In the early 1990s, a new kind of lending euphemistically termed as “specialized finance”, started to develop in the United States. This specialised lending involved, small, little-known firms basically lending money to cash-strapped Americans.
A large part of this lending was home loans and home-equity loans. Gradually, bigger banks and financial institutions became involved in this lending. This lending to cash-strapped Americans came to be known as subprime lending. The word “prime” is typically used in banking terminology with reference to the best customers of the bank.
As a part of subprime home lending, many Americans who did not earn enough to repay loans, were given home loans. Some of these loans started of with low interest rates and some with very low EMIs. As high EMIs kicked in, in the years to come, many individuals who had taken on subprime loans were not in a position to repay it. This problem peaked in 2007 and 2008, and very soon, the defaults started and as these defaults spiralled, they very briefly threatened to bring down the entire American and European financial system, in late August and early September 2008.
Subprime lending was one of the major reasons behind the financial crisis which broke out when Lehman Brothers, the fourth largest bank on Wall Street, went bust in mid-September 2008.
Dear Reader, you must be wondering why am I talking about this crisis more than a decade later. It looks like India might be moving towards its own subprime home loan problem, though the quantum of the problem may be nowhere as big as the one the United States faced, nearly a decade back. Nevertheless, there is a problem and it needs to be pointed out and acknowledged.
A little over a week back, the Reserve Bank of India, released a document rather nondescriptly titled Affordable Housing in India. The report has an extremely detailed section dealing with home loans in general and home loans of up to Rs 10 lakh in particular. Let’s look at Figure 1, which basically plots out the growth in home loans of up to Rs 10 lakh, given by public sector banks as well as housing finance companies (for reasons not explained, similar lending carried out by private sector banks has not been taken into consideration).
On the whole, loans of up to Rs 10 lakh grew by 23.5 per cent in 2016-2017, which is significantly higher than the 12.6 per cent growth in 2015-2016. In fact, when we take the number of home loans of up to Rs 10 lakh, then the rate of growth is even faster, as Figure 2 points out.
Figure 2: Home loans disbursements in terms of number of accounts.
As can be seen from Figure 2, the total number of home loans have grown the fastest in the up to Rs 10 lakh segment. Now take a look at Figure 3.
As can be seen from Figure 3, the proportion of non-performing assets (where the borrower has stopped repaying the home loan) is inversely proportional to the value of the home loan. Hence, the lower the value of the loan, higher the rate of default on it. That seems to be the trend.
For home loans of up to Rs 2 lakh, the rate of default is as high as 10.4 per cent. But for loans of higher than Rs 25 lakh, the rate of default falls to as low as 0.9 per cent. The data here raises a few points:
1) Why are so many home loan defaults being seen for lower home loan values? Take a look at Figure 1. In 2015-2016, the home loan growth of public sector banks for loans of up to Rs 10 lakh was just 0.1 per cent. In 2016-2017, it was at 30.6 per cent. This is a clear indication that in 2016-2017, there was pressure on public sector banks to disburse more home loans of up to Rs 10 lakh. Under this pressure, it seems, home loans have been given to many people who are not in a position to repay them. This is one conclusion that can be drawn from this data, given the greater than 10 per cent rate of default in home loans of Rs 2 lakh.
2) The government launched the Pradhan Mantri Awas Yojana in 2015-2016. Under this scheme the government offers an interest subsidy of 6.5 per cent to those of income of up to Rs 3 lakh. Of course, this subsidy has pushed banks and housing finance companies to give out home loans of low values. At the same time, it has led to a deterioration in the quality of lending.
3) One question that needs to be asked for sure, has the waive-off in farms loans, across different states, also had an impact on an increase in home loan defaults. This is something only banks and housing finance companies can tell for sure. Nevertheless, it is a question worth asking because any loan waive off increases moral hazard.
4) How much of a problem are these defaults? The total home loans of up to Rs 10 lakh, given by public sector banks and housing finance companies, during the last three financial years stands at Rs 1,08,732 crore. With a default rate of a little over 2 per cent (for loans of up to Rs 10 lakh as a whole), this is clearly a problem banks and housing finance companies can easily handle as of now. But as loans under the Pradhan Mantri Awas Yojana grow in order to achieve the vision of Housing for All by 2022, this can clearly become a problem for public sector banks and housing finance companies.
5) Interest rates are now expected to rise in the days to come. This will mean higher EMIs and that can possibly increase defaults further. Also, it needs to be noted here that the RBI report on affordable housing does not give out the total amount of home loans given for amounts of up to Rs 2 lakh.
All in all, there are no reasons to worry on this front as of now. But this is a problem, which needs to be nipped in the bud, to avoid future problems.
The column originally appeared on Equitymaster on January `18, 2018.