RBI’s move against 80:20 loans protects buyers in a slowing economy

Reserve Bank of India has done the right thing in tightening rules for lump sum disbursal of housing loans by banks, the so-called 80:20 loan products, as it restores balance between availability of loans and risks borrowers are exposed to. In a rising market, where real estate prices are going up and buyers are confident of a steady increase in income levels, the 80:20 product could have gone on.However, with the economy growing at its slowest pace in a decade, RBI has done the right thing to step in and tweak the rules. Of the three parties involved in such loans – buyer, real estate firm and bank – the buyer is the most vulnerable. But in this backdrop, it is no surprise that a note of caution has come from the lenders as well.
The 80:20 product is an improvisation that helps real estate companies lower their interest cost. Typically, bank loans to real estate companies are costlier than home loans because of extra risks associated with construction. By getting buyers and banks to agree to disburse the entire home loan even before construction has started, companies have tapped into cheaper funds. However, in the process the buyer bears a disproportionate amount of risk as he is responsible for the repayment. In the event there is a time overrun in construction, something common in India, the buyer stands exposed.
Also, banks today are grappling with the challenge of a rising trend of bad loans. As a proportion of gross advances, bad loans went up from 2.36% in March 2011 to 3.92% in June 2013, with the possibility of rising to 4.4% by March 2014 in a severe stress scenario. The weight of bad loans on their books acts as a drag on banks’ lending and stalls economic recovery. In this larger context, RBI’s move is timely.