforesaid classification would supplement the definition of ‘principle business’ because only those loans which ‘qualify’ as ‘housing loans’ would help determine the ‘principality’ of business of the company. Thus, defining these terms is a step in the right direction.
2. Defining ‘Principle Business’ and ‘Qualifying Assets’
The draft framework seeks to extend the definition of ‘principle business’ applicable for the NBFC to the HFCs. Under the definition, an NBFC must have financial assets more than 50% of its total assets and income from these financial assets must be more than 50% of the gross income. Both these conditions have to be satisfied as to the determining factor for the principle business of an NBFC. However, to implement this definition to the HFCs, RBI has proposed to introduce the concept of ‘qualifying assets’.
According to RBI, ‘qualifying assets’ would mean loans that are certified as housing loans under the draft framework. As per this concept, the HFCs must have at least 50% of its net assets as qualifying assets [housing loans], out of which at least 75% should be towards individual housing loans.
The HFCs which do not fulfill the above-mentioned criteria shall be treated as an NBFC – Investment and Credit Companies [NBFC-ICCs] and shall be required to approach RBI for the conversion of their CoR from HFC to NBFC-ICC. This should be affected in a phased manner to provide a breather to those entities not fulfilling the criteria but would like to continue as HFC in the future. Thus, companies will have to re-balance their loan portfolio to continue operations as HFC.
An important incentive for the companies to continue operations as HFCs is the benefit of the re-finance scheme extended by NHB. Under this scheme, the NHB extends long-term funds to HFCs at a concessional rate in order to allow the HFC to increase their lending activity. A succinct definition of ‘housing finance’ and ‘principle business’ would allow NHB to effectively determine which company qualifies for the benefit for re-finance and for what purpose can the company avail the benefit of re-finance. Thus, clearly defining these terms will contribute towards the effective regulation of HFCs.
Increased requirement of Minimum Net Owned Fund
The draft framework proposes to increase the threshold of minimum Net Owned Fund [NOF] for the HFCs. The NOF is the aggregate of the paid-up equity capital and free reserves after deducting accumulated balance of loss, deferred revenue expenditure, and other intangible assets. The RBI proposes to increase the NOF from Rs. 10 crores to Rs. 20 crores in a phased manner. The HFCs would be given 1 year to reach the limit of Rs. 15 crores and 2 years to cross 20 crores. This guideline will strengthen the capital base of existing smaller HFCs and of those companies intending to operate as HFC. Further, it will act as a barrier to entry for weaker players, and thus, strengthen the overall housing finance market.
Tighter Inter Group Lending Norms/ Double Financing
The housing finance market is plagued by the practices of double financing, where an HFC finances both, a group company constructing the dwelling units and the individuals purchasing flats in those dwelling units. Such practice created the issue of cross-collateralization and conflict of interest. RBI, in order to address concerns on double financing, has introduced tighter rules, according to which HFCs shall be allowed to lend only at a single level. This implies that the HFCs can either undertake an exposure on the group companies in the real estate business or lend to individual homebuyers in the projects of group entities, but not do both. Accordingly, the HFCs cannot take exposure of more than 15% of owned funds for a single company in the group and 25% across all companies of the same group. Further, while extending loans to individuals, who choose to buy housing units from entities in the group, the HFC would follow the arm’s length principles in letter and spirit. Thus, the restriction will prevent a scenario of overlapping collateral and facilitate smoother enforcement of security by the HFCs in the event of default either by the individuals or the group companies.
The draft framework, however, will have some impact on the real estate sector which is currently in a liquidity crisis due to the COVID-19 pandemic. Further, this may create issues for the Mahindra group, Tata group, Piramal Enterprises, and any other group entity which have operations in both real-estate and housing finance. Moreover, the language of the framework is ambiguous since it is not clear whether ‘group’ refers to the internal group or external group (financial entities other than group companies sponsoring the HFC). Thus, RBI must address these issues for the smooth implementation of the draft framework.
The RBI’s proposal to overhaul the rules governing the HFCs is long overdue, but a welcome step. The draft framework aims to remodel the HFCs as a category under the NBFC. The proposed framework aims to align the liquidity framework, securitization measures, foreclosure charges, fraud monitoring measures, Indian accounting standards, and information technology framework, as applicable to NBFC with HFCs. In total, the proposed framework is a positive step aimed at streamlining the regulations and reducing the regulatory arbitrage for HFCs.
The only grave concern for the HFCs will be the orderly application of the draft framework in the post COVID-19 era. However, the RBI has suggested that the implementation of the regulation may take up to 2-3 years. This will defuse the threat of asset-liability mismatch and mitigate the COVID-19 impact on the real estate sector. Thus, the framework addresses all the concerns and introduces a balanced guideline to ensure a robust ecosystem for the governance of HFCs in India.
ABOUT THE AUTHORS
Pratyaksh Sikodia is a third-year law student at National Law University, Jodhpur. His interest lies in Criminal Law and Constitutional Law. He can be contacted at Pratyaksh Sikodia.
Vedaant S. Agarwal
Vedaant is a third-year law student at National Law University, Jodhpur. His interest lies in Corporate Law and Securities Law. For any discussion related to the article, he can be contacted at firstname.lastname@example.org