Why the State Bank of India is in love with home loans

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In yesterday’s edition of The Daily Reckoning
, I had discussed why teaser rate home loans are a bad idea. Arundhati Bhattacharya, the chairperson of the State Bank of India (SBI), recently put forward the idea that the country’s largest bank should be allowed to launch teaser rate home loans.

As I had explained yesterday, teaser home loans are essentially home loans in which the interest rate is fixed in the initial years and is lower than the normal floating interest rate on a home loan. The lower interest rate is limited only to the first two-three years after which the loan is priced at the prevailing interest rate on home loans.

The question is, why does Bhattacharya want to launch teaser rate home loans? Let’s look at some numbers of SBI. As on June 30, 2015, the bank had given out home loans worth Rs 1,63,678 crore, having grown by a robust 13.5% since June 30, 2014.This, when the overall domestic lending grew by a much slower 5.38%.

Between June 30, 2014 and June 30, 2015, the bank gave out home loans worth Rs 19,468 crore. Where did the overall lending stand at? The total domestic lending of the bank grew by Rs 54,255 crore during the same period. Hence, home loans formed a massive 35.9% of the total lending that SBI has done within India, between June 2014 and June 2015.

To rephrase the earlier sentence, more than one third of all domestic lending of SBI, over the last one year, has been in the form of home loans. For a diversified bank, which is not just a home loan company, this skew is way too pronounced.

Nevertheless, even after this, why does Bhattacharya want to give out more home loans, by launching teaser rate home loans? In order to answer this question I would need the average home loan size of SBI. I found two newsreports, which gave me two very different numbers. One report published in October 2014, quoted a senior SBI executive said that the average home loan size in case of SBI was at Rs 30-32 lakh. Another report published in April 2015 said that the average home loan size in case of SBI was at Rs 20 lakh.

The second number seems to me more believable given that the average home loan size of HDFC is Rs 23.4 lakh (HDFC shares its average home loan size every quarter). My guess is that the average home loan size of SBI would be a little lower than that of HDFC, given its better reach.

So we will work with an average home loan size of Rs 20 lakh. The next number needed is that home loan to value ratio, at the time the loan is given out. I couldn’t find that number for SBI (dear reader, hope you understand how difficult it is to get numbers on anything in India, despite the improvement over the years).

The number in case of HDFC is 65%. What this means is that on an average HDFC gives 65% of the market value of a home being bought, as a home loan.  If we work with this number, the average market price of a home that SBI is giving a loan against is around Rs 31 lakh (Rs 20 lakh divided by 0.65). But this does not take one factor into account.

Almost no real estate deal in India is carried out totally in white money. There is a portion of black money that inevitably needs to be paid. It is very difficult to arrive at an all India number, but my guess is that 75:25 is a good conservative ratio to work with. This means that 75% of the value of the home is paid in white and the remaining in black.

Once this factor is taken into account the market price against which a home loan is given, shoots up to around Rs 41 lakh (Rs 31 lakh divided by 0.75). What does this mean? This means that the loan to value ratio is a little under 50% (Rs 20 lakh expressed as a percentage of Rs 41 lakh).

Hence, giving out home loans is a very safe form of lending. In fact, it is the safest form of lending. For mid-level companies, bad loans were at 10.3%. So for every Rs 100 that SBI gave as loans to mid-level companies, a little over Rs 10 wasn’t repaid.

For, retail loans the bad loans were at 1.17%. The bank does not give a separate number for home loans. Auto loans, education loans and personal loans, are the other forms of retail loans. The default rates in case of these loans is likely to be higher. Hence, the bad loans case of home loans should be lower than 1.17%.

The bad loans in case of HDFC amount to 0.54% of the total loans. What this means clearly is that almost no one who takes on a home loan defaults on it. Given this, it is not surprising that Bhattacharya wants to be allowed to launch teaser rate home loans. It is better for her to do that than be lending to corporates. As Bhattacharya had said: “This is one portfolio where NPAs are the lowest.”

The fundamental problem with teaser rate home loans is that a bank cannot be allowed to give out a loan at a rate of interest lower than its base rate or the minimum interest rate a bank charges its customers. Also, they cannot really be compared to normal home loans, given that the chances of the EMI jumping up in the years to come is significantly higher in case of teaser home loans. And that is a risk that Bhattacharya probably hasn’t taken into account.

The column originally appeared on The Daily Reckoning on August 27, 2015

Ms Bhattacharya, teaser rate home loans are a bad idea

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Vivek Kaul

The recent suggestion by the State Bank of India (SBI) Chairperson, Arundhati Bhattacharya, to get back teaser rate home loans into the system, has once again sparked the debate over this controversial product. Bhattacharya recently said at an event where the Reserve Bank of India governor Raghuram Rajan was also present: “In fact, the first suggestion that I made (was) that, for a limited period, home loans could be given at below base rate for the already heavy stock of housing.”

In early 2009, SBI had started a teaser home loan scheme at 8%. Bhattacharya went on to add: “Of course, at that time, it was tagged as a ‘teaser’, but, we at SBI, refute that because the due diligence conducted for those loans was same as for others. Even the eligibility (criteria) was same as for regular loans.”

Teaser home loans are essentially home loans in which the interest rate is fixed in the initial years and is lower than the normal floating interest rate on a home loan. The lower interest rate is limited only to the first two-three years after which the loan is priced at the prevailing interest rate on home loans.

For example, the interest rate on a teaser home loan may be fixed at 8% for the first two years, when the prevailing home loan rate is 10%. From the third year onwards, the prevailing interest rate on home loans is charged to the borrower.

The idea with teaser rate home loans is that at lower rates of interest initially, the EMI will also be lower. This will encourage more people to take on a home loan and buy homes. This Bhattacharya feels will help in clearing the inventory of unsold homes that has piled up all over the country. As she said: “Today, the base rate is 9.7%. I am told that real estate inventory is at a two-year high and I was thinking if it is possible for a little while… could something of this (teaser loan) kind be allowed.”

There are multiple problems if anything of this sort were to become a reality. First and foremost, is it the job of the nation’s largest public sector bank to help real estate companies’ clear unsold inventory? From whatever little I have learnt on how banks should operate, the primary objective of a bank is to lend to those who are likely to repay and also, make money in the process, without increasing the overall riskiness of the financial system. Second, why should a bank be allowed to lend below its base rate or the minimum interest rate a bank charges its customers?

Third, if a bank gives out a teaser rate home loan at let’s say 8%, is it making money on that lending? And if it’s not, why is it lending in the first place?
When SBI first started offering teaser rate home loans in February 2009, under the leadership of OP Bhatt, it received criticism from all fronts. Teaser loans were a major reason behind the financial crisis that had started in the United States in September 2008. The difference in the Indian and the American context was that the teaser home loans that SBI was offering, were nowhere as aggressive as the teaser home loans that had been offered in the United States.

In the American context some teaser loans were so structured that only a certain amount of interest had to be paid in the first few years. Hence, the difference between the initial EMI and the actual EMI which kicked in after the “teaser-rate” was over, was huge. Hence, it led to huge defaults. That wasn’t the case in India.

Nevertheless, given the environment in the immediate aftermath of the financial crisis, the teaser home loan did not go down well with the banking regulator. Also, as we shall see, a certain amount of risk did remain in the product. Further, even though, the other lenders such as HDFC, ICICI Bank etc., joined the teaser loan bandwagon and started offering teaser loans, they made it amply clear that they were only responding to competition.

In fact, Deepak Parekh, Chairman of HDFC had called teaser loans a “marketing gimmick”. He had also explained why the product remained risky, even in an Indian context. As he told the Mint newspaper in an interview: “Today what we are saying is, if it’s 8% or 8.25% for the first two years, the rate will be 9% afterwards and so the gap is very little. Suppose interest rates in India shoot up in the next three years, then what will happen? These are all floating rate loans and fixed only for first two years. So, 8% interest will become 12% or even more. Then, the gap will be too much and it’s a problem for the individual home-owners.”

And home loan interest rates did rise eventually in the years to come. There is no data available in the public domain to figure out what was the impact higher interest rates had on those who had taken on a teaser loan.

Further, as Parekh explained: “Financial innovation doesn’t take time; if one does it, everyone copies. It can be done in 24 hours.” If SBI were to launch a teaser rate home loan right now, every other bank would launch a similar product in quick time. This would increase the overall risk in the financial system.

Given all these reasons, teaser loans are a bad idea. And it is surprising that the idea to re-launch them has come from the head of the largest bank in the country. The good news is that it is unlikely that Raghuram Rajan is in the mood to listen to this suggestion.  In fact, he made it clear recently to real estate wallahs (real estate companies, lobbies and others associated with the sector) that they should stop asking for lower interest rates every time they open their mouths to speak. He asked them to start cutting prices instead.

As Rajan said: “It would be a “great help” if realty developers sitting on unsold stock bring down prices…Once the prices stabilise, more people will be keen to buy houses…I think we need the market to clear. With growing unsold stock, we need to see the ways to do it. Some of it might be by making loans easier, but we also don’t want to create a situation where prices stay high at the level which means demand can’t pick up.”

Also, as I have said many times in the past, real estate prices are at a level, where slightly lower EMIs really won’t make much of a difference. The real demand for homes to live in will only come in once builders start to cut prices.

The column originally appeared on The Daily Reckoning on Aug 26, 2015