30
Jun

A Comparison of Capital requirements for Microfinance and Housing Finance Institutions

By Nishanth K & Deepti George, IFMR Finance Foundation

In this post, we attempt to compare the regulatory landscape for NBFC-MFIs and Housing Finance Companies (HFC) within the broader context of the regulatory landscape for niche credit intermediaries.

Financial Institutions are required to hold regulatory capital to protect retail depositors from unexpected losses they may incur in the course of their business. This takes the form of capital adequacy ratio or the ratio of capital held by an institution to its risk-exposure which is measured by its risk-weighted assets. Among other capital requirements[1], the Reserve Bank of India (RBI) prescribes a minimum capital of 9% of risk-weighted assets[2] for banks. However, commercial banks have maintained levels of capital adequacy (13% as on September 2015[3]) that are higher than the regulatory requirements. Specific categories of NBFCs are typically required to meet higher capital adequacy ratios (CRAR), but are otherwise not prescribed any regulatory requirement. Systemically important NBFCs (with asset size of Rs. 500 crore or more) as well as NBFC-MFIs are required to have a CRAR of 15%. The below table (Table 1) gives the capital adequacy requirements for various types of financial institutions:

Institutions Minimum CRAR (%) Minimum Tier-1 CRAR (%)

Minimum Leverage ratio

(%)

As of Now As of March-2016 As of March-2017
Banks 9 7 (and a max. of 2% Tier-2 CRAR) 4.5
NBFC-D 15 7.5 8.5 10
NBFC-ND-SI 15 7.5 8.5 10
NBFC-MFI 15 Should be greater than or equal to Tier-2 CRAR 7
IFC 15 10
Gold Loan -NBFC 15 12 12 12 7
Non SI, NBFC-ND 7
HFC 12 Should be greater than or equal to Tier-2 CRAR

As you can see from Table 1, regulatory capital requirements are different for the various classes of financial institutions. What would be the basis for such differences? This could be because of the differences in risks that these institutions face as well as risks they pose to the real economy in the event of a crisis. A typical NBFC-MFI offers small ticket, unsecured loans to lower income borrowers. Although, banks too take exposure to such borrowers, the concentration of unsecured lending to relatively unknown customers with little or no credit information and high exposure to socio-political risk is considerably higher for instance in NBFC-MFI books. Credit ratings for NBFC-MFIs have continued to factor in risks associated with unsecured lending, socio-political intervention, geographic concentration and operational risks related to cash-based transactions and as a result called for the need to keep higher capital cushions for these entities.

HFCs offer three products: Housing loans, home improvement loans and Loans against Property, all of which are secured assets. In addition, some HFCs are also allowed to accept public deposits[4]. They are regulated by the National Housing Bank[5] (NHB), an apex development finance institution for housing. With the objective of promoting housing finance institutions, it provides financial and other support incidental to such institutions. While there are several players in the housing finance space, such as scheduled commercial banks, HFCs, other NBFCs, regional rural banks, cooperative banks, agriculture and rural development banks, and state level apex cooperative housing societies, the housing loan market is dominated by SCBs and HFCs.

HFCs have lower capital adequacy requirements in comparison to NBFC-MFIs: Although NBFC-MFIs and HFCs deal with completely different asset classes and are regulated by different entities (RBI and NHB respectively), they are both specialized financial institutions providing niche financial services (predominantly credit intermediation) and are of relatively similar sizes. However, the regulatory capital requirements for these institutions are quite different. HFCs enjoy relatively low risk weights (50%-100%) for home loans and commercial real estate loans for residential projects[6], besides lower CRAR of 12% compared to NBFC-MFIs which provide small ticket unsecured short-term loans to low income individuals (risk weighting of 100% for assets originated, CRAR of 15%).

Capital Adequacy Ratio maintained by HFCs[7]
CRAR 2015 2014 2013 2012
Median of HFCs 18% 17% 17% 15%
Small HFCs 11% 12% 13% 13%
Median of Small HFCs 15% 17% 17% 15%
Large HFCs 12% 12% 13% 13%
Median of Large HFCs 18% 17% 18% 15%
All HFCs 11% 12% 13% 13%

Source: Report, Indian Mortgage Finance Market Updated for 2014-15, ICRA[8] 


Capital Adequacy Ratio of NBFC-MFIs[9]
CRAR[10] 2015 2014 2013 2012 2011
Small MFIs 30% 44% 44% 50% 40%
Medium MFIs 20% 24% 29% 29% 30%
Large MFIs 18% 19% 21% 26% 29%
All MFIs 23% 30% 33% 33% 32%

This is interesting when capital adequacy requirements for these two institutional types are seen against their Expected Loss (EL) and Unexpected Loss numbers[11] calculated using the assumption that recovery rates for HFCs and NBFC-MFIs are 50% and 0% respectively.

Expected Loss (EL) Unexpected Loss (UL)
HFC[12] 0.95%

0.44% (at 50% recovery rate)

0.88% (at 0% recovery rate)

NBFC-MFI[13] 0.74% 0.87% (at 0% recovery rate)


MFIs have higher volatility in their PAR numbers, and this is consistent with their higher capital adequacy requirements.

HFCs have much better access to refinancing schemes: HFCs are accessing more diversified sources of funding, such as borrowings from the market in the form of non-convertible debentures and commercial paper, loans from banks and other institutions, and fixed deposits[14] for some of the large HFCs. However, smaller HFCs with lower or no access to public deposits depend considerably on refinance schemes offered by NHB – NHB refinance formed 23% of the total funding for small HFCs in 2015.

  All HFCs[15] Small HFCs
2015 2014 2013 2015 2014 2013
NCDs and Commercial Paper 52% 48% 49% 30% 27% 27%
Banks 26% 30% 27% 37% 38% 35%
Fixed Deposits 17% 16% 17% 10% 8% 7%
NHB Refinance[16] 4% 4% 4% 23% 20% 19%
Others 1% 3% 2% 9% 7% 3%

In comparison, the majority of funds for NBFC-MFIs came from borrowings from banks and other financial institutions besides equity capital. In 2014-15, NBFC-MFIs (which are a part of MFIN) received a total of Rs. 276.82 billion in debt funding[17] from Banks, which accounts for about 78% of the funding that NBFC-MFIs have access to.

Debt Funding Profile of NBFC-MFIs[18]
Total MFIs Small MFIs(GLP^<Rs 1bn) Medium MFIs(1bn<GLP<5bn) Large MFIs(GLP>Rs 5bn)
2015 2014 2013 2015 2014 2013 2015 2014 2013 2015 2014 2013
Banks 77.90% 79.29% 85.27% 37.75% 42.45% 52.61% 54.77% 63.93% 70.20% 82.39% 82.49%

 

87.71%

 

Other FIs 22.10% 20.71% 14.78% 62.25% 47.55% 47.39% 45.23% 36.07% 29.80% 17.61% 17.51% 12.29%

^GLP – Gross Loan Portfolio

Often, the differences in capital requirements for HFCs and NBFC-MFIs are explained by the inherent differences in the nature of the asset. However, we contest this view as the allocation of risk weights for the calculation of capital adequacy should take into consideration the credit risk associated with the different asset classes. Also, it is interesting to note that HFCs face much higher maturity and liquidity mismatches, a risk that is much easier to control for NBFC-MFIs given their short-term lending profiles.



[1] Master Circular-Prudential Norms for Capital Adequacy, July 2015, RBI
[2] This is higher than the minimum CRAR requirement of 8% suggested by the Basel Committee for Banking Supervision
[3] Financial Stability Report, May 2015, RBI.
[4] As of March 2015, there are 64 Housing finance Companies registered with the NHB out of which only 18 are allowed to take public deposits.
[5] NHB is a wholly owned subsidiary of RBI set up under the National Housing Bank Act, 1987
[6] http://www.nhb.org.in/Regulation/HFC(NHB)-Directions-(As-modified-upto-1st-July-2013).pdf
[7] ICRA defines Large HFCs to include HDFC, LIC HF, Dewan Housing finance limited and Indiabulls Housing finance limited. Small HFCs are HFCs other than the above mentioned.
[8] ICRA report, Performance Review of Housing Finance Companies and Industry Outlook, multiple years
[9] Source: MFIN – the MicroScape, FY2014-15
[10] Proxied by Capital/Total assets ratio. We make this approximation given that microfinance loans have a risk weight of 100%
[11] A rough estimate using methodology as covered in ”An approach to risk-pricing of loans” by Chakrabarti, Ahmed, Mullick
[12] EL: Average of GNPA ratio (PAR 90) for 2005 to 2015; Housing Finance Companies and the Indian Mortgage Finance Market, ICRA Rating Feature, various years. UL: Calculated at 50% recovery rate, at 99% confidence level
[13] EL: Average PAR 90 figures for non-AP MFIs, for 2011 to 2015; MFIN Micrometer, various years. UL: Calculated at 0% recovery rate, at 99% confidence level
[14] Not all HFCs are allowed to take public deposits. The list of those that can is given here
[15] ICRA report, Performance Review of Housing Finance Companies and Industry Outlook
[16] http://www.nhb.org.in/Financial/HFC-Booklet-of-All-Refinance-Schemes.pdf
[17] Micrometer, May 2015, MFIN Publications.
[18] Micrometer, May 2015, MFIN Publications

20
Aug

MBS with an impact: Mortgage backed securitisation for affordable housing finance

In the latest edition of The Euromoney Securitisation & Structured Finance Handbook 2014/15 (published by the Euromoney Handbooks, London) Sreya Ray & Vaibhav Anand of IFMR Capital have authored a chapter on the topic of Mortgage backed securitisation for affordable housing finance. In the chapter the authors provide a perspective on affordable housing finance and the challenges that it faces, along with an appraisal framework for AHFCs. In addition they detail a case study of IFMR Capital’s first ever mortgage backed securitisation for an AHFC.

Excerpt:

Affordable Housing Finance Companies (AHFCs) in India have emerged as a small but fast-growing segment committed to addressing the credit gap in the mainstream financial system for low-income households seeking mortgage finance. These AHFCs have overcome the challenges in credit appraisal of undocumented cash flows of low-income borrowers through a deep and localised understanding of the informal economy and innovative models to evaluate the financial position and creditworthiness using non-traditional data points. Given this non-traditional approach to credit appraisal, these AHFCs face challenges in accessing debt that they can then on-lend to their potential borrowers. Access to capital markets via securitisation can be a very effective tool to provide efficient, reliable and sustainable sources of funds for AHFCs on a maturity matched basis, provided the legal complexities and risks of a mortgage-backed securitisation (MBS) can be adequately managed. IFMR Capital pioneered the first ever MBS for an AHFC, Hebros AHL IFMR Capital 2014, on March 27, 2014, leading the way for AHFCs to enter capital markets.

Click here to download the chapter.

13
Dec

Introduction to Housing Finance: The Affordable Housing Finance Company (AHFC) Lending Model – Part 2

By Amit Bajpai, Sreya Ray and Bama Balakrishnan, IFMR Capital

This post is a continuation of our earlier post where we had introduced the environment for AHFCs and HFCs in India.

Lending Models of AHFCs

The target clients of AHFCs are mostly people with relatively low funding requirements who either do not have adequate credit history and/or will not be funded by larger HFCs or banks – due to low-ticket size loan requirements, due to earning income from occupations that may be perceived as risky, or due to having non-traditional earning sources that come from self-employment or employment in the unorganized economy with no formal financial documentation. Some segments of the target borrower market may indeed have banking habits and may have borrowings from formal institutions for other needs such as vehicle financing, credit cards, SME loans etc.

The lending model is fairly uniform across various AHFCs, with some variation in naming or sequence. The key features of the lending model are summarized as follows:

  1. In-house Origination & Collections – Many AHFCs are highly focussed on high quality clients and (with the exception of a few) prefer to have in-house origination. Likewise, the delinquency management process is kept in-house to maintain control, build accountability and implement fair collection practices.
  2. Separation of Business from credit – AHFCs emphasise the independence of credit from sales and align their incentive structures with high quality origination to achieve maintenance of asset quality and adherence of fair practices.
  3. Rigorous screening of client information – In the absence of traditionally-accounted cash flows (i.e. in formats such as financial statements, IT returns, payslips etc.), AHFCs rely on triangulation & validation of information through exhaustive personal discussion and verification processes (checking trade records, reference checks, physical visits).
  4. Emphasis on Cash Flow Analysis – AHFCs base their credit analysis and decision on cash flow analysis, using inputs obtained from clients as explained above. The credit team may also use proxy indicators to evaluate the standard of living.
  5. Legal, Technical and Internal Audit Functions – Some AHFCs have outsourced these critical functions to pre-approved/empanelled service providers to minimise fixed costs, while others have invested in building these functions in-house as they grow in scale. AHFCs have developed a good working knowledge of property evaluation and security creation given various laws and regulations governing the same. This is incorporated in the origination process through their lending policy. Property eligibility criteria are well defined and closely monitored.

There may be a divergence in process to the above for some AHFC players, as laid out below:

  1. Some AHFCs choose to rely on outsourced origination i.e. using agents, or by partnering with NGOs and MFIs.
  2. Some AHFCs prefer to work with salaried customers, where credit analysis is simpler and more standardised; while others may focus on the self-employed business class, who may be more under-served, owing to their inability to access bank funds (due to lack of traditionally-accounted income) and their need for faster, simpler processing and disbursement.
  3. AHFCs who focus on self-employed customers in the informal sector where fluctuation of income levels is higher, face higher credit and also have stronger processes on credit analysis, data validation and data verification. The information sourced from clients is checked at various levels by sales, independent agencies, Fraud Control Units and Credit, during its movement from application to sanction.

What are the stylized features of the AHFC lending model?

As more and more players enter the housing finance space and existing players scale up, the onus is on optimizing the lending model and capturing higher market share while protecting asset quality. Some processes that are characteristic of AHFCs are:

  • Existence of Fraud Control Units (FCUs) to check genuineness of KYCs.
  • Some HFCs have taken all household earning members as co-applicants to minimise likelihood of loan default.
  • Document Management System – A few HFCs have document truncation system which lets them scan all client documents on their software, thereby reducing their dependence of physical documents.
  • High Quality MIS – Some HFCs have inbuilt data validation checks and process controls which leaves little scope for process flow hiccups and data quality issues.
  • Double CB for low-income1 customers – As low-income/economically-weaker clients may be borrowers both from banks and MFIs, some HFCs perform Credit Bureau checks both for microfinance institutions and bank lending to these clients.

Road Ahead and Support Required

As has been explained above, AHFCs have designed innovative business models with a lot of attention to origination and credit quality, and who are focused on a customer segment inadequately served by the mainstream financial system. Even as AHFCs seek to scale up operations, capture and consolidate market share and diversify their geographic footprint, they require efficient sources of long term debt financing.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) Act was enacted in 2002 for regulation of securitization and reconstruction of financial assets and enforcement of security interest by secured creditors. The SARFAESI Act empowers Banks/Financial Institutions to recover their non-performing assets without the intervention of the Court. The SARFAESI Act defines financial institutions (FI) for whom the provisions of the Act are available. In order for an NBFC to qualify as an FI it would have to be a public financial institution as defined under S.4A of the Companies Act or be notified as an FI by the Central Govt. HFCs have from time to time been notified by the Ministry of Finance as FIs for the purpose of SARFAESI. It would be important for AHFCs to be notified as FIs under SARFAESI, as they become eligible for the same.

This apart, National Housing Bank(NHB) refinances lines, helpful as they are in addressing AHFC’s liquidity and ALM needs, are one solution. There is a need for other capital market financing solutions including structured finance products for AHFCs to realize their long-term growth plans.

Structured finance has enabled the microfinance institutions and small business lenders to access capital markets for funding requirements. Similar models could be replicated for the AHF companies. Through securitization transactions, the interests of AHF originators can be aligned to the requirements of investors with different risk-return profiles. Entities with deeper understanding of the underlying asset class and sound risk management capabilities can subscribe to high risk subordinate cash flows. This subordination not only acts as additional credit enhancement but also allows for the bespoke tenures for senior cash flows resulting in attractive options for capital market investors with varied investment mandates. Another way of risk participation is through providing performance guarantees to the AHF loan pools. One such step in this direction had been taken by NHB by setting up the India Mortgage Guarantee Corporation (IMGC) in 2012.


1 – The clients who have equal chances of being either in Microfinance Credit Bureau or Bank credit bureau

10
Dec

Introduction to Housing Finance: The Affordable Housing Finance Company (AHFC) Lending Model – Part 1

By Amit Bajpai, Sreya Ray and Bama Balakrishnan, IFMR Capital

Over the ages, shelter has remained as one of the most basic and important needs of human beings. People’s housing needs have increased manifold in recent times as the population grows, the middle class expands and younger generations choose to move into nuclear family units, or move near the increasingly popular regional work hubs. However, with high costs of construction materials, high capital costs and increasing complexity of the legal and technical paperwork needed, accessibility and affordability of house ownership continues to remain a challenge.

Housing finance acts as a bridge to provide financing and open up the housing market to aspiring house owners. In recent times, specialist housing finance companies (HFCs) targeting the low-income/financially-excluded household segment have emerged as a key player to meet the demands of the newly bankable population who do not have credit history in conventional terms, and are often not served by banks and mainstream HFCs. The lending model and operational processes of these specialist HFCs- which we will refer to as Affordable Housing Finance Companies (AHFCs) – are the subject of this post.

Housing Finance Sector Review: The Environment for AHFCs and HFCs

There are several players in the housing finance space, such as Scheduled Commercial Banks (SCBs), Housing Finance Companies (HFCs), Affordable Housing Finance Companies (AHFCs), Financial Institutions (FIs), Regional Rural Banks (RRBs), Scheduled Cooperative Banks, Agriculture and Rural Development Banks, State Level Apex Cooperative Housing Society and development organisations like MFIs or SHGs. However the most significant contribution comes from SCBs and HFCs (including AHFCs).1

As of 28 November 2013, there are 18 HFCs which have been granted Certificate of Registration2 (CoR) with permission to accept public deposits including 6 HFCs that are required to obtain prior written permission from National Housing Bank (NHB) before accepting any public deposits. 39 HFCs were granted CoR without permission to accept public deposits. 5 applications for grant of CoR are still under process.

HFCs typically offer three products – housing loan, home improvement loan and Loan against Property. As of March 31, 2012, the percentage of housing loan to total loans offered by HFCs was about 74%3. The general product bifurcation of disbursement for housing in FY 2011-12 by HFCs is given below which clearly depicts the high demand for loans below 25 lakhs.

AHFC_Post1_Img1

To enable continuous and uninterrupted disbursements of loans to eligible borrowers, AHFCs must have continuous, diverse, and reliable sources of funding. Currently, these sources are limited to raising equity from private sources, bank funds, private placement of debt, and for a handful of AHFCs (such as Gruh Finance, Saral Home Finance), public deposits with or without prior written permission. For the larger universe of AHFCs, however, the lack of access to capital markets and public deposits compels AHFCs to rely heavily on bank funding, in the form of both long- and short-term loans. This mixed composition of liabilities, when combined with the largely long-term nature of assets – the housing loan portfolio – to the tune of 86.7% of assets having a tenure above 7 years4, requires AHFCs to manage the risk of asset-liability duration mismatches including risk of refinancing short-term debt at higher interest rates. Hence, Asset Liability Management (ALM) becomes a key challenge to HFCs that are highly leveraged and rely predominantly on bank funding.

The regulatory authority and apex financial institution for HFCs, the NHB provides refinance assistance to eligible HFCs against their existing housing loans. Such a refinance scheme would be very beneficial for AHFCs and would help them in managing their ALM mismatches. NHB carried out refinancing to the tune of Rs 17,500 crore5 in the year ended June 2013 and expects to disburse Rs 20,000 crore under the refinance window. Funding of HFCs as on Mar 31, 2012 is shown in the below table:

AHFC_Post2_Img2

In Part 2 of this post we write about the key features of the lending model, divergence in processes adopted by some AHFCs and the road ahead.


  1. As per Report on Trend and Progress of Housing in India, 2012, Table 14 on Percentage-wise Breakup of Disbursements between various categories of PLIs in 2011-12, SCBs constituted 61.51% and HFCs 36.85% of the total disbursement.
  2. http://www.nhb.org.in/Regulation/list_of_housing_finance.php
  3. NHB-Report on Trend and Progress of Housing In India, 2012
  4. NHB-Report on Trend and Progress of Housing In India, 2012
  5. Article titled ‘Banks, housing finance firms rush for refinance’ published online on August 20, 2013 at www.business-standard.com
  6. Borrowings through bonds and debentures, inter- corporate deposits (ICDs), commercial papers, sub-ordinate debt.

13
Sep

Alternative Model of Rural Housing Finance – Part 2

By Mohammed Irfan, IFMR Capital

In the previous post of this series, we discussed the status of rural housing and motivations that determine the pattern of construction/upgradation of houses in rural areas. From the point of view of financial inclusion, such understanding of rural housing presents a huge unmet opportunity for an alternative model of housing finance. In recent times there have been Housing Finance Companies (HFCs) that operate with a focus towards customers in informal sectors. In this post we look at an HFC we recently visited.

Swarna Pragati’s housing finance model

With a vision to work in the rural housing market focusing on low income households, Swarna Pragati Housing Microfinance, a Housing Finance Company, started its operations in Maharashtra, Orissa and Karnataka. Swarna Pragati has tried to address innovatively the challenge of income assessment. This relationship based model aims at leveraging the established relationship and network of NGO-MFIs and the proven model of group liability to assess the ability to repay. Swarna Pragati partners with NGO-MFIs with considerable experience of operating in the geography. It relies on the documents which reconfirm the tenure of occupancy of the household in the absence of clear and proper title documents. The model primarily counts on the sentimental value attached to the house, and secondarily on the endorsement of mortgage in local revenue records, to address the challenge of willingness to repay. The para legal documentation acknowledges the mortgage in the absence of proper or complete title documents that can be deposited to create a mortgage. Since Panchayat Raj Institutions (PRIs) are local institutions which are very close to the borrowers, involvement of PRIs is respected by the borrower and the local community.

The housing finance to the low-income household is guaranteed by the group (in which the household member is part of) which has a recorded credit history with the NGO-MFI. Other features of the product are incremental financing and shorter tenure designed for incremental house building. Incremental financing helps in breaking up the housing loan into smaller parts, matching the requirement of the rural borrower who builds the house in modules/incrementally.

An incrementally financed, small-ticket, shorter tenure loan helps in matching the repayment capacity of the borrower. The balance between size of incremental housing finance and shorter tenor housing finance product is achieved on the basis of feedback and the strong relationships within the group and the local institutions. The operational restriction of disbursement to only 50% of the group members at any point in time is an in built risk mitigant in the model, preventing strategic and wilful default.

Swarna Pragati has rolled out its operations in three states through 7 partners and has reached out to more than 2500 customers during the last two and half years. The average size of housing finance that it provides is around INR 75,000 with tenure ranging from 36-60 months. During this short period of over two years of operations, Swarna Pragati has been able to maintain nil NPAs during this period.

Challenges

This model however has a few challenges left to be addressed:

  • The NGO-MFIs whose relationships and networks are leveraged upon relies on projects and grants that it accesses. In the event of any disruption to this, and due to the short term nature of such activities, the sustainability of partner institutions presents itself as a challenge given the longer term call that a Housing Finance Company takes.
  • The marketability of repossessed property in rural areas in case of default is very difficult. This limitation reduces the mortgaged property to act as a deterrent to default, and in case of default, the value of the collateral is called into question.

In the context of the huge shortage of housing not just in terms of the number of units but also the quality of housing especially in rural areas, there is a definite need for innovative housing finance models like that of Swarna Pragati. The uniqueness of rural housing calls for a differentiated approach to address the specific requirements of the target segment. Further scalability of such models in other parts of India would largely depend on addressing the risks and challenges outlined.