Rules governing non-banking financial companies (NBFC) in India’s real estate sector

Traditionally, India has had a bank dominated financial sector. Even so, there have always been Non-Banking Financial Companies (NBFC) to provide finance to mainly unorganized markets. NBFC have continued to complement banks in providing infrastructure finance. When it comes to providing medium-term capital, they enjoy more flexibility than banks, which gives them a competitive edge over banks.

Increasing share of NBFC in real estate investment

NBFC have gained popularity among builders as substitutes to banks. They have an inherent ability to make quicker decisions, assume greater risks and customize their services and charges more according to the needs of the clients. Other advantages include superior product lines, lower cost, broader and effective reach, robust risk management capabilities to check and control bad debts and proper comprehension of their customer segments (Rathi, 2017). The real estate sector and the construction industry are characterized by their unique financing format. Funds are provided by every possible source, state governments, banks, NBFC, housing finance companies, microfinance industries, private capital (formal or informal) or by individuals.  However, the financing is insufficient due to the growing complex needs of the sector (Isacc and Nalini, 2015).

Recent regulatory changes by the apex banking institution of India, the Reserve Bank of India (RBI) have allowed NBFC to access foreign capital via external commercial borrowing and channel it to infrastructure projects. The following figure demonstrates the advances made by NBFC among different verticals of the real estate sector.

Source: (RBI, 2015)

Advantages of NBFC over commercial banks

Real estate sector has been the centre of interest for NBFC in recent years. Real estate developers are becoming more inclined towards them as compared to commercial banks and other financing options. This is due to certain advantages offered by them like quick loan sanctions, friendlier loan application process, and no minimum deposit, unlike commercial banks (Bhasin, 2015). Also, the recent government’s initiative to boost the affordable housing segment has gained steam especially in semi-urban and rural areas. This has led to increase in demand for easy housing finance (The Economic Times, 2017). In addition, the infrastructure status as well as incentives given to the affordable housing has encouraged builders and investors to involve in this sector (Babar and Khan, 2017).

Moreover, the Indian banking sector has been cautious towards investing in the real estate sector due to growing bad loans. These factors altogether have provided a ripe opportunity for NBFC in providing cheap funds in the low risk section and expect higher returns owing to its demand (Sofia, 2016). Private Equity (PE) funds and commercial banks have continued to serve as major sources of finance for the development of real estate sector in India. Since 2010-2011, NBFC lending started gaining momentum as the major contributor, while banks’ share keeps dropping (Rathi, 2017). The graph below demonstrates the same.

Regulations governing NBFC investment in real estate sector

Over time, NBFC have evolved from being fragmented and informally governed to being well regulated. In many instances, they have adopted best practices in technology, innovation and risk management as well as governance. They are regulated by the RBI in India, within the framework of the Reserve Bank of India Act, 1934, Chapter III-B. After the enactment of RBI (Amendment) Act 1997, those with net owned funds of Rs. 1.25 lakhs and above have to register with the RBI. The Board for Financial Supervision (BFS) and the RBI began supervising them from July 1995 (Singh, Singh and Tiwari, 2016).

Regulation on lending to or investment in real estate by NBFC registered with Reserve Bank cover the following:

• In order to show the involvement of RBI on NBFC– non-deposit (ND) and issues related to risks in it some regulatory measures taken by RBI have come into scenario. Some of the regulatory measures taken by RBI are such as capital adequacy need and credit concentration norms (2007) and ALM reporting, maturity pattern of assets and liabilities and reporting requirements for assets size above than Rs 50 crore (2008).
• Furthermore, to bring core investment organizations or companies, the dispensation held earlier was removed in 2010. Also, the NBFC which take deposits are not at all allowed to give amount for investment or investing for purchase of land, until and unless it is for its own use.
• Both NBFC (deposit taking and non-deposit taking) which have assets of value Rs. 100 crore or above are needed to show data of their exposure to real estate.
• It has also been observed that for permitting investment for housing projects and to give No Objection Certificate (NOC), NBFC are required to have agreement of disclosing the brochures or advertisement of name of entity with builder/developer related to the property.
• Moreover, while providing loans under Credit Risk Guarantee Fund Trust for Low Income Housing (CRGFTLIH), the  micro-finance institutions are allowed to keep zero risk(Roy and Kumar, 2014).

Regulations connecting NBFC and banks

NBFC have been experiencing the problem of growing bad debts. In context of this issue the NBFC with assets of over Rs. 50 crore have now come under the ambit of SARAFAESI Act of 2002. This Act helps the financial institutions and banks in recovering the loans by auctioning a property. RBI has made several attempts to bridge the gap between regulations governing NBFCs and commercial bank. For instance, in November 2014, the RBI regulated its framework harmonizing the relations between NBFC and commercial banks.

Also, the Union  Budget of 2016-17 offered a 5% deduction in the overall income of NBFC sector in respect to the provision of risk related debts. This step was to ensure status equality on tax related issues between NBFC and Banks. This budget came with several regulatory frameworks related to NBFC such as allowance of FDI in activities associated with regulation of financial sector through automatic route (HDB Financial Services, 2016).

Future outlook

The NBFC segment has shown a growing trend in its assets as a percent of Indian GDP. After multiple regulations of RBI imposed for NBFC, a growth in their assets and profitability has been observed to be quite remarkable. The profitability is observed to be significantly higher than the commercial banks. Also, RBI regulations common to NBFC and banks have fostered a stronger association between them. However, they are exposed to challenges with the changing regulatory framework of RBI such as adoption of new ways of performing operations. In order to overcome these challenges, they need to adopt measures that will simplify their operational process.

References

• Babar, K. and Khan, S. (2017) ‘PE firms, NBFCs find investment opportunity in affordable housing’, Economic Times, June.
• Bhasin, T. (2015) When it comes to home loans NBFCs fare better than banks, Business Standards. Available at: http://www.business-standard.com/article/pf/when-it-comes-to-home-loans-nbfcs-fare-better-than-banks-115041500447_1.html (Accessed: 7 July 2017).
• Bhaskar, P. V. (2014) ‘NBFCs to become real game changers: RBI’. Delhi: IIFL. Available at: https://www.indiainfoline.com/article/news/nbfcs-to-become-real-game-changers-rbi-5856314310_1.html (Accessed: 18 December 2017).
• HDB Financial Services (2016) HDB Financial Services 9th Annual Report 2015-2016. Ahmedabad.
• Isacc, D. and Nalini, J. (2015) Emergence of NBFCs as game changers in the Indian Financial system.
• PWC (2015) ‘Banking on Non-Banking Finance Companies’. PWC, pp. 1–30. Available at: https://www.pwc.in/assets/pdfs/publications/2015/banking-on-non-banking-finance-companies.pdf (Accessed: 18 December 2017).
• Rathi, V. (2017) ‘Analysis of Institutional funding in Real Estate focus on Private Equity’.
• RBI (2015) Reserve Bank of India – Speeches, Reserve Bank of India. Available at: https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=910 (Accessed: 10 November 2017).
• Roy, A. and Kumar, L. (2014) ‘R Gandhi: Real estate and housing – a sensitive sector or Samvriddhi sector?’, Speech by Mr R Gandhi, Deputy Governor of the Reserve Bank of India, at the ‘NAREDCO CONCLAVE – Banking & Investment Reforms: Housing for all by 2022’, Mumbai.
• Singh, S., Singh, A. P. and Tiwari, S. (2016) ‘The Role & Regulations of NBFCs (Non Banking Finance Companies) in India: The Structure and status profile’.
• Sofia (2016) ‘NBFCs and PEs role in Indian real estate sector’, Realty N More.
• The Economic Times (2017) ‘Affordable housing emerging as new focus of housing finance firms: Industry’, The Economic Times, May.
• Yadav, S. K. S. (2015) ‘The operational and Financial performance of Non-banking Financial Sector in India’, International Journal of Business and Administration Research Review, 312.