The prime risk involved in lending activity is the ‘credit risk', i.e. the risk of loss due to a borrower's failure to repay the loan. The risk assessment depends on many factors such as creditworthiness of the borrower, purpose of loan, repayment term, security available to fall upon in case of default etc. Since home loan is advanced against non-income generating asset (house property) and has a long time span extending up to 30 years for repayment, the credit risk perceived is much higher compared to other loans. It could be a dream for home loan lenders to have a credit guarantee system which will virtually remove the risk of lending.
The dream of banks and Home Finance Companies (HFCs) is going to be realised very soon as NHB (National Housing Bank), the regulator for HFCs, has set up a Mortgage Guarantee Company (MGC) which will be operational soon.
It primarily transacts the business of providing mortgage guarantee, under specific guidelines issued by the Reserve Bank of India. It will provide credit guarantees to HFCs and commercial banks on behalf of home loan borrowers.
Banks and HFCs will have to pay the company a small amount towards premium (fee) for buying mortgage guarantee for the home loans advanced. The banks/HFCs may share the guarantee fee with borrowers or may pass on such fee to borrowers, just like mortgage insurance and property insurance premiums. The premium would depend on factors such as loan amount, tenure, borrower's profile, income of borrowers, credit history, and securities available.
The premium amount collected from thousands of loans by the company would be pooled and a corpus fund maintained. When a loan goes bad, the bank/HFC will invoke the mortgage guarantee and the MGC will make good the outstanding debt to the bank/HFC from the corpus fund.
India Mortgage Guarantee Company (IMGC)
After almost three years since the NHB announced that the first MGC is going to be operational ‘ soon,' the ‘India Mortgage Guarantee Company' (IMGC) is going to be set up. It will have an initial capital of Rs. 120 crore with 38 per cent stake by the NHB, while U.S.-based Genworth Financial will be the technical partner with 36 per cent stake. The Asian Development Bank (ADB) and International Finance Corporation (IFC) each will have 13 per cent stake in the company.
Base of mortgages to be widened
Until now, the growth in mortgage business has remained very much limited as it has not reached the majority of people. Housing finance has remained an exclusive arena for the formal employee sector and high net-worth individuals.
The lenders find it safe to lend to employee-class applicants as documentary evidences are available to establish the income by way of salary particulars and Income Tax returns. The banking transactions of applicants will help to substantiate the income, and to verify saving habits and repayment patterns of other loans availed. Further, CIBIL [Credit Information Bureau (India) Ltd.] reports too will help the credit appraisers to verify the credit history of applicants and fairly assess the credit risk.
Loans for business class and agriculturists
The majority of citizens from informal employment sectors, the self-employed, businessmen and agriculturists are kept away from the housing finance system, as such citizens are unable to produce proper income documents, their banking transactions are poor and they don't have credit history which can be verified in CIBIL reports.
Once the mortgage guarantee system is in place, banks and HFCs will surely start extending home loans to such people, who are presently not eligible for home loans, by evolving proper credit appraisal techniques. On the one hand, the mortgage guarantee will immensely help banks and HFCs to grow faster and broaden their base; on the other hand, citizens from all strata of society will be benefited as they become eligible for getting housing finance.
Once credit risk is removed, the cost of lending comes down and regulatory authorities may also reduce provisioning for standard assets, which reduces the lending costs. Thus, home loan volumes grow faster. Even though there is cost added for the mortgage guarantee facility, the home loans may become cheaper.
It is quite likely that once credit guarantee is available, in a bid to usurp a larger market share, the lenders may dilute the credit norms to increase business volumes. This will surely create sub-standard assets.
The lenders may try to hoodwink MGCs in presenting a rosy picture of home loan assets and may even try to ‘manage' the authorities of MGCs, while seeking credit guarantee. Hence it is very much necessary to have sound guidelines for MGCs. The RBI has issued comprehensive guidelines which need to be followed religiously.
A proper mechanism needs to be in place to monitor MGCs and see if they are strictly following the guidelines.
It is necessary to take the cue from advanced economies where the credit system is more advanced, but in developing countries like India, it is necessary to modify the system to suit to our economic environment and ensure that the system has in-built stringent ‘checks and balances.'
The mortgage guarantee system was introduced in the U.S. after the ‘Great Depression' of the 1930s. Although it immensely helped in developing mortgages, it also lead to the ‘sub-prime' crisis in 2008, which not only put the U.S. economy in a shambles, but shook the entire world economy. We need to learn a lesson from this before adopting such a system in our country.
With the IMGC functioning, it will usher a new era in developing a sound mortgage finance system in the country.
If home finance reaches the majority, the construction sector, aptly referred to as the ‘driver of economy,' will get a big boost.
(The author is Director, Institute of Home Finance, and can be contacted at deshpanderp2007