The housing sector is considered a critical contributor to economic growth because of its ability to generate demand in multiple industries (such as the core industries of steel and cement, or companies selling tiles, plumbing or electrical fittings), provide both direct and indirect employment and generate income for service sectors (such as architecture). Finance is a key lubricant for the sector, both for builders and buyers. Like other financial activities, housing finance too is subject to risks and has natural circuit breakers. Any attempt to subvert these inevitably causes the system to overheat, trip up, and leave in its wake a bruised and sometimes broken industry. Recovery takes a long time and invariably inflicts pain across different classes of economic agents. The Indian housing finance sector is still in a gloomy phase of the cycle, except there is no clarity whether a downturn has just begun or whether the worst is behind us. The twin problems of excess borrowing and indiscriminate lending, with scant regard for risk, have led to widespread heartburn. The balance sheets of numerous housing finance companies (HFCs) are littered with the carcasses of defunct housing projects and gaping holes left behind by bankrupt builders. Judging from the recent stock performance of a few leading HFCs, it would seem a recovery is imminent, but that would be premature, given the stock market’s twitchy propensities. Another indicator could perhaps be the new set of prudential norms announced by the National Housing Bank (NHB), the regulator. These draft guidelines, which mandate higher capital adequacy norms (rising by one percentage point every year to 15% by 2022) and lower borrowing limits (12 times the net funds owned by 2022) for HFCs, might create an illusion that the worst is over and it’s time for crucial repairs.
Nothing could be more misleading. Some leading HFCs have indeed repaired their balance sheets, brought in fresh equity and rebalanced their operations. However, their numbers are limited. The basic problem is the NHB’s liberal regulatory regime, which allowed HFCs to enter with very low equity but simultaneously let them raise loans worth 16 times their net funds. Such low entry norms drew all kinds of companies into the housing finance business with very little of their own money but with free access to public resources. This created perverse incentives for risky business practices. Many HFCs were in it for a valuation kick. Show abnormal asset growth and then sell out, risk be damned. At last count, there were more than 80 HFCs in the country. In addition, the NHB’s lax regulatory oversight, especially its inability to heed warning lights when HFCs were borrowing short to fund long-term assets, gives rise to doubts about the regulator’s distance from the regulated. It is also hard to believe that the NHB, as a subsidiary of the Reserve Bank of India, could be so oblivious to the systemic risk entailed. There is still time to make good. Apart from tighter regulatory norms, the NHB should also re-examine the minimum equity norms for HFCs. Higher capital adequacy requirements and lower overall borrowing limits will force HFCs to slow down their asset build-up. But India still needs finance for housing activity on both sides of the fence. Increasing the minimum share capital needed for operations will force many HFC promoters to bring in fresh funds, which would not only replenish balance sheets for future growth, but also eliminate any bugs that might be hiding undetected in the books of HFCs.