RBI denies banks' plea on loans to realtors

The Reserve Bank of India has rejected the request of banks that they be allowed to restructure real estate loans without providing for likely losses if the loans go bad, according to an Economic Times report.

A loan is said to be restructured when the original terms of the agreement (interest rates, tenure) are diluted to enable troubled borrowers to repay loans. This also helps banks to recover a good chunk of the funds they have lent.
This RBI move is welcome for two reasons, points out CNBC-TV18. One, home prices could soften (or at least the steep rate of climb could be arrested) as banks put pressure on property developers to repay loans. This in turn could force builders to push up sales by dropping prices if need be. Second, and more important, by bringing greedy realtors to heel, the RBI may also be able to rein in a key contributor to inflation: soaring property prices.

The RBI stance is in marked contrast to that of finance minister P Chidambaram, who last week is said to have told banks to help out builders of residential projects facing a cash crunch. This could also set the stage for a fresh conflict between the RBI and the finance ministry, which have been publicly sparring over interest rates.

When property prices crashed in 2008-09, banks should have ideally forced builders to sell property at prevailing rates and repay the loans owed to banks. Instead, with permission from RBI, banks rolled over the loans, by allowing builders to keep paying interest even if they were unable to repay the principal amount. Had the RBI not given this leeway, banks would have had to set aside huge provisions for doubtful loans, which would have then dented their profits. The central bank had little choice but to give this concession, given the backdrop of the raging global financial crisis which was hurting the Indian financial sector as well.

But the move set a bad precedent. Knowing that it was as much in the interest of banks not to let the loans go bad, developers held on to high prices, undeterred by slowing sales as they were in no hurry to repay the loans. Even now, many banks resort to 'evergreening' of real estate loans (giving fresh loans to repay the old loans) so that they don't have to make provisions which would hurt their profits and thereby valuations.

There are two more things that need to be done to ensure that unrealistic real estate prices don't create distortions in the economy.
One, there have to be rules in place to ensure that builders have a good chunk of their own funds (equity) tied up in the project. According to a presentation made by Corporation Bank to the finance ministry last week (as reported in The Economic Times), builders are showing advances collected from purchasers as their equity contribution. With the rest of the funds arranged from banks, builders have little to lose in case the project is delayed.

Second, the government needs to expedite the setting up of a regulator for the real estate sector. Stringent penalty clauses in the agreements with home buyers will put additional pressure on the builder to complete projects on time.