Shagufta Parveen and Mehul Bachhawat also contributed to this article.
On June 17, 2020, the Reserve Bank of India ("RBI") released draft framework for the regulation of Housing Finance Companies1 or HFCs ("Draft Framework"). This move has been initiated pursuant to conferment of powers for regulation of HFCs to RBI from National Housing Bank ("NHB") vide press release dated August 13, 20192 and amendment in the National Housing Bank Act, 19873 ("NHB Act"). The Draft Framework proposes to bring the HFCs under the regulatory umbrella of RBI, thus, bringing it to the level playing field with other Non-Banking Finance Companies ("NBFCs").
The proposed Draft framework though in line with the NHB Act, aims to tighten the norms and bring clarity in the applicable regulatory framework in the housing finance sector. The proposed Draft framework also clarifies that the areas where existing HFC regulation differs from that of NBFCs, either existing provisions would be maintained, or amendments would be introduced to the extent possible without disturbing the ecosystem. The Draft Framework proposes to define 'housing finance' and address concerns over the conflict of interest arising out of lending and investments in group entities. Further, the Draft Framework aims to filter out the larger players that are systemically important to the HFCs and reduce the regulatory arbitrage of HFCs. The draft guidelines are open for comments from relevant market participants and stakeholders till July 15, 2020.
A brief summary and analysis of the key changes proposed by the RBI under the Draft Framework are as follows:
Clarifying the regulation of HFCs
Earlier, HFCs were granted exemptions from registration with RBI as per chapter IIIB of the RBI Act, 1984 vide notification dated June 18, 1997 by exercising powers under Section 45NC of RBI Act, 1934. With transfer of the regulations of HFCs from NHB to RBI vide press release dated August 19, 2019, vide gazette notification4, these exemptions were withdrawn and chapter IIIB (except section 45-IA which states mandatory requirement of all NBFCs to obtain CoR from RBI for commencing business) was made applicable to all HFCs.
The Draft Framework seeks to give effect to the applicability of the said chapter IIIB and accordingly, the companies intending to function as HFCs are required to seek registration with the RBI under section 29A of NHB Act, 1987. However, the existing HFCs holding certificate of registration ("CoR") issued by NHB are not required to approach RBI for fresh CoR. This step shall ensure that the already existing HFCs do not go through the hassle of re-registering the entity under RBI and removing any scope of ambiguity.
Succinct definition of Housing Finance
Under the Draft Framework, the 'housing finance' or 'providing finance for housing' has been defined as: Financing, for purchase/construction/reconstruction/renovation/repairs of new/old residential units for loans extended to individuals or group of individuals including co-operative societies, corporates, government agencies, educational, health, social, cultural or other institutions/centres, which are part of housing project in the same complex and which are necessary for the development of settlements or townships and builders amongst others for specified permitted activities.
For individuals, the scope of housing finance includes loans for the construction/purchase of new dwelling units, old dwellings by mortgaging existing dwelling units. Under the new regime, the builders can avail loan for the construction of the residential dwelling units. This definition will eliminate cross collateralisation of existing real estate projects, dwellings by builders for construction of new residential dwelling units.
The definition provided in the Draft Framework regarding the categorisation of the activities comprising of 'housing finance' is extensive and inclusive and the transaction that does not fall within the contours of the definition has been proposed to be treated as non-housing loans. The Draft Framework further goes a step ahead to clarify that loans provided for furnishing of dwellings, loans given against mortgage of property for any purpose other than buying/ construction of a new dwelling unit/s or renovation of the existing dwelling unit/s, are to be treated as non-housing loans hence, clearly demarcating and restricting the ambit of the definition of the 'housing finance'. Under the NHB Act, there was no definition of housing finance thus leaving scope for ambiguities and arbitrary usage. Thus, clear definition of 'housing finance' will ensure elimination of non-compliant entities and adept interpretation.
'Principal Business' and 'Qualifying Assets' for HFCs
In order to fill the gap created by NHB Act and to make HFCs more coherent with the NBFCs, the definition of 'principal business' applicable for the NBFCs has been proposed to be extended to HFCs. Hence, a company will be treated as an HFC if its financial assets are more than 50% of its total assets (netted off by intangible assets) and income from financial assets is more than 50% of the gross income and both these tests are required to be satisfied as the determinant factor for principal business of an HFC.
RBI clearly lists out 'qualifying assets' in the Draft Framework to remove any ambiguity around what constitutes 'housing finance' and set limits on HFCs exposure to developers and loan against property. Thus, as per the Draft Framework, at least 50 percent of an HFCs net assets (excluding cash, bank balances and money market instruments) should be housing loans and within that at least 75% should be loans extended to the loans to the individuals.
The HFCs which do not fulfil the abovementioned criteria shall be treated as an NBFC - Investment and Credit Companies (NBFC-ICCs) and shall be required to approach RBI for the conversion certificate of registration from HFCs to NBFC-ICC. The same has been proposed to be affected in a phased manner in order to provide breather to those entities not fulfilling the criteria but would like to continue as HFCs in future. The qualifying criteria for real estate lending and individual loans by HFCs will require rebalancing of portfolios of lending by the HFCs not meeting the criteria in the real estate development and project financing. Thus, the RBI proposing a staggered shift (60/70/75 per cent over 2022/2023/2024) towards such rebalancing is a welcome move.
Clear demarcation between systemically and non-systemically important HFCs
At present the HFC regulations are common for all HFCs irrespective of their asset size and ownership. The Draft Framework aims to classify the HFCs as systemically important (asset size of Rs. 500 crore & above) and non-systemically important (asset size less than Rs. 500 crore). In addition, all deposit taking HFCs (HFC-D), irrespective of asset size, will be treated as systemically important HFCs.
Further, as per the Draft Framework, the perpetual debt instruments ("PDI") would be considered as part of Tier 1 and Tier II capital for non-deposit taking systemically important HFCs. Further, PDIs or any other debt capital instrument in the nature of PDIs, already issued by either deposit taking HFCs or non-systemically important HFCs would be reckoned as Tier I or Tier II capital as the case may be for a period not exceeding three years. The Draft Framework also states that since HFCs are treated as a category of NBFCs for regulatory purposes, investments in shares of other HFCs and also in other NBFCs (whether forming part of group or not), shall be reduced from the Tier I capital to the extent it exceeds, in aggregate along with other exposures to group companies, ten per cent of the owned fund of HFC.
This regulatory framework is a new regime which was not present under NHB Act. This specific guideline will provide capital raising options to the non-deposit taking systemically important HFCs for enhanced capital fund requirement for carrying out business and for meeting regulatory requirements.
The systemically important HFCs will be regulated by the existing NHB regulations or harmonised with NBFC regulations, whereas the regulation of the non-systemically important HFCs will be brought on par with relevant regulations for the non-systemically important NBFCs.
The clear demarcation between the systemically and non-systemically important HFCs will ensure that the players having higher asset size are subjected to stricter norms in comparison to those having lower asset size. This step will further ensure financial stability of the HFCs and weeding out of non-compliant or weak HFCs. Also, since deposit taking HFCs have high risk magnitude, they are kept at systemically important category, irrespective of their asset size.
Increased requirement of Minimum Net Owned Fund (NOF)
The Draft Framework proposes to increase the NOF for the HFCs from Rs. 10 crores to Rs. 20 crores in a phased manner where the HFCs are required to reach the limit of Rs. 15 crores within 1 year and Rs. 20 crores in 2 years.
This specific guideline will ensure enhancement of capital base of the HFCs especially of smaller HFCs and companies proposing to seek registration under NHB Act. Further, the minimum requirement of NOF will ensure barrier to entries for weaker players thus safeguarding the interests of the borrowers.
Tighter inter-group lending norms
To address concerns of double financing and conflict of interest in lending and investments in group entities, the Draft Framework seeks to implement stricter norms. As per the Draft Framework, an HFC can either lend to the construction companies within its group or to homebuyers purchasing from the projects of the said construction companies. Further, the Draft Framework states that in the event the HFC takes an exposure in the group entities (lending and investment) of the construction companies, such exposure cannot be more than 15% of owned fund for a single entity (25% for group). It is also proposed that in relation to extending loans to individuals, who choose to buy housing units from entities in the group, the HFC would follow arm's length principles in letter and spirit.
The restriction in double financing will ensure that the collateral provided by the individuals and/or the group construction company is not overlapping, thus facilitating smooth enforcement of security by the HFCs in the event of default either by the individuals or the group companies, as applicable.
In this context, the Draft Framework is grey in the conflict of interest arising out of financial entities other than group companies sponsoring HFCs such as parent holding companies having stakes in the HFCs. Therefore, going forward RBI is required to address such cross-holdings and conflict of interest in the Draft Framework.
Harmonising of rules applicable to NBFCs with HFCs
The RBI vide the Draft Framework has sought to align the liquidity framework and liquidity coverage ratio ("LCR"), securitization, forclosure charges, lending against security of share, monitoring of frauds, information technology framework, outsourcing of financial services, Indian accounting standards as applicable to NBFCs with HFCs. The application of the NBFCs regulations to HFCs are proposed to be carried out in phased manner in order to give enough breathing timeline to HFCs to adopt to the new regulations.
The guidelines applicable to NBFCs for Liquidity Risk framework and LCR are proposed be to extended to all non-deposit taking HFCs with asset size of ₹100 crore & above and all deposit taking HFCs. It shall be the responsibility of the Board to ensure adherence to the guidelines
The directions pertaining to Monitoring of frauds as applicable to NBFCs are proposed to be extended to HFCs in place of present guidelines issued by NHB. These directions cover various aspects pertaining to classification of frauds, monitoring of frauds and reporting to the Board, to the police authorities, RBI, etc. All reports in the formats given in these Master Directions of Monitoring of Frauds may however continue to be forwarded to NHB.
Information Technology (IT) Framework: The IT framework applicable to NBFCs covers IT Governance, IT Policy, Information & Cyber Security, IT Operations, IS Audit, Business Continuity Planning and IT Services Outsourcing. The directions are categorized into two parts, those which are applicable to Systemically and Non-Systemically Important NBFCs. In view of the decision to classify the HFCs into systemically important and non-systemically important entities these instructions have been proposed to apply accordingly.
Securitization: NHB has not prescribed specific guidelines on securitisation for HFCs. Thus, the Draft Framework proposes to bring all HFCs (systemically important and non-systemically important) under the ambit of guidelines on securitisation transaction as applicable to NBFCs.
Lending against shares: Currently, there are no guidelines in place for lending against the security of shares by HFCs. For the sake of uniformity, it is proposed to extend instructions applicable to NBFCs to lend against the collateral of listed shares to all HFCs.
Managing Risks and Code of Conduct in Outsourcing of Financial Services: As no guidelines have been prescribed for HFCs with regard to outsourcing of Financial Services, it has been proposed to extend the guidelines applicable to NBFCs in this regard to all HFCs.
Foreclosure charges: The Draft Framework have also restricted the levying of foreclosure charges/pre-payment penalties, by the HFCs, on any floating rate term loan sanctioned for purposes other than business to individual borrowers with or without co-obligants. This guideline has been proposed to ensure customer protection and uniformity with regard to repayment of various loans by borrowers of banks and NBFCs.
Implementation of Indian Accounting Standards: Instructions issued to NBFCs on Implementation of Indian Accounting Standards has been proposed to be extended to HFCs. Prudential floor for Expected Credit Loss (ECL) shall be based on the extant instruction on provisioning applicable to HFCs.
Since, HFCs are always treated as the subset of NBFCs, harmonization of the regulatory provisions of NBFCs with HFCs will ensure uniform regulatory environment leaving only certain specific features unique to HFCs be governed by specific regulations.
In addition to the above, there exist certain major differences between extant regulations of the HFCs vis-à-vis that for NBFCs which are as follows:
a. Capital requirements (CRAR and risk weights) – The minimum CRAR prescribed for HFCs currently is 12% and which shall be progressively increased to 14% by March 31, 2021 and to 15% by March 31, 2022. Further, the risk weights for assets of HFCs are in the range of 30% to 125% based on asset classification, LTV, type of borrower, etc. However, for NBFCs, the minimum CRAR is 15% and risk weights are broadly under 0%, 20% and 100% categories.
b. Income Recognition, Asset Classification and Provisioning (IRACP) norms – There are major differences in provisioning norms applicable to standard, substandard and doubtful assets in HFCs' books.
c. Norms on concentration of credit / investment – The credit concentration norms for NBFCs and HFCs are similar. However, NBFCs enjoy certain exceptions in this regard.
d. Limits on exposure to Commercial Real Estate (CRE) & Capital Market (CME) – The limits prescribed for HFCs for exposure to CRE by way of investment in land & building shall not be more than 20% of capital fund and for CME shall not be more than 40% of net worth total exposure of which direct exposure should be 20% of net worth. No limits prescribed for NBFCs.
e. Regulations on acceptance of Public Deposits viz., period of public deposit (12 months to 120 months for HFCs against 12 months to 60 months for NBFCs), ceiling on quantum of deposit (3 times of NOF for HFCs against 1.5 times for NBFCs with minimum investment grade rating), interest on premature repayment of deposits (ranging from 1% to 4% below prescribed rate for HFCs as against 2% to 3% below prescribed rate for NBFCs depending upon duration and prescription of rate), maintenance of liquid assets (13% for HFCs against 15% for NBFCs), etc..
The Draft Framework recognises the challenges and gaps faced by the housing finance sector and aims to provide a comprehensive regulatory framework to address the same. Further, it draws over the NBFCs regulations to complement various aspects common in the NBFCs and HFCs. Thus, overall, the Draft Framework is a balanced guideline and is welcome step towards ensuring robust ecosystem for governance of HFCs which was missing in the NHB Act. The only pressing challenge shall be systematic application of the said guidelines in the post pandemic world.
1 Review of extant regulatory framework for Housing Finance Companies (HFCs)-Proposed Changes", Press Release 2019-2020/2510, Reserve Bank of India, June 17, 2020, available at https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=47871
2 "Transfer of Regulation of Housing Finance Companies (HFCs) to Reserve of India", Press Release: 2019-202/419, Reserve Bank of India, August 13, 2019, available at https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=47871
3 The Finance (No. 2) Act, 2019, Ministry of Law and Justice, August 1, 2019, available at http://egazette.nic.in/WriteReadData/2019/209695.pdf
4 Gazette Notification No. DOR.047/CGM (MM)-2019 dated November 19, 2019
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