Om Prakash Bhatt, chairman of State Bank of India (SBI), the nation’s largest lender, seems to be quite disappointed with the Indian central bank’s decision to raise the provisioning requirement for so-called teaser home loans. In its mid-year review of monetary policy, the Reserve Bank of India (RBI) last week raised the provision for standard assets of such loans five fold—from 0.4% to 2%. Higher provisioning will jack up the cost of funds for banks and discourage them from aggressively pushing for teaser loans. According to RBI, such loans impact the quality of assets as chances of defaults by the borrowers are high.
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I am told that at the customary bankers’ meeting with the RBI brass, Bhatt felt it was a personal attack on him and pointed out that the central bank’s nominee on SBI’s board had all along been aware of the product but never objected to it. He also said that such a product, where customers are given a discount in the initial stage, is a special loan scheme and not a teaser loan. I did not have a chance to speak to him on this but watched him on television asserting they are not teaser loans.
Investopedia, a comprehensive investing dictionary on the web, describes teaser loans as “an adjustable-rate mortgage loan in which the borrower pays a very low initial interest rate, which increases after a few years”. It also says, “Teaser loans try to entice borrowers by offering an artificially low rate and small down payments, claiming that borrowers should be able to refinance before the increases occur.” Teaser loans, according to Investopedia, are usually offered to low-income home-buyers. “Unfortunately, when these borrowers try to refinance the loan before the rate increases, most will not qualify for standard mortgages. This leaves borrowers with increased monthly payments, which many cannot afford. This method of loaning is considered risky, as default rates are high.”
State Bank of India’s default rate in home loans, I am told, is around 3%, but that doesn’t affect the balance sheet of the bank as mortgages as a percentage of total assets are very low. Some analysts say special loans could be around Rs 20,000 crore, or 25% of the bank’s total home loan portfolio of Rs 80,000 crore. For Housing Development and Finance Corp. Ltd (HDFC), India’s oldest mortgage firm, the teaser loan portfolio is around 27% of its retail home loans, or Rs 17,500 crore. HDFC’s mortgage book is around Rs 1.06 trillion and retail loans constitute about 68% of it. An estimate by rating agency Crisil Ltd pegs teaser loans at 20-25% of the Indian financial system’s outstanding home loan portfolio of Rs 3.4 trillion in September. HDFC, State Bank of India, ICICI Bank Ltd, LIC Housing Finance Ltd and Axis Bank Ltd account for about 80% of this, and the market has been growing at a compound annual growth rate of 25% in the past five years.
Bhatt, 59, one of the most aggressive bosses that SBI has ever had, introduced this product in the wake of the global credit crunch that followed the collapse of US investment bank Lehman Brothers Holdings Inc. India didn’t have a recession but economic growth slowed for a few quarters and such a product, Bhatt had said, would spur demand for home loans. The teaser loans are offered at 1-1.5 percentage points cheaper than the market rate in the first year. It goes up marginally in the second year and, in the third year, catches up with the prevailing market rate. According to Bhatt, home-buyers don’t find it difficult to repay when the rate goes up as their income level also rises in two years. Apart from giving a boost to demand for home loans, there were a couple of other reasons behind the introduction of such a product. First, SBI wanted to have a larger pie of the mortgage market, and second, this product offered the bank an outlet to earn a relatively better return at a time when it had huge surplus cash and was earning very little by parking money with the regulator daily.
RBI infuses cash into the system through its repo window and absorbs excess liquidity through the reserve repo window. Currently, the repo rate is 6.25% and reserve repo rate 5.25%. When the global credit crunch was at its peak, the reverse repo rate had dropped to 3.25%. Earning 8% on special home loans was always better for SBI than 3.25% even though it barely covered its incremental cost of money as the bank mopped up huge amounts of cash from depositors by offering high rates in the wake of the crisis.
HDFC, initially very critical of SBI’s move, joined the race to stave off any threat to its market share. The origin of such a product in India, however, goes back to October 2003 when ABN Amro Bank NV launched its “All Smiles Home Loans” offering 6% interest for the first year and 6.5% in the second year, irrespective of the amount and maturity of mortgages.
As the average life of a home loan is about 13-14 years, the initial discount is not too big. Banks also make money charging a pre-payment penalty if borrowers find the rate applicable after two years too high and clear the loans. But to earn that, banks must ensure that the borrowers have the capability of servicing the loans. In the developed markets, teaser loans typically target sub-prime borrowers. In their aggression to grab a larger market share, banks should not compromise on the quality of assets. Mortgages make up 7% of India’s gross domestic product and the country has a housing shortage of 24.7 million units. Which means that there is enough scope for banks to make a huge play in the home loan market, even if they were to stick to traditional products where the risk is less.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email your comments to firstname.lastname@example.org