Why SBI is Launching a Home Loan that Caused the Financial Crisis - Vivek Kaul's Diary
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Why SBI is Launching a Home Loan that Caused the Financial Crisis

Feb 2, 2016

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In August 2015, Arundhati Bhattacharya the Chairman of the State Bank of India (SBI), had suggested that the country's largest bank be allowed to launch teaser rate home loans. As she had said back then: "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." Base rate is the minimum interest rate a bank charges to its customers.

The bank had first launched teaser rate home loans in 2009. These 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 the home loans. Hence, the EMIs for the borrower during the first few years are lower than they would have been in the normal scheme of things.

Yesterday (i.e. February 1, 2016), SBI went a step further, and launched a home loan in which the monthly payments initially will be even lower than the EMIs paid in case of teaser rate home loans. It launched what it calls the SBI FlexiPay Home Loan.

As the press release of the announcement of this home loan points out: "The new offering, 'SBI FlexiPay Home Loan', will enable young working professionals / executives to get higher loan amount compared to their loan eligibility under normal Home Loan schemes. The additional loan amount will help such professionals in acquiring better and spacious living spaces for themselves and their families, taking into account their future needs."

Hence, anyone applying for a FlexiPay Home Loan will get a higher amount of home loan than his or her loan eligibility would permit under normal circumstances. And there is more to this as well. As the SBI press release points out: "Further, to lower the impact of such additional loan amount on monthly repayments in the form of EMIs, the customers availing Home Loan under 'SBI FlexiPay Home Loan Scheme' will also be offered the option of paying only interest during the moratorium (pre-EMI) period of 3 to 5 years, and thereafter, pay moderated EMIs. The EMIs will be stepped-up during the subsequent years."

So, other than getting a higher loan amount, the loan also comes with the option of the borrower only paying the interest on the loan during the first few years. And this makes things very interesting.

As the SBI press release points out: "Soaring aspiration levels and rising awareness about the impact of quality living spaces on healthy and harmonious living are resulting in our newer generation of working professionals to show greater preference for better and larger homes. But they are constrained from purchasing their dream homes due to the relatively lower income available at early stage of their career."

Hence, the FlexiPay home loan will essentially allow people buy a home which they otherwise wouldn't have been able to afford given their current level of income. As SBI puts it, the loan tries to "to bridge the gap between affordability and demand for quality residential spaces in the country".

There are multiple questions that arise here. Let me try and answer them one by one.

  1. Why is SBI doing this? The answer lies in the numbers. The bank like other public sector banks has significantly lower bad loans when it lends to retail consumers than when it lends to corporates. As on September 30, 2015, the bad loans when it came to lending to retail sector (i.e. home loans, auto loans, personal loans etc.) were at 1.03% of the total lending carried out to the sector. This number had been at 1.37% as on September 30, 2014.

    In comparison, the bad loans while lending to mid-level corporates were at 10.62%. Bad loans while lending to small and medium enterprises were at 8.72%. Also, while the overall bad loan rate in case of retail loans is 1.03%, it is safe to say that the bad loans rate while giving out home loans would be lower.

    One explanation for this lies in the fact that it is easy to unleash legal proceedings (or the threat of) against retail borrowers and get them to pay up than it is to do against corporates. Hence, it makes sense for the bank to give out home loans in comparison to other loans, where recovery is difficult.

    In fact, between September 2014 and September 2015, 25% of all domestic lending carried out by the bank was in the form of home loans.
  2. Should SBI be doing this? It is clear that SBI wants to give out more home loans. The trouble with the FlexiPay home loan is that it relaxes the lending standards while giving out a home loan. As the press release points out that the loan will help the borrower "to get higher loan amount compared to their loan eligibility under normal Home Loan scheme".

    While this will allow the bank to lend more, relaxing lending standards in order to lend more is not always the best way to expand the loan book. As the SBI press release further says the loan will help "to bridge the gap between affordability and demand for quality residential spaces in the country".

    The function of any bank is to give loans and to give them out to those people and institutions who are likely to return it. It is not the function of a bank to improve the real estate scenario in a country by lowering its lending standards.

    Further, in the interest only version of the loan the EMI is likely to jump up once the principal repayment (through the EMI) also kicks in after a period of three to five years. In fact, even after three to five years, when EMIs kick-in, the borrowers will have to "pay moderated EMIs".

    The bank is essentially working with the assumption that the income of the borrower will go up during the period and he will be in a position to pay the higher EMI. But is that likely to be the case?

    Let's try and understand this through an example. The scheme allows for upto 1.2 times higher loan eligibility compared to the loan eligibility under the normal home loan scheme. The loan amount has to be Rs 20 lakh or higher. What this means is that anyone with a loan eligibility of Rs 50 lakh under normal conditions, can take a loan of upto Rs 60 lakh.

    Over and above this he can choose only to pay interest on it for the first five years. The current rate of interest on an SBI home loan is 9.55% (9.5% for women). Hence, the monthly payment for the first five years will come to Rs 47,750 (9.55% of Rs 60 lakh divided by 12).

    The question is if the borrower chooses to pay this amount as an EMI what loan amount will he be eligible for? SBI offers a tenure of up to 30 years on its home loans. At an interest of 9.55% and a tenure of 30 years, an EMI of Rs 47,750, is good enough to repay a loan of Rs 56.55 lakh, which isn't very different from Rs 60 lakh. (The EMI for a Rs 56.55 lakh home loan to be repaid over 30 years and at an interest of 9.55% comes to Rs 47,757).

    The trouble is the eligibility of the borrower under the normal home loan is only Rs 50 lakh and he won't get a loan of Rs 56.55 lakh. By structuring the loan the way it has, SBI gets to collect interest longer than it actually would have.

    What happens once the EMI kicks in after five years? The bank talks about moderated EMIs. It does not define what it means by it. Assuming that principal repayment starts after five years, the EMI will jump to around Rs 52,630.5. This means that the borrower will repay the home loan over the next 25 years, making the total tenure of the loan repayment 30 years. The scheme allows for repayment period of 25 to 30 years.

    If the repayment is made over the next 20 years, meaning a tenure of 25 years, the EMI jumps to Rs 56,124. The EMI does not increase significantly in comparison to the earlier monthly payment. The reason for this lies in the fact that SBI has limited the loan eligibility under this scheme to just 20% more than the normal home loan scheme. Hence, to that extent SBI is not making a very risky loan, even though it is taking on some more risk than it currently is.

    Also, it is important to understand here that once SBI launches a product, other banks and housing finance companies will have follow. If they stick to 1.2 times the normal loan amount, they will not be giving out very risky loans. If they get aggressive and up the ante, that will mean the lowering of home loan lending standards throughout the system. Hence, the RBI will have to keep a watch on this.
  3. What can we learn from the American experience? Interest only home loans were a big reason behind the home loan bubble in the United States between 2000 and 2007. In the American context they were referred to as the option adjustable-rate mortgage (ARM). An option ARM was a 30-year home loan in which the borrower had the option of paying a lower EMI initially. One version of the product was called 5/1 interest-only option ARM.

    In this, the interest rate was reset after the first five years and then every year after that. Also, for the first five years, the borrower needed to pay back only interest on the home loan. In the American case, the interest rate in case of an interest only home loan was significantly lower than the normal home loan.

    Hence, this product allowed borrowers to buy homes which were significantly more expensive than they could afford. In the Indian case, the interest on the interest only home loan is the same as the normal home loan.

    Also, in the United States, after a point there was a race among banks and financial institutions to give out these loans. As more such loans were given, home prices went up, leading to a huge real estate bubble.

    Once the higher EMIs started kicking in, the borrowers started defaulting on their loans. This eventually led to the start of the financial crisis that the world is currently battling. Given this, the lessons from the American experience are very clear. Interest only home loans are pretty risky if the interest rate differential between a normal home loan and an interest only home loan is high. That is clearly not the case with the new SBI FlexiPay home loan and this brings us back to the original question.
  4. Why is the SBI doing this? From what the RBI governor Raghuram Rajan has been saying, it doesn't seem that this home loan scheme would have had a total buy-in from him. Given this, I think SBI may have been nudged to launch this scheme by the finance ministry, in order to get the real estate sector going in this country. Given that I have no evidence for this, to that extent this remains a conspiracy theory.

    Nevertheless, if this scheme and other such schemes launched by other banks and housing finance companies gain some traction, they will prolong the real estate bubble in the country even more. Hence, instead of reviving real estate, it will make purchasing a home even more difficult. At the same time, I don't think SBI is taking on an undue risk by launching this scheme. But it remains to be seen how other banks enter this space. If they lower lending standards by increasing the loan eligibility further, we may have a problem.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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8 Responses to "Why SBI is Launching a Home Loan that Caused the Financial Crisis"

GVKRAU

Feb 2, 2016

Quid pro quo for getting the post of Chairman SEBI? Let us watch!

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vip

Feb 2, 2016

The SBI is probally lending to peter to make sure Paul can pay back his loan to them.
The real estate sector is in a constipated situation currently, developers cant repay, so why not help them (SBI & the developers) out by sending peter out to buy what Paul cant sell. This way the SBIs NPAs could look a little better, is it window dressing? or will this kind of Quantative Easing be the laxative that will work ?

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R K Nagpal

Feb 2, 2016

REAL ESTATE INDUSTRY WILL LANGUISH FOR FEW MORE YEARS DUE TO GREED OF DEVELOPERS ,LACK OF TRANSPARENCY , LACK OF TIMELY DELIVERY RESULTING IN LACK OF BUYERS TRUST IN MAJORITY OF DEVELOPERS . THERE ARE RAMPANT CASES OF DOUBLE FINANCING . THEY TAKE MONEY FROM BUYERS AND ALSO FROM THE BANKS. IT IS EXPECTED THAT THERE WILL BE SUBSTANTIAL NPA IN DEVELOPERS SEGMENT IN THE NEXT 1-2 YEARS.THEY TAKE THE MONEY OF 90 TO 95 % OF THE COST IN 2- YEARS BUT DO NOT DELIVER UNITS ANY WHERE BETWEEN 3 TO 8 YEARS AFTER THE SCHEDULED DATE.

UNLESS THE GOVT BRINGS PROPER REAL ESTATE REGULATOR BILL & RESTORE BUYERS CONFIDENCE NO BODY IS PREPARED TO GIVE MONEY FOR UNIT UNDER CONSTRUCTION EVEN WITH INCREASED FINANCE. THERE IS A WAKE UP CALL FOR BUILDERS THEY HAVE TO MEND THEIR WAYS & GOVT MUST BRING REAL ESTATE REGULATOR BILL AT THE EARLIEST.. RICKY

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UK Menon

Feb 2, 2016

If a man takes a Housing loan of Rs.60 lakhs under normal Housing loan of SBI and starts the repayment from the 2nd month itself, he will have to pay Rs.1,82,41,560/-(Provided the rate remains at 9.55% throughout the tenure). But if he takes the loan under FlexiPay Home loan, he will have to pay up Rs.1,86,54,120/-; approximately Rs.4.13 lakhs more. If he is going to repay by way of stepped up EMIs, the payout will be even higher. Clearly bank is going to gain. RBI has earlier told that such types of teaser loans carry higher risks and had fixed a higher provision on such loans & this accelerated provision has to be maintained by the banks beyond the teaser period by one more year- i.e if the teaser period is 5 years, the increased provision has to be maintained for till years. Hence SBI cannot afford to offer the same rate of interest as charged on the regular borrowers to the FlexiPay Housing Loan borrowers in the long run. Moreover in SBI the borrower has to pay conversion fees @0.56% of the balance outstanding to get the benefit of lower rate of interest whenever the rates are lowered. RBI had recently relaxed the Loan to Value ratio and risk weight for Housing loans up to Rs.75 lakhs in view of increasing inventory and tepid sales in the real estate sector. But can banks afford to dilute its norms at the cost of increasing risk? One should also consider the fact the average duration of deposits with banks is reducing very fast. Nowadays the longest tenor that a depositor would like to keep his deposit with the bank is 2 years or less. At the same time Banks are so liberal in giving housing loans with duration up to 30 years, resulting total mismatch of assets and liabilities. One of the main reasons for the large NPAs in Indian PSBs was that the banks entered into the lending for Infrastructure, Power, Telecom & Aviation sectors. All these sectors have pretty long gestation periods and it is not possible for commercial banks to give continuous support to them for such long periods. Government have unwisely allowed the Development Financial Institutions like ICICI, IDBI etc- who were the primary lenders for these sectors- to become commercial banks and the PSBs entered into this type of lending burning their hands as they lack the expertise or skills to deal with such loan accounts. Are bankers doing the same thing again by lending to Housing sector for such long period of 30 years? Only time can tell.

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Meher

Feb 2, 2016

SBI Home Finance Limited which was a subsidiary of SBI was closed and cheated the share holders. When SBI is not in position to the loans granted earlier by SBI Homes once again trapping the home loan seekers and share holders. Beware

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Ajay

Feb 2, 2016

I think, there is a distinct possibility that FM has a hand in it. And I don't think it is being done to revive the real estate market. It is being done to bail out the reals estate sharks that are reeling under unsold inventory particularly in the premium section.

The real estate market can be revived in no time (considering that there is so much pent-up demand for housing) if the prices are brought to even the higher end of reasonableness. But that will reduce profit margins and then who will supply money to massive electioneering campaigns which is the area of interest and core competence of the prime minister? So first bail out industrialists at the cost of small savers and retirees and now bail out real estate sharks at the cost of gullible home aspirants. Achhe Din indeed!!!

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R. ASOKKUMAR

Feb 2, 2016

SBI is not taking unreasonable risk as rightly pointed out by the Author. The product is restricted to working professionals. Even if average increase in the annual income of borrower is conservatively restricted to 10%, based on the example given in the article, the debt service coverage ratio in future will definitely improve.As I see it, there is another reason why SBI is doing this: surplus funds will be deployed at higher rate in stead of lying idle or being lent at lower rate in the Call Money market.SBI is smart.

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R Jambunathan

Feb 2, 2016

Thanks for a well thought and well presented article. May be SBI is not taking undue risk due to this new product "SBI Flexi Pay Home Loan". However some of the assumptions made by SBI may not be valid in respect of many cases. I is also not clear whether sanction under this product is restricted to some "special" people who in the assumption of SBI will have increased income to repay the loan.

Of course the product it self is not very new. The same product was offered long back calling it a telescopic repayment facility. But let us remember one thing. When the income for a person increases, his expenses also increase.

For the borrower, it is a sweet coated pill.In reality he is asked to pay more interest whether he realises his dream or not. So please be aware of your dreams and realities.

As a risk mitigation measure, it would be better if SBI restricts this product to "ready to occupy properties" alone, as as per to days market standards, if the borrower goes for an under construction property, there is a big possibility of his "dream" remaining as a "dream" with regard to possession of his property after a period of five years.

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