Key Aspects of the Revised Regulatory Framework for Housing Finance Companies – Real Estate and Construction

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A housing finance company (“HFC“) is another form of non-bank financial corporation (“NBFC“) which is primarily engaged in housing finance. With the growth of major HFCs in India offering home loans to home buyers, the housing finance industry has experienced unprecedented growth as a service provided by the government to private actors entering the housing financial market to provide such services.

Provisions for the regulation of HFCs are set out in the National Housing Bank Act, 1987 (“NHB Act“) with the National Housing Bank (“NHB“) being the regulatory authority for HFCs. In order to avoid double regulation, certain exemptions have been granted to HFCs from the provisions of Chapter IIIB (Provisions relating to non-bank institutions taking deposits and to financial institutions) of the Reserve Bank of India Act, 1934 (“RBI Law “) by notification dated June 18, 1997.

In 2019, the NHB Act was amended and certain regulatory powers for HFCs were given to the Reserve Bank of India (“RBI“) in accordance with these changes. As a result, the exemptions granted to HFCs under the RBI Act have been withdrawn and the provisions of Chapter IIIB (with the exception of Section 45-IA (Registration requirement and net held funds)) of the RBI Act were made applicable to all HFCs following a notification dated November 19, 2019 issued by the RBI. On November 18, 2020, the RBI issued another notification (which replaces the previous notification dated November 19, 2019) to exempt HFCs from the provisions of Articles 45-IA (Registration requirement and net held funds), 45-IB (Maintaining the percentage of assets) and 45-IC (Reserve fund).

The RBI has undertaken a review of the regulations applicable to HFCs and has proposed some changes to the regulatory framework for HFCs. On June 17, 2020, the RBI released a draft framework and invited the public to comment on it.

Revised regulatory framework for HFCs

On October 22, 2020, the RBI released the revised regulatory framework (“Revised framework “)1 for HFCs. The main aspects of the revised framework are:

Definition of HFCs

In the revised framework, an HFC has been defined as a non-bank financial company engaged in housing finance activities and which meets the following conditions:

(a) Its financial assets (in the field of housing finance) represent at least 60% of its total assets; and

(b) Of the total assets (net of intangible assets) not less than 50% should be allocated to finance housing for individuals.

Transition time for existing HFCs to meet asset-based criteria

The revised framework granted a transition period until March 31, 2024 for existing registered HFCs to meet the asset-based criteria as defined above in the event that those HFCs offer to continue their activity as HFCs:

Chronology

Minimum percentage of total assets towards housing finance

Minimum percentage of total assets to finance housing for individuals

March 31, 2022

50%

40%

March 31, 2023

55%

45%

March 31, 2024

60%

50%

Existing HFCs, which do not meet the asset-based criteria, are expected to submit a Board-approved plan to the RBI within 3 (three) months, including a roadmap to meet the above criteria and a transition timeline. . In the event that an HFC is not able to meet the above criteria according to the schedule, that HFC will be treated as NBFC – Investment and Credit Companies (“NBFC-ICC “) and would be required to request the RBI to convert its registration certificate (“CoR”) from HFC to NBFC-ICC.

Definition of housing finance

In general, the term “housing finance” can be viewed as financing for residential housing purposes and ideally should not include financing for non-residential purposes such as commercial real estate, etc. However, there was no formal definition of the term ‘housing finance’.

The revised Framework established a clear definition of housing finance. According to the definition, the term “housing finance” means financing, for the purchase / construction / reconstruction / renovation / repairs of residential housing units which would include (a) loans to individuals or to a group of individuals, including cooperative societies for the construction / purchase of new housing, (b) loans to individuals or a group of individuals for the purchase of old housing, (c) loans to individuals or to a group of individuals for the purchase of old / new housing by mortgage of existing housing, (d) loans to builders for the construction of residential housing, (e) loans to businesses / government agencies for employee housing, etc. .

All other loans, including loans for furnishing residential units, mortgage loans on property for purposes other than the purchase / construction of new residential unit (s) or renovation of existing housing units, would be treated as non-housing loans and would not fall under the definition of “housing finance”.

Net Held Fund (“NOF”) requirement

The revised framework increased the minimum NOF requirement for HFCs from INR 100 million to INR 200 million. According to the revised Framework, each company proposing to start / operate a housing finance activity as a main activity will have to have an NOF of at least 200 million INR.

Existing HFCs with an NOF below 200 million INR will need to achieve an NOF of at least 150 million INR by March 31, 2022 and an NOF of at least 200 million INR by 31 March 2023.

In the event that an existing HFC fails to achieve the prescribed level of NOF within the stipulated period, the registration of that HFC would be canceled. In the event that such an HFC proposes to be treated as NBFC-ICC, then it should apply to the RBI conversion of its CoR from HFC to NBFC-ICC.

Exposure to group companies carrying out real estate activities

The revised Framework aims to curb the practice of double financing by HFCs. From now on, HFCs can either be exposed to the group company engaged in real estate activities, or lend to buyers of single-family homes at retail as part of the projects of these group companies.

In the event that an HFC prefers exposure to group companies, this exposure through loans and investments, directly or indirectly, cannot exceed 15% of the funds held for a single group entity and 25% of the funds held for all these group entities. In addition, such exposure should be at arm’s length.

Applicability of other directives / regulations issued by RBI

The revised Framework established a list of other regulations that would apply to all HFCs. In addition, HFCs should also comply with the general guidelines for fraud monitoring in NBFCs and the information technology framework for the NBFC industry issued and amended by the RBI from time to time. In addition, RBI proposed that in order to achieve a smooth transition, harmonization between HFC and NBFC regulations be phased in over the next 2 (two) years. RBI is expected to issue a comprehensive master instruction for HFCs covering all applicable instructions shortly. HFCs must however continue to comply with all existing instructions issued by NHB, which are not covered by the revised Framework.

Our thoughts

While the revised framework aims to provide a comprehensive framework for regulating HFCs and has also provided clarification on the fundraising activities that would fall under housing finance activities, the restrictions introduced by the revised framework with respect to the double financing by HFCs could have an impact on the real estate sector which is already facing a liquidity crisis.

In addition, certain aspects could be restrictive for small HFCs. For example, the revised framework requires existing HFCs to achieve a minimum NOF of 200 million INR. Previously, HFCs were required to maintain a minimum NOF of INR 100 million. Small HFCs could face difficulties in meeting this requirement and may have to abandon their CoR unless these small HFCs succeed in raising the necessary funds to be able to meet the NOF criteria. At the same time, it could offer a great opportunity for foreign players looking to invest in the Indian housing finance sector. As the housing finance industry is regulated by the NHB and RBI, foreign direct investment is allowed up to 100% automatically in HFCs. However, prior regulatory approval will be required in the event of a substantial acquisition of shares or control of an HFC, or a change in management of an HFC (resulting in a change of more than 30% of directors, excluding independent directors).

Another aspect concerns the thresholds of eligible assets for the main HFC commercial criteria. Before the amendment of article 29A of the NHB law, a company applying for registration as an HFC was required to have, as one of its main objects, the exercise of a housing finance activity ( directly or indirectly). Under the amendments to the NHB Act, section 29A of the NHB Act now uses the term “main activity”. The revised framework prescribed thresholds of eligible assets to determine the main business criteria that would also be applicable to existing HFCs. Existing HFCs could face difficulties in meeting key business criteria and if they do not meet the qualifying asset criteria by March 31, 2024, then these HFCs would have to ask RBI to convert to NBFC-ICC .

Footnote

1 The text of the corresponding circular is available at the following link:

https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11988&Mode=0

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.


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