Can banks afford a home loan rate cut?

For the majority it appears to be difficult

It is true that many of the existing borrowers who availed the home loans during low interest regime and who are facing the brunt of higher equated monthly installments (EMIs), disturbing their family budget are anxiously waiting for the housing loan interest rates to come down.

It is also true that there are many prospective borrowers sitting on the fence, waiting for reduction in home loan interest rates so that it could address, to some extent, the problem of spiralling property prices.

However, looking at the cost of funds, servicing costs and level of returns from home loans portfolio, it may well be an astounding task for the banks especially for those charging comparatively lower rates of interest, say 9% to 10% per annum, to afford lowering home loan rates.

With the inflation continuing to rise — latest available data shows it has crossed 5% mark — banks will find it tough to reduce the rate of interest on deposits. Therefore, their cost of funds will continue to be high. In the matter of servicing costs also, there is not much difference between accounts with higher loan amounts and smaller loan amounts.

Thus, servicing cost as a proportion to loan amount is higher in case of smaller loan accounts, and especially in the category of loans up to Rs 20 lakh. Further, with increasing NPA levels in the home loan portfolio, returns from the said portfolio are also under pressure.

Given the above scenario, and since more than 80% of the loans in the home loan portfolio of a majority of the banks are for less than Rs 20 lakh, any reduction in interest rate for this category of borrowers is likely to hurt the banks.

However, since the rate of interest vary substantially in case of different banks, ranging from 9% to 12.25% per annum for borrowers availing loans up to Rs 20 lakh, those banks charging comparatively higher rates of interest can look into the possibility of reducing the interest rates, keeping in view lower risk weight attached to this category of loans, as also the underlying good security in the form of immovable property. Overall, for majority of banks cutting home loan rates appear to be a difficult proposition.

Forced rate cuts may hurt the economy

Housing loan disbursements by commercial banks during FY07 stood at around Rs 45,500 crore, rising approximately 25% from a year ago. According to RBI data, outstanding housing loans grew by around 15% to Rs 2,46,700 crore as of November 23, 2007 over the last year. Despite such growth, housing loans to GDP ratio stands at around 8.6%, compared to more than 50% in some developed economies. Pricing of housing loans is dependent upon many factors such as the long duration of loans (an average tenure of 15 years), interest rate scenario and credit worthiness of borrower. Pricing of housing loans also establish lending rate curve and influence the pricing of short-term loans.

Longer tenure of housing loans poses a significant challenge of asset liability mismatch for banks as they finance these loans (average tenure: 15 years) with deposits (average tenure: 2 years). Cost involved in terms of managing this mismatch also needs to be factored into the pricing of the housing loan.

For fixed rate housing loans, declining interest rates would entice borrowers to refinance their loans and thus increase the cost of housing loans. There is also a cost involved in terms of making provisions for defaults in the housing loan. Defaults in the housing loan segment occur when the borrower reaches a point of indifference due to changes in external environment.

Moreover, housing loans, one of the most significant component in banks’ credit portfolio (22.4% of gross bank credit as of November 2007), is also arguably the most unscientifically priced product in India. Very little data on housing loans is captured, the insights from which can be utilized to price loans. Lack of a well functioning credit bureau also restricts banks’ ability to share credit history of borrowers among themselves.

Hence, any kind of persuasion or undue pressure on banks to lower their housing loan rates could prove detrimental to the economy as a whole, at least in the medium-term. What remains to be seen is how much influence the government, as the majority shareholder in PSBs (which still constitute around 70% of the industry by assets), would exert on banks in this regard and how banks respond to that.

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Source : Economic Times

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