With increased competition, the marketing and distribution channel strategies of Indian mortgage lenders have become more aggressive.

Renu Karnad reports on a rapidly expanding market.

With about one in every sixth person in the world living in India, housing therefore assumes significant importance. Housing is classified as a basic need in India and successive governments have highlighted its priority status. Nevertheless, housing policies have tended to remain statements of intent with priorities placed on fulfilling other social needs.

Today, the scenario has changed. Given India’s large fiscal deficit, there is a consensus that the government’s role must be that of a facilitator, creating the enabling environment to foster a healthy housing market, rather than taking on the task of building and financing housing itself.

Housing finance sector

Numerous obstacles have hindered, and continue to hinder, efforts to develop a robust housing sector. Constraining the construction of new homes is a series of archaic laws – many dating back to the 19th century. These laws have led to prolonged litigation, creating artificial scarcities of land, often leading to unrealistic property prices.

Access to formal housing finance at the retail level did not exist in India until the setting up of Housing Development Finance Corporation Limited (HDFC), as a specialist mortgage finance company in 1977. HDFC’s success proved to sceptics that the business of housing finance could still be viable despite no credit history data, foreclosure norms or easy access to long-term funding. This perhaps inspired the entry of other specialised players, although banks tended to shy away from this business.

Towards the late 1990s, against the backdrop of falling interest rates, banks recognised that they had to grow their retail portfolios to maintain profitability. They focused their retail efforts particularly on housing because delinquency rates tended to be lower compared with other retail lending, such as credit cards or personal loans.

Performance

Almost as a herd instinct, many banks adopted aggressive entry mode strategies into the housing finance market to gain market share. Strategies included undercutting on price, waiving processing fees and extending loans in excess of the value of the property. Banks that maintained insufficient credit quality checks were soon saddled with high defaults, forcing some to withdraw from the market.

Today, the market is more rational with three main players accounting for 80% of incremental disbursements. In effect, HDFC, India’s largest housing finance company, and State Bank of India and ICICI Bank, India’s largest two commercial banks, have created an oligopolistic market structure.

In the past five years, housing loans have grown at more than 35% annually. The share of specialist lenders, however, has shrunk from 70% in 2000 to 35% currently. While banks have a larger reach, most specialist lenders are redefining their roles as niche players with a local presence.

Growth of housing finance

Various factors have contributed to increased demand for housing finance. First is urbanisation. With an urban population of 27%, a figure that is expected to grow by 2.5% every five years, the migratory factor continues to put pressure on housing stock, creating demand for housing finance.

Favourable demographics and rising disposable incomes for a large section of the population have also contributed to the growth in home loans. India has a young population with an average age of 28.4 years.

The new urban population, more economically secure with a growing job market in a booming economy, is more likely to seek housing finance earlier in life. The age of an average home loan borrower has fallen from about 45 years to between 30 and 35 years today.

Increased affordability as a result of higher incomes has also played a major role in increasing demand for home loans. For instance, it required about 22 times a borrower’s annual income to purchase a house in a typical suburb in Mumbai in 1995; this fell to a multiple of five times by 2006.

Although interest rates have edged upwards by about 200 basis points from the all-time low of 7.5% in 2005, rates are still low compared with the peaks of 18% in 1997. Further, tax incentives permit deductions of up to Rs250,000 ($5560) on the principal and interest component of the loan. These factors have contributed to making housing loans more attractive.

The most significant change in the market, however, has been the need to reach out more effectively to customers. With increased competition, marketing and distribution channel strategies have become more aggressive. The strongest distribution force today is the direct selling agent, offering a door-to-door service. The market has transformed from a sellers’ to a buyers’ market with the customer now being able to shop for the cheapest loan, armed with bargaining power.

Market concerns

Although the demand for housing loans continues to be strong, there are concerns about rapidly rising house prices in certain regions. The central bank, The Reserve Bank of India, has cautioned banks against overheating the market. Some of the recent measures include increasing risk weights on individual and commercial mortgages to 75% and 150% respectively; raising provisioning requirements on standard mortgage loans; and issuing directives preventing lending to projects that do not have requisite clearances in place. (It is estimated that a developer in India requires more than 57 approvals from various regulatory bodies.)

Liabilities and mismatches

On the funding side, specialist lenders typically have higher funding costs because they do not have access to cheque accounts. On the other hand, banks are funding long-term housing loans with short-term funding, exposing themselves to asset liability mismatches. The housing market needs access to long-term funding sources, such as pension and provident funds, which current regulations hinder.

While the cyclical nature of property markets is inevitable, it is important to ensure that any overheating does not become a breeding ground for speculators. Most borrowers in India are first time buyers and therefore genuine users of the home. As prices rise, buying a house becomes more difficult.

Despite the boom in home loan financing, mortgage penetration is abysmally low at barely 5% of gross domestic product. With an estimated housing shortage of more than 22.4 million units just in urban areas, the market potential remains immense.

Renu Karnad is executive director of Housing Development Finance Corporation, India.

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