The Reserve Bank of India (RBI) has come out with detailed guidelines on classification of commercial real estate (CRE) exposure of banks. The guidelines come into effect with immediate effect.

The guidelines were finalised after a careful consideration of suggestions on a draft note circulated by the apex bank sometime ago. The RBI, however, has clarified that the guidelines are based on a set of principles and examples outlined. Hence, it has argued that they need not necessarily be exhaustive.

The RBI is of the view that the banks should be able to determine whether an exposure is CRE or not. Accordingly, banks should record a reasoned note justifying the classification, it further says. According to the apex bank, it is possible that an exposure could have multiple classifications, such as CRE, infrastructure lending and capital market exposure. In such cases, the exposure should be reported under all relevant classifications, with a footnote to avoid double counting. Such cases would attract all regulatory concessions and limits, if any, as applicable to the classifications, the RBI further clarifies.

While finalising the guidelines on classification of CRE exposure, the RBI has relied on the definition given by the Basel-II framework for income-producing real estate (IPRE). For an exposure to be classified as IPRE/CRE, the funding will have to result in creation/acquisition of real estate (such as office buildings to let, retail space, multi-family residential buildings, industrial or warehouse space and hotels), where the prospects for loan repayment would depend primarily on the cash flows generated by the asset. To put it simply, the primary source of cash flow for repayment of such funded assets would generally have to be lease or rental payments or sale of assets. Any exposure taken against an existing commercial real estate would also come under this category if the prospects for repayments primarily depend on rental/sale proceeds of the real estate. Similarly, extension of guarantees on behalf of companies engaged in commercial real estate activities, exposures on account of derivative transactions undertaken with real estate companies, corporate loans extended to real estate companies and investment made in the equity and debt instruments of real estate companies also qualify to be classified as commercial real estate exposure.

The RBI has clarified that if repayment depends primarily on factors such as operating profit from business operations, quality of goods and services, tourist arrivals et al, then they would not be classified as commercial real estate exposure.

Though lending in respect of special economic zones (SEZs) has been defined as a category eligible for classification as ‘infrastructure lending,’ the RBI has cleared the ambiguity by giving some illustrative examples to drive home the point that certain types of exposures in respect of SEZs could well have the characteristics of CRE exposure. In such cases, they would be simultaneously classified as CRE exposure and ‘infrastructure lending’. The risk weight applicable to them would be that of CRE exposure. However, they would be eligible for all the regulatory sops available to `infrastructure lending’ as per the RBI norms. “Banks should keep in mind the substance of the transaction rather than the form,” the apex bank says. In this context, it points to a case where a SEZ is developed by a single company entirely or mainly for its own use. In this instance, the repayment will depend on the cash flows generated by the economic activities of the units in the SEZ and the general cash flow of the company rather than the level of real estate prices. Hence, it should not be classified as CRE, the RBI has clarified.

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