Changes for Housing Finance Companies proposed by RBI

Brief Introduction

On August 13, 2019, RBI issued a notification stating that Housing Finance Companies shall now be treated as in the same boat as NBFCs for regulatory purposes and will come under unmediated surveillance.[1]Accordingly, the Finance Act (No. 2) Act, 2019 (23 of 2019) amended the National Housing Bank Act, 1987, diversifying powers of regulation with RBI.[2] This move was in line with Finance Minster’s 2019-2020 budget speech. Furthermore, it was approved that HFCs shall continue to comply with the mandate issued by the National Housing Bank (NHB) till the RBI issued an amended framework and proposed changes for housing finance companies. Moreover, the grievance redressal system of the NHB shall continue to apply to HFCs.

What are Housing Finance Companies[3]?

An HFC is basically a company registered under the Companies Act, 1956 or 2013. It essentially provides finance to housing companies, whether directly or indirectly. An HFC requires registration with the NHB before commencing its business and is accordingly governed under the National Housing Bank Act, 1987. Some well-known examples of HFCs are HDFC Housing Finance Ltd., LIC Housing Finance Ltd., Indiabulls Housing Finance Ltd., etc.

As per Section 29A of the National Housing Bank Act, 1987, no HFC can commence business without obtaining a certificate of registration from NHB issued under Chapter V of the Act. Section 33B grants power to the NHB to wind up an HFC if it commences business without securing a certificate of registration. Furthermore. From April 1, 2014, every entity eager to be registered as an HFC must have a minimum net owned fund of ₹10 crores.

A net owned fund is the aggregate of the paid-up equity capital and free reserves as disclosed in the recent balance sheet after deducting accumulated balance of loss, deferred revenue expenditure, and other intangible assets therefrom.

As per Section 29A (4) an HFC shall have adequate capital structure and earning prospects and shall be in a position to pay its present or future depositors in full whenever their claims accrue. Furthermore, the affairs of an HFC shall not prejudicial to the public interest and the growth and operation of the housing finance sector or detrimental to the interest of its depositors.

The primary difference between banks and HFCs is that the former is regulated by RBI, whereas the latter is regulated by the NHB. An HFC cannot accept demand deposits, cannot issue cheques drawn on itself since they do not form part of the payment and settlement system, and deposit insurance facility and credit guarantee corporation is not available unlike in case of banks.[4]Advantages of taking a loan from an HFC are that they offer a higher loan quantum, are comparatively lenient regarding credit score, and follow an expeditious documentation process.

The NHB is an apex financial institution formed under the National Housing Bank Act, 1987. It was formed with the objective to promote, supervise, and register HFCs at both local and regional levels. Once a wholly-owned subsidiary of the RBI, it is now under the control of the Central Government, following the purchase of complete stake for ₹1,450 crores.[5]

A company which has commenced business before June 12, 2000, can accept public deposits provided they have a net owned fund of ₹25 lakhs and have applied for a certificate of registration before the aforementioned date. However, in case of HFCs carrying on business after June 12, 2000, can accept public deposits provided they have a net owned fund of two crores or more and have a certificate of registration valid to accept deposits. The amount of public deposits depends on the credit rating of HFCs. For e.g. an HFC with a credit rating of ‘A’ can accept deposits of upto five times its net owned fund. The rate of interest after July 6, 2007 has been fixed at 12.5% p/a compoundable at monthly rests.

Uncertainty as to whether HFCs are financial creditors of developers

The process of registration requires a company to submit a physical copy of the application, in duplicate along with other essential documents to the head office of NHB with a demand draft of ₹10,000 in favour of NHB payable at New Delhi. In case of rejection, a company can appeal to the Central Government under Section 29A (7) within 30 days from the order of rejection. NHB can cancel the certificate of registration if it fails to comply with the provisions stated in Section 29A (5).

In Indiabulls Housing Finance Ltd. V. Rudra Buildwell Projects Private Ltd.[6] the NCLAT on May 14, 2019 held that a housing finance lender was not a financial creditor of the developer. Whereas, in Indiabulls Housing Finance Ltd. V. Alpine Realtech Pvt. Ltd.[7] the NCLT on June 12, 2019 held that a housing finance lender is a financial creditor of the developer entity.[8] In view of this ambiguity, the NHB issued a circular[9] on July 19, 2019 advising HFCs to desist from offering loan products involving servicing of the loans dues by builder/developers etc. on behalf of the borrowers.

What are NBFCs?

Recently the RBI warned NBFCs against non-transparency in digital transactions and violation of extant guidelines on outsourcing of financial services and fair practices code.[10] As per section 45-I (c) of the RBI Act, 1934, an NBFC is a company incorporated under the Companies Act, 1956 or 2013 carrying on the business of financial institution. Such institution must be engaged in the business of loans and advances, acquisitions of stocks, equities, debts, etc., issued by the government, local authority or other marketable securities but does not include institutions whose principal business is agricultural activity, industrial activity, sale/purchase/construction of any immovable property, etc. Some well-known NBFCs are Shriram Transport Finance Company Ltd, Bajaj Finance Ltd., Muthoot Finance Ltd., etc.

NBFCs are governed by the RBI and categorised into types on the basis of liabilities, such as asset finance company, investment company, loan company, etc. The Draft Framework, NBFCs like HFCs were not required to be registered with RBI. An NBFC shall have a minimum net owned fund of two crores with an unblemished credit score and 1/3rd of its directors possessing financial experience. Such credit rating has to be taken every 6 months and be submitted to the RBI. An NBFC cannot receive deposits which are payable on demand and the time limit for public deposits should be for a minimum of 12 months and a maximum of 60 months with an interest rate prescribed by the RBI. A minimal of 15% of the public deposits have to be maintained in liquid assets. Furthermore, every NBFC having a public deposit of ₹20 crores and above or has assets worth ₹100 crores and above has to file a half-yearly asset-liability management return.[11]

Draft Framework

The Draft Framework is a welcomed step to keep in cheek unscrupulous HFCs and clean up the real estate sector.[12]The main contention has been regulatory arbitrage, with the collapse of Infrastructure Leasing and Financial Services and allegations of fraud at Dewan Housing and Finance ltd., HFCs will be under the strict scrutiny of RBI. RBI even proposed that HFCs can either undertake an exposure on the group company in real estate business, or lend to individual retail homebuyers, but cannot do both.[13] Subsequent to the proposed changes, shares of most NBFCs surged dramatically.[14]

The preamble of the draft has proposed changes in the following areas:

1. Defining principal business and qualifying assets for HFCs,
2. Defining the phrase ‘providing finance for housing’ or ‘housing finance,
3. Classifying HFCs as systemically important (asset size of ₹500 crores and above) and non-systemically important (asset size less than ₹500 crore), and
4. RBI’s direction on liquidity risk framework, liquidity coverage ratio, and securitisation, for NBFCs, to be made applicable to HFCs

Some of the highlights of the draft are stated hereunder

1. Coherent definition of housing finance[15]: The term ‘housing finance’ or ‘providing finance has been more extensive and inclusive. It has been defined as ‘financing’, for purchase/construction/ reconstruction/renovation/repairs of residential dwelling units, which includes loans to individuals or group of individuals including co-operative societies, corporates, government agencies, educational, health, social, etc. which are part of housing project in the same complex and which are necessary for the development of settlements or townships and builders amongst other for specified activities. Likewise, any activity which does not fall within the aforementioned criteria shall be treated as non-housing loans.

Furthermore, the draft seeks to clarify the loans given against mortgage of property, loans provided for furnishing of dwellings, etc. The scope of housing finance for individuals includes loans for construction/purchase of new dwelling units, old dwellings by mortgaging existing dwelling units. Hence, builders can now avail loan for the construction of residential dwelling units.

This is an accepted step as there was no definition of housing finance in the National Housing Bank Act, 1987. This led to its arbitrary and immoral usage violating the ethical bond between a builder and a humble seekers of a residential house. This will help detect and snare fraudsters.

1. Definition of ‘principal business’ and list of qualifying assets extended to HFCs[16]: The definition of ‘principal business’ has been extended to HFCs. This means that an HFC is now proposed to fulfil the 50-50 test, i.e. an entity will be treated as an HFC if its financial assets are more than 50% of its total assets and 50% of its total assets and income from financial assets is more than 50% of the gross income. Both tests are essential to be classified as principal business.

Furthermore, the draft precisely states the qualifying assets to remove any vagueness. Hence, at least 50% of the HFCs net assets should be housing loans within which at least 75% should be loans extended to individuals. For HFCs who do not fulfil the twin canons shall be treated as NBFC – Investment and Credit Companies (NBFC-ICCs) and will have to apply to RBI for a certificate of conversion accordingly.

1. Revision in governing law: HFCs were earlier granted exemption from provisions of Chapter IIIB of the RBI Act, 1934 vide notification dated June 18, 1997, by exercising powers under Section 45NC of the RBI Act, 1934. Consequent to the transfer of regulation from NHB to RBI, the earlier exemptions are dissolved, hence, Chapter IIIB of the RBI Act, 1934 will be applicable to HFCs. Therefore, all HFCs are required to get a certificate of registration from RBI just like NBFCs. However, existing HFCs shall continue to be valid.
2. Distinction and delineation between systemically and non-systemically important HFCs:There is currently no demarcation between HFCs on the basis of their asset size or ownership. The draft seeks to classify HFCs with asset size of ₹500 crores and more and all deposit-taking HFCs (HFC-D) regardless of assets size to be considered as systemically important HFCs. Likewise, HFCs with asset size less than ₹500 crores shall be considered as non-systemically important.

Meanwhile, other NBFCs shall be treated under regulations existing under NHB in consonance with NBFC regulations. This will be done as per the master direction issued by RBI for NBFC and non-systemically NBFC-ND-non-SI as updated on February 17, 2020.

Furthermore, the perpetual debt instruments (PDI) will be considered as part of Tier I and Tier II capital for non-deposit taking systemically important HFCs. Moreover, any such instrument already issued shall be reckoned as Tier I or Tier II capital for a period not exceeding 3 years. This will facilitate non-deposit systemically important HFCs in raising capital. The divergence will aid in surveillance over HFCs will greater asset size.

• Increase in net owned fund requirements:The draft seeks to increase the net owned fund requirement for HFCs from ₹10 crores to ₹20 crores. RBI intends to do so gradually in a phased manner, where HFCs are mandated to reach the limit of ₹15 crores within one year and ₹20 crores in two years.
• Restrictions on double financing[17]: The draft endeavours to stall double financing and conflict of interests in lending in group entities. Accordingly, an HFC can either lend to the construction companies within its group or to individual homebuyers purchasing retail homes from the projects of construction companies.

Furthermore, if an HFC seeks to take any exposure in its group entities, either lending or investment, directly or indirectly, such exposure cannot be more than 15% of owned fund for a single entity in the group and 25% of the owned fund for all such group entities. Moreover, the arm’s length principles shall apply to individuals who decide to buy housing units from entities in the group.

This will ensure that the ancillaries provided by individuals or group entities are not overlapping.[18]

• Overseeing and scanning for frauds: The master direction on monitoring of frauds in NBFCs (Reserve Bank) directions, 2016[19] covers classification and monitoring of frauds in addition to reporting the same to the board, police, RBI, etc. The draft seeks to extend the same to HFCs with asset size of ₹100 crores and more and all deposit-taking HFCs. However, all reports as prescribed in the formats spelt out in the master directions may continue to be forwarded to NHB.
• Information technology framework: The master direction on information technology for all NBFCs (with asset size above ₹500 crores – systemically important, and with assets size below ₹500 cores, 2017[20] covers governance, policy, operations, audit, outsourcing, etc. in the field of information technology in addition to cyber security. These directions are categorised into two parts, one which applies to systemically NBFCs and the other which applies to non-systemically NBFCs. In consequence to the withdrawal of the circular dated June 15, 2018[21], the aforementioned directions are now proposed to be made applicable to HFCs.
• Restriction on foreclosure charges: The draft has proposed to extend the restriction of levying of foreclosure charges/pre-payment penalties, by the HFCs, on any floating rate term sanctioned for purposes other than business to individual borrowers with or without co-obligants. This is a progressive measure which will expedite customer protection and bring uniformity with regard to the repayment of various loans by borrowers of banks and NBFCs.
• Securitisation: The NHB currently has no security guidelines on securitisation for HFCs. Thus, the draft seeks to bring all HFCs (systemically important and non-systemically) will fall under the ambit of guidelines of securitisation transaction as applicable to NBFCs contained in Annex XXII to master directions – NBFC – systemically important non-deposit taking company and deposit taking company (Reserve Bank) directions, 2016.[22]
• Lending against shares: The draft seeks to extend instructions applicable to NBFCs to lend against the collateral of listed shares to all HFCs to ensure uniformity. This means that HFCs will be required to maintain at all times a loan to value ratio of 50%. In cases where lending is being carried on for investment in capital markets, they can only accept Group 1 securities as collaterals for loans above ₹5 lakhs.
• Uniformity in regularity –implementation of Indian Accounting Standards: The draft seeks to extend Indian Accounting Standards to HFCs just like NBFCs. The prudential floor for expected credit loss shall be based on the extant instructions applicable to HFCs. This will ensure uniformness in regulation.

RBI endeavours to bring HFCs at par with NBFCs. However, both are still different in various fields such as Capital to Risk Asset Ratio (CRAR) and risk weights and Income Recognition, Asset Classification and Provisioning (IRACP) norms. Furthermore, credit concentration norms for both are alike.

However, NBFC-IFCs are an exception as they can exceed the concentration of credit by 10% of its owned fund in lending to a single borrower. Moreover, HFCs can invest in land and buildings in commercial real estate upto 20% of its capital fund.

The proposed draft aims to bring clarity to the regulatory framework reduce regulatory arbitrage prevalent in the HFC industry owing to the absence of coherent definitions. It brings HFCs into the same boat as NBFCs and under the scrutiny of RBI. This will ensure stricter compliance. RBI had sought public comments and responses over the mail of HFCs, market participants and stakeholders on the draft for cogitation and consideration before issuing the final guidelines. Unfortunately, the date for public contemplation has passed since the final date was July 15, 2020.[23]

Conclusion

As per the latest ICRA ratings, the asset quality of HFCs is going to worsen going forward. The gross NPAs in the housing segment is estimated to increase 2.5-3% in the financial year 2021 from an estimate of 1.7% as of March 2020.[24]

Recently, RBI has stated that the government has approved a scheme under which eligible non-bank lenders will be provided short-term liquidity through special purpose vehicle (SPV). Under the scheme, the SPV will purchase short-term papers from eligible NBFCs & HFCs which will subsequently utilise the proceeds solely for extinguishing existing liabilities. However, to avail the scheme, such company should not have its net NPAs more than 6% as of March 31, 2019, and must have made a net profit in at least of the last preceding two years, either 2017-18 or 2019-19.[25] The draft is a welcomed move as the housing and real estate comes second to agriculture in terms of employment. With stricter compliance and a contemporary framework, the industry can pick up again.

Also read Sahara Real Estate Corporation Limited and Others v. Securities Exchange Board of India and Anr

[1] Housing finance companies to be treated as NBFCs; come under RBI oversight, BUSINESS STANDARD available at https://www.business-standard.com/article/economy-policy/housing-finance-companies-to-be-treated-as-nbfcs-come-under-rbi-oversight-119081301585_1.html (Accessed on 18/07/2020)

[2] Housing finance companies to be treated as NBFCs: RBI, ECONOMIC TIMES available at https://realty.economictimes.indiatimes.com/news/allied-industries/housing-finance-companies-to-be-treated-as-nbfcs-rbi/70668354 (Accessed on 18/07/2020)

[3] FAQ, National Housing Bank available at https://test.nhb.org.in/FAQs/FAQs.php#:~:text=A%20Housing%20Finance%20Company%20is,housing%2C%20whether%20directly%20or%20indirectly. (Accessed on 18/07/2020)

[4] Housing Finance Company Registration, EFILING INDIA available at https://efilingindia.in/Efiling/Housing-Finance-Company-Registration (Accessed on 18/07/2020)

[5] This housing bank, once owned by RBI, is now govt owned entity; here’s why, FINANCIAL EXPRESS available at https://www.financialexpress.com/industry/banking-finance/this-housing-bank-once-owned-by-rbi-is-now-govt-owned-entity-heres-why/1565008/ (Accessed on 19/07/2020)

[6] Indiabulls Housing Finance Ltd. V. Rudra Buildwell Projects Private Ltd. Company Appeal (AT) (Insolvency) No. 172 of 2019

[7]Supra

[8] Manisha Parnjape & Bharati Shah, Are Housing Finance Lenders ‘Financial Creditors’ Of Developers Under Subvention Schemes: An Update available at https://www.mondaq.com/india/fund-management-reits/848270/are-housing-finance-lenders-financial-creditors39-of-developers-under-subvention-schemes-an-update (Accessed on 19/07/2020)

[9] NHB/ND/DRS/ Policy Circular No.96/2019-20 available at https://nhb.org.in/wp-content/uploads/2019/07/NHBND-DRS-Policy-Circular-96-2019-20.pdf (Accessed on 19/07/2020)

[10] RBI warns banks, NBFCs on lack of transparency in digital transactions, INDIAN EXPRESS, available at https://indianexpress.com/article/business/banking-and-finance/rbi-warns-banks-nbfcs-on-lack-of-transparency-in-digital-transactions-6475098/ (Accessed on 19/07/2020)

[11] NBFC: Non-banking Financial Corporations, CLEARTAX available at https://cleartax.in/s/non-banking-financial-company-nbfc (Accessed on 19/07/2020)

[12] NR Bhusnurmath, RBI reins in housing finance companies… at last! Will help real estate clean-up process, FINANCIAL EXPRESS available at https://www.financialexpress.com/industry/banking-finance/rbis-new-norms-for-hfcs-will-reign-in-unscrupulous-entities-and-clean-up-real-estate-sector/1997820/ (Accessed on 19/07/2020)

[13] After DHFL fallout, RBI proposed housing finance companies to give loans to homebuyers, FINANCIAL EXPRESS available at https://www.financialexpress.com/industry/banking-finance/rbi-releases-new-directions-for-housing-finance-companies/1994907/ (Accessed on 19/07/2020)

[14] Kshitij Bhargava, PNB Housing shares jump, HDFC flat after RBI mulls telling home loan firms to actually give home loans, FINANCIAL EXPRESS available at https://www.financialexpress.com/market/pnb-housing-finance-hdfc-lic-housing-shares-rbi-home-laons-by-nbfc/1997039/ (Accessed on 19/07/2020)

[15] Subramanian Natarajan, Regulatory framework for Housing Finance Companies (HFCs)- Proposed RBI guidelines available at https://taxguru.in/rbi/regulatory-framework-housing-finance-companies-hfcs-proposed-rbi-guidelines.html (Accessed on 19/07/2020)

[16] Abir Lal Dey, A Stringent Regime For Housing Finance Companies Proposed By Reserve Bank of India: Brief Analysis And Key Comments, MONDA available at https://www.mondaq.com/india/financial-services/961500/a-stringent-regime-for-housing-finance-companies-proposed-by-reserve-bank-of-india-brief-analysis-and-key-comments (Accessed on 19/07/2020)

[17] Leena Chacko & Shweta Sharma, Housing Finance Companies – Prposed changes by RBI, CYRIL AMARCHAND MANGALDAS available at https://corporate.cyrilamarchandblogs.com/2020/07/housing-finance-companies-proposed-changes-by-rbi/ (Accessed on 19/07/2020)

[18]RBI to tighten rules for home finance firms available at https://www.thehindu.com/business/Industry/rbi-to-tighten-rules-for-home-finance firms/article31854231.ece#:~:text=Double%20financing&text=Further%2C%20the%20RBI%20said%20if,for%20all%20such%20group%20entities.(Accessed on 14/08/2020)

[19] Master Direction – Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016, RBI avialble at https://rbidocs.rbi.org.in/rdocs/notification/PDFs/MD49F29092016392149B3597145A1ACADCF520A1D1A97.PDF (Accessed on 19/07/2020)

[20] Master Direction – Information Technology Framework for the NBFC Sector, RBI available at https://rbidocs.rbi.org.in/rdocs/notification/PDFs/MD53E0706201769D6B56245D7457395560CFE72517E0C.PDF (Accessed on 19/07/2020)

[21] Information Technology Framework for HFCs, NHB available https://nhb.org.in/wp-content/uploads/2018/06/NHBND-DRS-Policy-Circular-90-2017-18.pdf (Accessed on 19/07/2020)

[22] Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016, RBI available at https://rbidocs.rbi.org.in/rdocs/notification/PDFs/45MD01092016B52D6E12D49F411DB63F67F2344A4E09.PDF (Accessed on 19/07/2020)

[23] Gayatri Subramanian, Legal News Bulletin, MONDAQ available at https://www.mondaq.com/india/securities/960378/legal-news-bulletin–the-reserve-bank-of-india-rbi-has-proposed-changes-in-the-regulations-applicable-to-the-housing-finance-companies-hfcs-for-public-comments (Accessed on 19/07/2020)

[24] Asset quality of housing finance companies to worsen: ICRA, ET REALTY available at https://realty.economictimes.indiatimes.com/news/allied-industries/asset-quality-of-housing-finance-companies-to-worsen-icra/76656130 (Accessed on 19/07/2020)

[25] Government approves scheme for providing liquidity to HFCs: RBI, ET REALTY available at https://realty.economictimes.indiatimes.com/news/allied-industries/government-approves-scheme-for-providing-liquidity-to-hfcs-rbi/76738535 (Accessed on 19/07/2020)