This article is written by Simran Bais, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.com.

Introduction

The regulatory power of the Housing Finance Companies (hereinafter referred to as ‘HFCs’) was transferred from National housing Bank (hereinafter referred to as ‘NHB’) to Reserve Bank of India (hereinafter referred to as ‘RBI’) by the Central Government with effect from Aug 09, 2019. (see here) It was further submitted that the RBI in the due course of time will regulate the framework for HFCs and determine the extent to which rules can be subjected to HFCs and till this particular point of time the HFCs were directed to comply with the instructions as issued by NHB. 

The proposal (see here) of RBI includes:

1.  Withdrawal of the existing exemption to the HFCs under Chapter IIIB (Provisions relating to Non-Banking Institutions receiving Deposits and Financial Institutions) of the RBI Act, 1934 (“RBI Act”) vide notification dated June 18, 1997. (see here)
2. Regulation of double financing.
3. Classification of HFCs.
4. Increase the minimum net owned fund.
5. Harmonize definitions and instructions on fraud monitoring.

Before venturing into this domain it is important to understand the meaning of Housing Finance Companies and its scope thereof. 

A company which is registered under the Companies Act, 1956 which performs the function of transacting business essentially of providing finance for housing whether directly or indirectly is said to be a Housing Finance Company. 

The position prior to the notification was that the registration with National Housing Bank was mandatory in nature. In terms of types of liabilities, there was categorization of HFCs by NHB into deposit and non-deposit accepting HFCs. 

Analysis of the draft released by RBI

It can be reiterated that the NHB was set up to function as a principal agent to promote housing finance institutions and to provide financial aid to such institutions at both local and regional levels. Needless to put, a HFC is required to be in the business of providing Housing Finance.  

However, it becomes imperative to note that the term Housing Finance was not defined anywhere under the National Housing Bank Act, 1987.  Therefore, in this particular context the NHB placed reliance on the definition of housing finance institution which was provided under the NHB Act, 1987.

The preposition (see here) which was put forward by RBI now attempt to define Housing Finance or providing finance for housing as:

“Financing, for purchase/ construction/ reconstruction/ repairs/ renovation of residential dwelling units includes the following-

• Loans to individuals or a group of individuals inclusive of cooperative societies for construction or purchase of new dwelling units.

• For the purchase of old dwelling units loans provided to the individuals.

• Loans to individuals for the purchase of plots for construction of residential dwelling units provided that a declaration is given to the effect by the borrower that he intends to construct a house on the plot within a period of three years from the date of availing of such loan.

• Loans provided to individuals for or buying old or new 12 units by mortgaging the existing dwelling units.

• For the purpose of renovation or reconstruction of existing dwelling units’ loans granted for the same.

• For the construction of residential dwelling units lending percolated to the public agencies including state housing board. 

• Loans to corporates/ Government agencies (through loans for employee housing).

• In the same complex, construction of educational, health, cultural or social centers as a part of housing projects necessary for the housing in township for the loans granted. 

• For construction of houses and ancillary matters of infrastructure loans granted within the same area which helps in improving conditions in slum area for which the credit may be extended on the guarantee of the Government, or indirectly to them through the State Governments.

• Loans granted for the scheme concerning slum improvements which is implemented by Slum Clearance Boards and other public agencies.
• For the construction of residential dwelling units lending provided to the builders.”

The draft issued by the RBI categorically presents the clarification as to what would include a housing loan and what not. The exclusion list includes loans given for furnishing of dwelling units and/or loan for the purpose other than buying or construction of a new dwelling unit or renovation of the existing being given against a mortgage of property. 

Another proposal on the table is the determination of definition of the “principal business” and its scope thereof. RBI has suggested for considering the term similar to that defined with respect to Non-Banking Financial Companies. The determination becomes necessary because the HFCs are required to have housing finance (provider) as the principal business, in order to come within the promotion of NHB. Hence, an HFC would be in the “principle business” of providing housing loan if the company has a) more than 50% of its total assets(netted off by intangible assets) as financial assets; and b) that more than 50% of the gross income is income from financial assets.(see here) 

Furthermore, an HFC would also have to clear the test of “Qualifying Assets” similarly applicable to the NBFC-Micro Finance Institutions. 

Understanding qualifying assets 

According to the circular, Qualifying asset is ‘housing finance’ or ‘providing housing finance’ when the following is satisfied:

1. Not less than 50% of the net assets should be qualifying assets, further out of this percent, 75% and more should be put into utilization for individual housing loans. (Individual housing loans include clauses (a) to (e) in housing finance, providing finance for housing);
2. Net assets refer to total assets minus cash, bank balances, and money market instruments.

The above-mentioned criteria need to be fulfilled by the HFCs failing which they would be considered only as NBFC-Investment and Credit Companies, and will further have to approach RBI for their CoR (Certificate of Registration) conversion. 

Proposed Regulation of Double Financing

The next important proposal (see here) of RBI is regulation of double financing. Double financing is understood to be “lending to construction companies in the group and to retail individual home buyers”. RBI limited such a lending option with the HFC and thus, an HFC is now allowed to choose only one either the group or retail buyers. Moreover, with this option taken, there are further limits i.e., an exposure to group entities whether direct or indirect cannot exceed 15% of owned fund and similarly cannot exceed 25% for single entity in the group. Further, exposure to individuals would have to comply with the arm’s length principles. 

Proposed Classification

RBI has proposed harmonization (see here) between the definitions and regulation of HFCs and NBFCs and in order to align the same it has suggested the classification of HFCs into systematically important HFCs and non-systematically important HFCs. 

Such a classification separates the all the deposit taking HFCs (asset size irrelevant) and non-deposit taking HFCs with more than Rs 500Crore of asset size from those non-deposit taking HFCs having asset size below Rs 500 Crore.

In addition to this, to facilitate the alignment the definition of “public deposit” in NHB Directions, 2010 with respect to HFCs has been amalgamated with the definition of “acceptance of public deposits’ given under the RBI Master Directions on Acceptance of Public Deposits, 2016. As a result, any amount received by HFCs from NB or any public housing agency will be exempted from the definition of public deposit.

Proposed changes to Minimum Net Owned Fund (NOF)

The Net Owned Fund as per the explanation provided under Section 45-IA of the Reserve Bank of India Act, 1934, (see here) means: The paid-up equity capital’s aggregate and free reserves as enclosed in the latest balance sheet of the company after deducting therefrom accumulated balance of loss. There is a proposal of RBI to double the minimum NOF making it Rs. 20 Crore. The claim put forward by RBI is that the aim should be to strengthen the capital base for smaller HFCs and companies applying for registration under the NHB Act. 

Harmonization

Tier I and Tier II capital of HFCs had a provision of “perpetual debt treatment” (PDI) except all other similarities with the capital of NBFCs when it comes to the definition. However, RBI has moved ahead by recommending that PDIs will be considered as Tier I and II only by HFCs-ND-SI i.e., Non-deposit systematically important HFCs. (see here)

In furtherance to this, the monitoring guidelines as issued by the NHB, New Delhi as applicable currently on the HFCs will be replaced by the 2016, Master Direction on Monitoring of Frauds in NBFCs as issued by the RBI on September 29, 2016.(see here) 

Moreover, the Information Technology Framework so issued by the NHB for the HFCs in 2018 is replaced with the Master Direction on Information Technology Framework for all the NBFCs, 2017.(see here) The guidelines on securitization of NBFCs will be applicable for all the HFCs irrelevant of their classification as suggested.(see here) In light of no rules governing the HFCs lending against the security of shares, the Master Directions governing NBFCs is extended to cover the HFCs. 

In order to comply with these following requirements are to be fulfilled: 

a) maintenance of a loan to value (LTV) ration of 50% at all times, 

b) HFCs can accept only Group 1 securities as collateral for loans of more than Rs 5 Lakhs, when the lending is for investment in capital market, 

c) a quarterly report has to be filed with the stock exchanges in the format as given in Annex V of the Master Directions on NBFC-ND-SI. 

Other Applications

RBI has brought in the applicability of the Indian Accounting Standards to the HFCs, moreover, outsourcing guidelines applicable to the NBFC-ND-SI will be governing the outsourcing activities of the HFCs. 

Conclusion/ Key Takeaways

• RBI has proposed a definition for the housing finance thus filling up the void.
• According to the analysts, the regulatory changes would be a relief to residential developers because the term now specifically includes the lending to builders for construction of residential dwellings as housing finance. 
• According to a banking expert, the regulations would bring quality in the sector because only the serious player would stay. 
• For HFCs, minimum capital risk-weighted assets ratio (CRAR) is currently at 12%, which will be increased to 14% by 31 March 2021 and 15% by 31 March 2022. (see here)
• It is to be noted that RBI has not amended the NOF requirement for NBFC-ICC which is only Rs 2 crore as compared to Rs 20 crore for HFCs.

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