How predatory lending practices in the housing finance sector broke the back of Indian middle class

The home buyers got some hope this year when the judges of the Supreme Court under the leadership of Chief Justice Dipak Mishra took cognizance and issued orders against the promoters of real estate companies in the matters of Jaypee Infratech, Amrapali, Unitech and Supertech etc. But these cases are just the tip of the iceberg. The real estate frauds are widespread throughout the length and breadth of this country.

The question remains whether the promoters of these real estate companies could have pulled these large-scale frauds alone? A closer look reveals that a mess of this scale could not have been committed without the assistance from, amongst other actors, the housing finance lenders, viz., the scheduled commercial banks and housing finance companies (HFCs). For brevity, I will be referring to the scheduled commercial banks and HFCs as “lenders”.

Predatory Lending

Predatory lending is the practice by lenders of imposing unfair and abusive loan terms on the borrowers. The practice of predatory lending is prohibited in the United States of America, especially in the housing sector, through a set of fair lending laws.

In India, housing finance is regulated by the Reserve Bank of India (RBI) and the National Housing Bank (NHB). While the RBI regulates the commercial banks, NHB was formed through a central legislation, inter alia, to regulate the HFCs.

When the real estate prices were soaring, the lenders collaborated with builders and developers in key markets across India and issued joint advertisements to multiply sales of their most secure product – the housing loan.

The advertisements carried representations that reputed lenders have approved the real estate project and are providing home loans. The first and most important check of a home buyer, whether the lenders are backing the real estate project and providing home loans or not, itself was compromised. The circulars of the RBI and NHB were violated continuously by the lenders at the expense of the home buyers in the following ways:

1. RBI Circular of 2006 to Scheduled Commercial Banks on Real Estate Project Approvals

In the year 2006, RBI realized that there was a substantial increase in lending by banks to the real estate sector and several of these loans were excessively risky. The RBI issued a directive addressed to the managing directors and CEOs of all scheduled commercial banks with a view to curb this risky lending pattern and to reinforce the mandate of strong loan approval process.

The RBI advised that “while appraising loan proposals involving real estate, banks should ensure that the borrowers should have obtained prior permission from government /local governments/other statutory authorities for the project, wherever required.

In order that the loan approval process is not hampered on account of this, while the proposals could be sanctioned in the normal course, the disbursements should be made only after the borrower has obtained requisite clearances from the government authorities.”

This directive of the RBI was clearly not adhered to in letter and spirit by several commercial banks. In fact, some of the commercial banks went out of the way to lend to several developers whose large residential and commercial projects were based in Noida, Greater Noida, Gurugram, Pune and Hyderabad, among other key real estate markets.

Several months later, these developers either failed to get project approvals from local authorities or diverted borrowed money to other business interests and hence failed to deliver the flats promised to buyers, risking the underlying security of the housing finance transaction. Today, some of these developers are under the insolvency resolution process and others are on the verge of seeking protection under the same.

2. RBI Circular for Monitoring of End-Use of Borrowed Funds

In 2010, the RBI’s audit revealed that several scheduled commercial banks have diluted their monitoring and diligence of end use of borrowed funds which is facilitating diversion of funds by the companies which borrowed funds for specific end-use. The funds borrowed by companies for a specific purpose of development of a real estate project were being diverted.

To regulate this, the RBI, in January 2011, issued a circular reinforcing the need for robust diligence mechanism to ensure adherence to the loan agreement terms and monitor end use of borrowed funds. RBI advised the banks to put in place effective mechanisms to ensure post-sanction supervision. The steps should include, the RBI advised, meaningful scrutiny of the periodical progress reports and operating/financial statements of the borrowers, and regular visits to the assisted units and inspection of securities charged/ hypothecated to the bank etc.

While this was an important directive from the RBI, it brought to light the reckless lending by the Indian banks, vulnerability of their loan portfolios and non-existent credit appraisal systems. These unmethodical and illegal practices of the Indian banks, in a few months from the date of this RBI circular, would go on to accentuate the Indian bad loan problem.

3. RBI and NHB Circulars of 2013 curbing Subvention / 80:20 Home Loan Products

To exploit the opportunity and lure maximum customers, the lenders came up with creative home loan products in collaboration with real estate companies. These schemes were in the form of interest subvention schemes, popularly called 80:20 schemes or 75:25 schemes that promised commencement of repayment of home loans only upon delivery of flats, but with a fine-print. The lender would disburse around 80% of the property price as a single shot upfront payment to the real estate company on behalf of the home buyer and the obligation to repay this amount is cast on the home buyer. EMIs would commence on the earlier of delivery of the flat or two years from the date of loan disbursement.

After the damage was done and several lenders backed real estate projects were already delayed and the Indian real estate bubble was on the verge of a burst, the RBI and NHB in 2013 issued separate but identical circulars advising the lenders to discontinue their subvention home loan products. The RBI and the NHB in these circular stated that subvention schemes are likely to expose the banks as well as their home loan borrowers to additional risks such as non-completion of the project on time, etc. Further, any delayed payments by developers/builders on behalf of individual borrowers to banks may lead to lower credit rating/scoring of such borrowers by credit information companies (CICs) as information about servicing of loans gets passed on to the CICs on a regular basis. In cases where bank loans are also disbursed upfront on behalf of individual borrowers in a lump-sum to builders without any linkage to stages of construction, banks run disproportionately higher exposures with concomitant risks of diversion of funds.

Because RBI and NHB were aware of the predatory lending practices of the lenders, they emphasised that “banks while introducing any kind of product should take into account the customer suitability and appropriateness issues and also ensure that the borrowers/customers are made fully aware of the risks and liabilities under such products.”

As the subvention schemes did not stop, in 2016, the NHB issued another circular reminding the lenders of its 2013 circular and warning them that penal provisions of National Housing Bank Act, 1987 may be invoked against them if the practice is not immediately discontinued. An opportunity to set a resounding precedent by penalizing the errant lenders, who exposed lacs of home buyers across the key national markets to grave financial risk, was missed.

As the RBI and NHB did not invoke penal provisions of laws against the lenders or their management, the predatory lending practices continue. Lenders continue to offer subvention or 80:20 home loan schemes, under various nomenclatures.

Moratorium on EMIs

The predatory lending practice of the lenders not only assisted the promoters of real estate projects to receive unreasonable funding, it also broke the back of the Indian middle class. Because the lenders failed in their obligation to follow sound lending practices, an overwhelming number of real estate projects came apart. Amongst other malpractices, the promoters and developers of these real estate projects diverted funds to their other business interests and amassed private wealth at the expense of public money. Several housing projects got delayed with delay periods ranging from 2 years to whopping 10 years.

The home buyers today are facing extreme financial burned of paying housing rentals along with EMIs. That too without any reasonable expectation of delivery of the flat booked a decade ago. A default on the EMI would expose them to litigation under Section 138 of the Negotiable Instruments Act, 1881 and proceedings before the debt recovery tribunal. Several of them have stopped payment of their EMIs and are being harassed by lenders for such non-payment. Their right to life continues to get infringed.

The predatory lending practices of the banks and HFCs also created an unprecedented scenario where the underlying security of a housing finance transaction is non-existent even a decade after the loan transaction.

The gravity, complexity and size of this crisis, involving human element, calls for the RBI and NHB to intervene and issue directions to scheduled commercial banks and HFCs to provide a moratorium on EMIs to the home buyers until the delivery of their houses or refund of their principal amount paid to the builder, with interest. While the damage caused by this socio-economic offence is hard to recompense, a moratorium on EMIs will atleast provide a provisional relief from the continuing injustice.

(The writer is a senior advocate. Views expressed are personal.)