Chiefs of India’s public sector banks, that account for close to 70% of banking assets, have announced two concessional mortgage schemes to prop up the sagging home loan market.
After growing at about 23% every year between fiscal 2002 and 2006, home loan growth dropped to about 6% each in fiscal 2007 and 2008. In the current fiscal, the mortgage market may remain flat or even shrink as high realty prices and rising interest rates are keeping buyers away.
Though the market has grown significantly since 2002, barring the exception of the past two years, mortgages as a percentage of the gross domestic product, or GDP, are still low in India compared with the developed countries.
Mortgages as a percentage of GDP in India have risen from 3.4% in 2001 to 6% in 2007, but in China, the world’s fastest growing economy, they are now 12% of the country’s GDP. The comparable figure for Korea is 26%, Malaysia 29%, Singapore 32%, Germany 53%, the US 80% and the UK 83%.
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Housing is one of the key areas on which the government is focusing to lift economic growth that’s slowing from an average annual pace of 8.9% in the past four years. Lower interest rates prop up the demand for homes, which in turn, creates demand for steel and cement and generates jobs in the construction sector.
The public sector banks have devised two schemes. They will price all fresh home loans up to Rs5 lakh at 8.5% for the first five years. During this time, if the interest rate drops, they will bring down the rates. Otherwise, the rate will be reset after five years, and it can go up or down, depending on the prevailing rate. The borrowers will also have the freedom to choose to stick to a fixed-rate loan or change to a floating rate. What’s more, there will be no processing charges and no prepayment penalty. Finally, there will be a free life insurance cover for the borrowers.
Interest rate for home loans above Rs5 lakh and up to Rs20 lakh has been fixed at 9.25% for the first five years. All other terms and conditions are similar to that of smaller loans with only one difference. For Rs5 lakh loans, the borrowers will need to chip in 10% on their own but in case of higher loan amount, their contribution will have to be 15%. In other words, if a flat costs Rs5 lakh, the buyer needs to put in Rs50,000 and for flats worth Rs20 lakh, the buyer’s contribution has to be Rs3 lakh.
Even though CEOs of close to a dozen public sector banks attended the press conference in Mumbai to make this announcement, the blueprint for the package was made in Delhi in close consultation with finance ministry bureaucrats. In many ways, the package is significant.
First, it clearly shows that the government is rolling back financial sector reforms. Till a few years back, interest rate only on savings bank accounts and non-resident Indian, or NRI, deposits for liabilities and export credit for assets were regulated. The government had fixed the rate of agriculture loans (at 7%) in 2005 and now it has also regulated home loans. Second, since the discounted rates will be applicable only to new loans, the package discriminates between new and old buyers.
Third, the collective decision by public sector banks smacks of cartelization in violation of an Act that prohibits monopolies and restrictive trade practices.
Fourth, it also repositions the Indian Banks’ Association, or IBA, the national banker lobby, as a body of public sector banks. Even though the CEOs took pains to explain that IBA has nothing to do with this and it is purely an initiative of the public sector banking industry, the fact is IBA, which represents public, private and foreign banks operating in India, was actively involved in giving finer touches to the draft that was written in Delhi.
Finally, such a package will dent the profitability of public sector banks as the cost of funds is much more than the return on home loans. Banks are offering about 10.5% interest on one-year deposits. Taking into account the reserve requirements, the actual cost works out at least 11%. So, the banks will lose 2.5 percentage points on every small loan and 1.75 percentage points on loans up to Rs20 lakh. Besides, no processing fee and prepayment penalty will increase their losses.
Still, why is the government, the majority owner of public sector banks, forcing them to do the harakiri? After all, it earns dividend income if the banks make profits.
The official reason for this is bolstering the sagging economy. But had the general election not been round the corner, the government may not have goaded its banks to offer cheap home loans.
It needs the support of the builders, who traditionally make large donations for election campaigns. These builders are saddled with huge inventories as nobody is buying flats. Since the government cannot force banks to offer cheap loans to builders, it is asking them to cut down the interest rates on mortgages and this will indirectly help the builders to clear their unsold stock.
But this is unlikely to happen as more than the interest rates, it’s the higher price of real estate that has been keeping buyers away. We have already seen a 10-25% correction in property prices across the board, but this is not enough to prop up sales. A cut in interest rate will not dramatically change the scenario. It will merely weaken the public sector banks.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to firstname.lastname@example.org