RBI’s Proposed changes to Regulatory Framework applicable to ‘Housing Finance Companies’ HFCs

The Central Government had, with effect from 9^th August 2019, transferred regulatory powers of the Housing Finance Companies (HFCs) from the National Housing Bank (NHB) to the Reserve Bank of India (RBI). Subsequently Reserve Bank of India has now placed a draft of the changes proposed in the regulations applicable to HFCs. “RBI has undertaken the said review and has identified a few changes which are proposed to be prescribed for HFCs,” the central bank said on June 18, 2020.

A review of the extant directions/ guidelines applicable to HFCs has been carried out with a view to regulating HFCs as a category of Non-Banking Financial Company (NBFC). Accordingly, in areas where the extant regulation of HFCs are in tandem with that of NBFCs, the relevant paras in the NBFC Master Directions would be made applicable mutatis mutandis to HFCs. In areas where extant HFC regulation differs from that of NBFCs, either existing provisions would be retained, or changes would be brought out wherever possible while ensuring that the changes are made in a least disruptive manner.

Given below are the major changes envisaged in the regulatory framework for HFCs:

1. Applicable law for the regulation of HFCs:

Companies intending to function as HFCs shall seek registration with the Reserve Bank under Section 29A of NHB Act, 1987 and existing HFCs holding Certificate of Registration issued by NHB need not approach RBI for fresh CoR.

2. Defining the term ‘Providing Finance for Housing’ or ‘Housing Finance’

It is observed that the term ‘providing finance for housing’ or ‘housing finance’ is not formally defined. However, in general parlance, it can be treated as providing finance for residential housing purposes and should ideally not include finance for non-residential purposes like commercial real estate, etc. for this purpose, the meaning of the term housing finance as indicated for various purposes in circulars issued by RBI, NHB and also under the Income Tax Act 1961 was examined. It is proposed to have an inclusive definition of the terms ‘providing finance for housing’ or ‘housing finance’ as per provisions of RBI’s master circular on housing finance addressed to banks and NHB’s illustrative list of housing loans. Accordingly, ‘Housing Finance” or “providing finance for housing” means:

Financing, for purchase/ construction/ reconstruction/ renovation/ repairs of residential dwelling units, which includes:

1. Loans to individuals for purchase of old dwelling units.
2. Loans to individuals for purchasing old/ new dwelling units by mortgaging existing dwelling units.
3. Loans to individuals for purchase of plots for construction of residential dwelling units provided a declaration is obtained from the borrower that he intends to construct a house on the plot within a period of three years from the date of availing of the loan.
4. Loans to individuals for renovation/ reconstruction of existing dwelling units.
5. Lending to public agencies including state housing boards for construction of residential dwelling units.
6. Loans to corporate/ Government agencies (through loans for employee housing).
7. Loans for construction of educational, health, social, cultural or other institutions/ centre, which are part of housing project in the same complex and which are necessary for the development of settlements or townships.
8. Loans for construction of houses and related infrastructure within the same area, meant for improving the conditions in slum areas for which credit may be extended directly to the slum-dwellers on the guarantee of the Government, or indirectly to them through the State Governments.
9. Loans given for slum improvement schemes to be implemented by Slum Clearance Boards and other public agencies.
10. Lending to builders for construction of residential dwelling units.

All other loans including those given for furnishing dwelling units, loans given against mortgage of property for any purpose other than buying/ construction of a new dwelling unit/s or renovation of the existing dwelling unit/s, will be treated as non-housing loans.

3. HFC is required to have a ‘Principal Business’ of providing housing finance.

Term ‘Principal Business’ is not defined under the NHB Act.  RBI now proposes to define and extend the definition of ‘Principal Business’ similar to that used for Non-Banking Financial Companies (NBFCs).

The RBI has defined the term through its press release dated April 08, 1999 saying that a company:

1. Required to have financial assets more than 50% of its total assets (netted off by intangible assets); and
2. Its income from such financial assets should be more than 50% of the gross income. It is imperative that both the above mentioned conditions are satisfied in order to determine the constituents of ‘Principal Business’

4. Along with the “Principal Business” as defined above, it is also required to have “Qualifying Assets”

‘Qualifying Assets’ refers to ‘housing finance’ or ‘providing finance for housing’ and will be subject to the following:

1. Qualifying assets should not be less than 50% of Net assets, out of which at least 75% should be utilized towards individual housing loans which are loans as stated above under the definition of “housing finance” or “providing finance for housing”.
2. “Net assets” means total assets other than cash and bank balances and money market instruments.

Such HFCs which do not fulfil the above criteria will be treated as NBFC – Investment and Credit Companies (NBFC-ICCs) and will be required to approach RBI for conversion of their Certificate of Registration from HFCs to NBFC-ICC. However, a phased timeline will be given to HFCs which do not currently fulfill the qualifying assets criteria, but wish to continue as HFCs in future. The timeline shall be phased as under:

5. Classifying HFCs into ‘Systemically Important’ and ‘Non – Systemically Important’ entities for regulatory purposes

Presently HFC regulations are common for all HFCs irrespective of their asset size and ownership. It is proposed to issue HFC regulations by classifying them as;

1. Systemically Important
2. Non-systemically Important

This is to introduce a graded approach as applicable to NBFCs in general.

• Systemically Important HFCs (HFC – SI)
• Non – Deposit taking HFCs (HFC – NDSI) with asset size of ₹500 crore & above;
• All deposit taking HFCs (HFC – D), irrespective of asset size,
• Non-systemically Important HFCs (HFC – non – SI)
• HFCs with asset size below ₹500 crore

While the regulations for HFC-NDSI & HFC-Ds will be as existing under NHB regulations or harmonized with NBFC regulations, the regulations for HFC-non-SI (i.e., HFCs with asset size below ₹500 crore) will be brought on par with relevant regulations for NBFC-ND-non-SI.

6. Minimum Net Owned Fund (NOF) requirement of Rs. 20 crore

RBI also proposed to double the minimum net owned fund (NOF) requirement for housing finance companies to Rs 20 crore. The step is aimed at strengthening the capital base mainly of small housing finance companies (HFC) and companies proposing to seek registration under NHB Act. The existing HFCs would be provided with a glide path to achieve minimum Net Owned Fund (NOF) of Rs 20 crore. They will be required to reach Rs 15 crore within one year and Rs 20 crore within two years.

7. Harmonizing definitions of Capital (Tier I & Tier II) with that of NBFCs

The components of Tier I and Tier II capital are similar for NBFCs and HFCs except for the treatment of perpetual debt instruments (PDI). Presently PDIs are not considered as part of capital of HFCs unlike that of NBFCs. It is proposed to align the definitions of capital (both Tier I and Tier II) of HFCs with that of NBFCs.

1. Inclusion of PDIs as a component of Tier I and Tier II capital on the lines of NBFCs.
2. PDIs can be treated as part of Tier I / Tier II capital only by non-deposit taking systemically important HFCs.
3. PDIs or any other debt capital instrument in the nature of PDIs, already issued by either deposit taking HFCs or non-systemically important HFCs will be reckoned as Tier I or Tier II capital as the case may be for a period not exceeding three years.

Since HFCs are treated as a category of NBFCs for regulatory purposes, investments in shares of other HFCs and also in other NBFCs (whether forming part of group or not), shall be reduced from the Tier I capital to the extent it exceeds, in aggregate along with other exposures to group companies, ten per cent of the owned fund of HFC.

8. Public Deposits

There is a restriction under the HFCs (NHB) Direction 2010 dated July 01, 2019 (NHB Directions) in relation to the acceptance of public deposits. The term ‘Public Deposits’ has been defined under such directions which is similar to the definition given under the RBI Master Direction on ‘Acceptance of Public Deposits’ dated August 25, 2016 (updated as on February 22, 2019) (“Master Directions on Acceptance of Public Deposits”), except that as per the definition in NHB directions, any amount received from NHB or any public housing agency are also exempt from the definition of ‘Public Deposit’. For the purposes of aligning the regulations of HFCs with NBFCs, RBI now proposes to align the definition of ‘Public Deposits’ with the Master Directions on Acceptance of Public Deposits with an addition of exception that any amount received by HFCs from NHB or any public housing agency will also be exempt from the definition of ‘Public Deposit’.

9. Group entities engaged in ‘Real Estate Business’

In order to address concerns on double financing due to lending to construction companies in the group and also to individuals purchasing flats from the latter, the HFC concerned may choose to lend only at one level. That is, the HFC can either undertake an exposure on the group company in real estate business or lend to retail individual home buyers in the projects of group entities, but cannot do both. If the HFC decides to take any exposure in its group entities (lending and investment) directly or indirectly, such exposure cannot be more than 15% of owned fund for a single entity in the group and 25% of owned fund for all such group entities. As regards extending loans to individuals, who choose to buy housing units from entities in the group, the HFC would follow arm’s length principles in letter and spirit.

10. Monitoring of frauds

All instructions to NBFCs with regard to monitoring of frauds are covered in the Master Direction – Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016. These directions cover various aspects pertaining to classification of frauds, monitoring of frauds and reporting to the Board, to the police authorities, RBI, etc. With a view to harmonizing all instructions pertaining to fraud monitoring, it is proposed to make these directions applicable to HFCs in place of present guidelines issued by NHB. All reports in the formats given in these Master Directions of Monitoring of Frauds may however continue to be forwarded to NHB, New Delhi as being done hitherto.

11. Information Technology Framework

The master direction on Information Technology (IT) Framework for all NBFCs (with asset size above Rs500 crore (systemically important) and NBFCs with asset size below Rs 500 crore) dated June 08, 2017, covers IT Governance, IT Policy, Information & Cyber Security, IT Operations, IS Audit, Business Continuity Planning and IT Services Outsourcing. These directions are now proposed to be made applicable to HFCs and consequently the Information Technology Framework issued by NHB vide circular dated June 15, 2018 is now proposed to be withdrawn.

12. Securitization

NHB has not prescribed specific guidelines on securitization. It is proposed to bring all HFCs (systemically important and non-systemically important) under the ambit of guidelines on securitization transaction as applicable to NBFCs.

13. Lending against shares

Currently, there are no guidelines in place for lending against the security of shares by HFCs. For the sake of uniformity, it is proposed to extend instructions applicable to NBFCs to lend against the collateral of listed shares.

14. Foreclosure charges

As a measure of customer protection and also in order to bring in uniformity with regard to repayment of various loans by borrowers of banks and NBFCs, no foreclosure charges/ pre-payment penalties shall be levied on any floating rate term loan sanctioned for purposes other than business to individual borrowers with or without co-obligants. Since similar regulations are currently not prescribed for HFCs, it is proposed to extend these instructions to HFCs.

15. Implementation of Indian Accounting Standards

Instructions issued to NBFCs on Implementation of Indian Accounting Standards will be extended to HFCs. Prudential floor for Expected Credit Loss (ECL) will be based on the extant instruction on provisioning applicable to HFCs.

In addition to the above, there exist certain major differences between extant regulations of the HFCs vis-à-vis that for NBFCs which are listed below and the harmonization of same shall be carried out in a phased manner over a period of two to three years, until such time, the HFCs shall continue to follow the extant norms.

Capital requirements (CRAR and risk weights)– The minimum CRAR prescribed for HFCs currently is 12% and which will be progressively increased to 14% by March 31, 2021 and to 15% by March 31, 2022. Further, the risk weights for assets of HFCs are in the range of 30% to 125% based on asset classification, LTV, type of borrower, etc. However, for NBFCs, the minimum CRAR is 15% and risk weights are broadly under 0%, 20% and 100% categories.

Income Recognition, Asset Classification and Provisioning (IRACP) norms– There are major differences in provisioning norms applicable to standard, substandard and doubtful assets in HFCs’ books.

Norms on concentration of credit / investment– The credit concentration norms for NBFCs and HFCs are similar. However, NBFCs enjoy certain exceptions in this regard.

Limits on exposure to Commercial Real Estate (CRE) & Capital Market (CME)– The limits prescribed for HFCs for exposure to CRE by way of investment in land & building shall not be more than 20% of capital fund and for CME shall not be more than 40% of net worth total exposure of which direct exposure should be 20% of net worth. No limits prescribed for NBFCs.

Regulations on acceptance of Public Deposits, period of public deposit (12 months to 120 months for HFCs against 12 months to 60 months for NBFCs), ceiling on quantum of deposit (3 times of NOF for HFCs against 1.5 times for NBFCs with minimum investment grade rating), interest on premature repayment of deposits (ranging from 1% to 4% below prescribed rate for HFCs as against 2% to 3% below prescribed rate for NBFCs depending upon duration and prescription of rate), maintenance of liquid assets (13% for HFCs against 15% for NBFCs), etc.

In brief, below is the list of major changes proposed in the ‘draft guidelines’

• Classifying HFCs as systemically important (asset size of Rs 500 crore and above) and non-systemically important (asset size less than Rs 500 crore).
• Directions on Liquidity Risk framework and LCR, securitization, etc., for non-banking finance companies (NBFCs), to be made applicable to HFCs.
• To address double lending, the revisions propose HFCs can either take exposure on the group company in real estate business or lend to an individual, retail homebuyers in group entity projects.
• For loans to individual buyers who choose to buy housing units from entities in the group, the HFC would follow arm’s length principles in letter and spirit.
• HFCs exposures, whether in terms of lending and investment cannot exceed 15 percent of the owned funds in a single entity in the group and 25 percent of owned funds for all such group entities.
• The change in the definition of housing finance brings loans to builders for construction of residential dwelling units, schools and hospitals within its purview while excluding loans against the property from it.
• HFCs will also be required to have a minimum 50 percent of net assets as “housing finance”. A four-year timeline for individual loan portfolio has also been proposed, of which at least 75 percent must be housing finance. These conditions if not met would lead to the HFC being categorized as an NBFC – Investment and Credit Companies (NBFC-ICCs).
• Existing home loan lenders will be required to double their minimum net owned fund to Rs 20 crore in two years, in order to strengthen the capital base.