Deepak Mohanty: Perspectives on housing finance in India
Remarks by Mr Deepak Mohanty, Executive Director of the Reserve Bank of India, at the
International Conference on "Housing: an engine for inclusive growth", organised by the
National Housing Bank, New Delhi, 12 April 2013.
* * *
The assistance provided by A.B. Chakraborty, Ravi Shankar, Abhiman Das and Binod B. Bhoi is acknowledged.
I thank Mr R.V. Verma, Chairman and Managing Director, National Housing Bank (NHB) for
the opportunity to be a part of this distinguished panel on "Housing Finance Post Sub-prime".
Housing is a basic necessity. Yet a large number of households do not have access to
decent housing, particularly in a developing country like ours. In view of the importance of
housing, a key element of public policy in many countries has been to encourage house
ownership largely through fiscal incentives and better availability of housing finance. At the
same time, the demand for housing finance has encouraged financial innovations, at times
resulting in financial crisis like the recent one. While development of housing finance in
advanced countries has a long history, the expansion of housing finance by the formal
financial sector in India is of relatively a recent origin. Keeping in view the demand-supply
gap, our favourable demography, increasing urbanisation and better growth prospects, the
demand for housing finance will continue to grow. The challenge, therefore, is expansion of
housing finance to a wider section of the population with the necessary safeguards to
preserve financial stability.
Against this background, I will touch upon the sub-prime crisis in the US with the objective of
distilling the lessons that can be drawn for the development of housing finance. I will then
dwell upon the developments in housing finance in India with a particular reference to banks.
I will also discuss the initiatives taken by the NHB and the Reserve Bank to develop the
statistics on housing finance, particularly house price indices. I will conclude with some
thoughts on developing housing finance on the way forward.
Sub-prime lessons
Globally, developments in housing markets and house prices have drawn considerable
attention in both academic and policy circles in the aftermath of the global financial crisis.
The recent global crisis emanated from the sub-prime segment of the US housing market.
While the crisis has spread and become broad-based across the globe, the post-crisis
recovery has also been predicated on the prospects of the housing sector in many advanced
economies.
As emphasized in the literature, there are different channels through which housing affects
the economy: First, housing wealth constitutes a significant portion of total wealth of
households in the advanced economies. For instance, housing wealth accounted for about
one-half of household net worth in the US and over two-thirds in the euro area. Hence, any
variation in it may have significant impact on households' consumption and thereby
aggregate demand in the economy. Second, housing markets have implications for the
supply side of the economy as labour mobility and employment is affected by the housing
economy. Third, house prices, like any other asset prices being interest rate sensitive, affect
transmission of monetary policy. Finally, boom and bust in house prices have implications for
business cycles and hence financial stability.
Historically, sharp increases in house prices have been followed by sharp declines after the
price bubble bursts. Reinhart and Rogoff (2009) show that the six major historical episodes
of banking crises in the advanced economies since the mid-1970s were all associated with a
housing bust.1 In the decade preceding the sub-prime crisis, not only did the house price
increased substantially, it was also more synchronous across the advanced economies
(Chart 1). Thus, sharp increases in house prices over a prolonged period are often predictive
of crises in the future.
Moreover, the run-up in property prices was also associated with large expansion in credit
leading to a substantial increase in household debt. According to the International Monetary
Fund (IMF), in the advanced economies, the ratio of household debt to income rose by an
average of 39 percentage points to 138 per cent during the 5-year period preceding 2007.2
Cecchetti (2012)3 argues that booms in the prices of assets used as collateral create
procyclicality and property price booms tend to be much worse than equity price booms.
The institutional structure for housing finance and the role of government differ across
countries. It is argued that the key determinants of market depth of housing finance in
advanced economies are greater acceptability of housing as collateral and well defined legal
rights of borrowers and lenders. The mortgage loans are typically long-term, 20-30 years.
But, mortgage interest rates in most cases tend to be linked to short term rates with the
provision for periodic resets. There are exceptions, however, such as the US, where
longterm fixed-rate mortgage even for 30 years is available. Loan to value ratios (LTVs) also vary
widely across countries. Similarly, one can observe significant variation in the degree of
governmental participation in the housing market across the advanced countries and EMEs,
in terms of subsidies and tax benefits as also measures to provide affordable housing
(Chart 2).
Notwithstanding the desirability and beneficial role of housing finance, sharp rise in house
prices coupled with rapid growth in housing credit does raise concerns in the context of
financial stability. Post-crisis it has been argued that central banks should also use
macroprudential tools along with normal interest rate policy to pre-empt excessive rise in house
prices to mitigate risks. The instruments that are generally suggested fall under three broad
categories: capital-based tools such as, countercyclical capital buffers, sectoral capital
requirements and dynamic provisions; liquidity-based tools such as, countercyclical liquidity
requirements and asset-side tools such as, caps on loan-to-value (LTV) and debt-to-income
(DTI) ratios.4
Housing finance in India
Let me now turn to housing in India. As per the Census, during the decade of 2001 to 2011,
while housing stock increased by 51 per cent, number of households has increased by
47 per cent. Notwithstanding recent improvements, urban India in 2012 had an estimated
shortfall of about 19 million houses. Most of the housing shortage is obviously for
economically weaker section (56 per cent) and low income group (39 per cent) people.5
Institutional financing for housing in India is dominated by commercial banks. As on March
2012, outstanding housing loans by banks and housing finance companies was
Rs.6.2 trillion, of which about two-thirds were accounted for by banks.
Overall trend in annual growth of credit of scheduled commercial banks in India indicates that
the share of credit for housing in aggregate credit rose from under 5 per cent in March 2001
to 12 per cent by March 2006. This was facilitated by a number of favourable factors: First,
sustained reduction in inflation resulted in lowering of lending rates. Second, removal of the
restriction of prime lending rate (PLR) as the floor rate for pricing housing loan coupled with
reduction in risk weight from 100 per cent to 50-75 per cent for housing loan to individuals
aided competitive pricing of such loans. Third, the acceleration in GDP growth raised the
demand for housing. Thereafter, the rate of growth in housing credit has moderated.
Consequently, its share in total bank credit has declined gradually to about 8 per cent by
March 2012.
As a percentage of GDP, outstanding housing credit from banks rose from 1.2 per cent in
2001 to a peak of 5.3 per cent in 2006 before moderating to 4.2 per cent by March 2012. The
weighted average lending rate (WALR) on housing loan first declined from 12.8 per cent in
March 2001 to a low of 8.6 per cent in 2006 before rising to 11.1 per cent by March 2012.
Though the interest rate on housing finance has gone up since 2006, it has remained below
the overall weighted average lending rate of banks (Chart 3).
The moderation in growth of housing credit after 2006 could be attributed to the following
factors: First, some slowdown in housing credit growth could be expected after the initial
catch-up phase as the pent up demand is met. Second, GDP growth also moderated
following the global financial crisis which dampened the demand for housing. Third, the
tightening of prudential norms of increasing risk weights to a range of 50-125 per cent,
higher provisioning against standard housing assets and prescription of LTV norms to
mitigate risks could also have led to some moderation.
Notwithstanding tighter prudential standards, direct housing loan of up to Rs. 2.5 million and
indirect bank finance to government agencies for rehabilitation of slum dwellers, and to
housing finance companies (HFCs) for rehabilitation of slum dwellers as well as for
construction of individual dwelling units of up to Rs. 1.0 million are treated as priority sector
loans. Government also allows deduction from income up to Rs.0.1 million per annum for
principal repayment and Rs. 0.15-0.25 million for interest component for income tax
purposes. In addition, there are several specific government schemes for housing for the
underprivileged. While these measures have incentivised house ownership, there is a huge
gap between demand and supply besides affordability. Let me now turn to house prices
which have implications not only for demand but also for financial stability.
House prices
Real estate prices are conceptually somewhat different from the prices of goods and
services. While prices are generally determined by supply and demand, real estate prices
additionally reflect market's expectations of future prices. As experience shows, if
expectations are belied there could be dramatic adjustments in prices raising stability
concerns. Compilation of house price indices is challenging not only because of difficulty of
gathering accurate price data but also due to quality changes in the construction of similar
size of houses even in the same locality. To overcome these challenges, various methods for
measuring house prices such as hedonic prices, repeat sales, median prices and sale price
appraisal ratio have been developed. It is therefore not feasible to construct a single index
that would satisfy all the requirements. The choice of a method therefore is largely influenced
by the ease of regular availability of data and the characteristics of the housing market. For
example, the Case-Shiller index based on repeat sales data is popular in the US. However,
given the predominance of new construction and first time ownership, repeat sales method
may not be suitable in the Indian context.
In India currently, we have two publicly available House Price Indices (HPIs): (i)
NHBResidex compiled on survey based information for 20 cities, and (ii) RBI-HPI based on
registration prices information for 9 cities. The work of compilation of a HPI was initiated by
the Reserve Bank in 2007 beginning with Mumbai city. Subsequently, the coverage has been
extended to eight more cities: Delhi, Chennai, Kolkata, Bengaluru, Lucknow, Ahmadabad,
Jaipur and Kanpur. Apart from data for individual cities, a composite house price index (HPI)
covering these 9 cities with base 2008-09:Q4=100 is currently being disseminated by the
Reserve Bank on a quarterly basis. As per the Reserve Bank's composite HPI, house prices
have nearly doubled since 2008-09 (Chart 4).
Furthermore, the Reserve Bank is also developing a housing asset price monitoring system
covering such details as LTV ratio, EMI to income ratio and price to income ratio based on
housing loan data from select cities collected from select banks and HFCs.
Way forward
Let me now conclude with some thoughts on the way forward. First, besides institutional
finance, self financing from private sources, withdrawals from provident funds and loans from
employers are important sources of housing finance. The available national accounts data on
households' investment in physical assets do not distinguish between pure households and
propriety & partnership concerns. Hence, there is a need to develop a distinct component of
pure households' investment in residential construction for a more comprehensive measure
of contribution of housing to households' net worth.
Second, both the NHB-Residex and RBI-HPI, besides providing a cross-check on house
prices, facilitate a comparison between final market prices and registration prices. The
coverage of the cities needs to be expanded to develop a representative all-India urban
house price index.
Third, in order to enhance the information base of the housing finance market, the Reserve
Bank should place in public domain its detailed database on house price monitoring system.
Fourth, keeping in view the recent moderation in expansion of institutional finance for
housing, an important question is whether securitization would help in expanding housing
finance and also address the problem of procyclicality, thereby stabilizing house prices. As
the US experience with the sub-prime crisis shows, securitization could impart liquidity and
enhance efficiency only when it leads to creation of simple structures easily understood by
market participants and regulators. Given our early stage of development of the mortgage
market, there is scope for housing disintermediation both through more active involvement of
apex refinancing institutions like the NHB and also through development of simple
securitized mortgage products backed by adequate regulatory safeguards.
Fifth, in order to mitigate risks in housing finance, besides application of macro-prudential
regulations, there is a need to develop a fixed rate housing loan product of longer maturity.
Thank you.