Table of Contents
Reduction in loan-to-value ratio
While lending money against any tangible security, the lender can advance a loan up to a certain percentage of the asset’s value. This is called the loan-to-value (LTV) ratio. This ratio sets the maximum amount that a lender can advance, against security of the asset. The difference between the value and the eligible loan amount, is called as the margin. This margin is required by the bank, to cover the risk arising out of reduction in the value of the underlying asset, as well as to take care of future interest amount, in case it is not served by the borrower. The LTV depends upon the quantum of the loan, as well as nature of the loan. For home loans, the LTV also depends on the value of the home being purchased.
There are three slabs of home loans, for the purpose of LTV. The first slab is for loan amounts up to Rs 30 lakhs. The RBI has made no change in the LTV ratio for this category and it remains at 90%. The next slab is for home loans between Rs 30 lakhs and Rs 75 lakhs, for which, the RBI has increased the LTV from 75% to 80%. There is no change in the LTV for the top slab of home loans above Rs 75 lakhs.
Reduction in risk weight
Lending of money carries the risk of default and thus, different risk weights are assigned to different loans, on the basis of the probability of the loan becoming bad and irrecoverable.
The risk weight for a loan, depends on the value of security available with the lender, as well as the amount of loan. Personal loans carry higher risk weight, as compared to home loans, as the probability of default in home loans is lower, as nobody wishes to risk their place of residence.
Banks source their funds from two sources – their own capital and deposits received from their customers. The deposits can be in the form of saving accounts, current accounts or fixed deposits. Since the deposits are repayable to the depositors, either on demand or on maturity, the banks are required to have their own risk capital, to absorb unexpected losses. Based on the risk weights assigned to various loan portfolios, the aggregate risk value for the entire loan portfolio is computed. This aggregate of the risk value, multiplied by the capital adequacy ratio stipulated by the Reserve Bank, represents the minimum capital that the banks are required to have. The capital adequacy ratio measures a bank’s capital, in relation to its risk-weighted assets. As per the Basel III guidelines prescribed by the RBI, the minimum capital adequacy ratio is set at 10.10% for March 31, 2018, which will increase to 11.5% as on March 31, 2019. So, for a loan portfolio of Rs 1 lakh, the bank will have to have capital of Rs 10,100, as its own capital.
The risk weight for each loan, depends on the LTV ratio of the loan. For a loan up to Rs 30 lakhs, a bank can have an LTV ratio of maximum 90%. For a loan up to Rs 30 lakhs, the risk weight is 35%, in case the LTV is 80% and lower. If the LTV ratio is more than 80%, the risk weight stipulated by the RBI is 50%. For a loan between Rs 30 lakhs and Rs 75 lakhs, where the RBI-stipulated LTV is maximum 80%, the risk weight has been reduced to 35% from 50% applicable earlier. For loans above Rs 75 lakhs, which are considered riskier and where the RBI-stipulated LTV is capped at 75%, the revised risk weight has been brought down to 50%, from the earlier requirement of 75%. As a result of significant reduction in risk weights for loans above Rs 75 lakhs, the SBI announced a reduction in its home loan rates by 0.10%. SBI had already reduced its home loan lending rates, for loans up to Rs 75 lakhs, in May 2017.
Reduction in the statutory liquidity ratio
Banks are required to keep a certain percentage of their deposits, with the RBI, in the form of government securities. This is called as statutory liquidity ratio (SLR). The RBI slashed the statutory liquidity ratio by 0.5%, to 20%.
This move, will release significant money into the banking system, for the banks to lend. As home loans are safe and there is not much credit off take, part of the additional funds released due to the reduction in the SLR, may find its way to home loans and thus, increasing the availability of funds.
Reduction in standard asset provision requirements
As a per the RBI’s policies, banks are required to make provisions for loans which have gone bad or loans where recovery seems doubtful, as a certain percentage of the loan. Even for good loans, which are called ‘standard loans’ in banking parlance, the banks have to make provisions on an overall basis. For loans over Rs 75 lakhs, the banks are now required to provide only 0.25% of the overall home loan, instead of the earlier 0.40% of the total loan amount.
Impacts of these measures on home loans
Due to reduction in the risk weights for various category of home loans, banks will be able to lend more money with the existing capital, resulting in increased supply and greater competition among lenders. This will eventually result in lower lending rates for home loans. A lower SLR is likely to have the same effect, as the funds available for lending will increase. The lower provisioning requirement, will also make more funds available, ultimately ensuring a reduction in home loan rates. The imminent reduction in home loan rates, will result into increased demand for housing, including those for affordable housing and thus, benefit developers, as well as home buyers.
(The author is a taxation and home finance expert, with 30 years’ experience)