How Black Money Helps Indian Banks Finance Real Estate - Vivek Kaul's Diary
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How Black Money Helps Indian Banks Finance Real Estate

Mar 2, 2016

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Black money or money which has been earned and on which tax has not been paid, is a common phenomenon in India. The fact that only around 3-4% Indians pay income tax explains this. This hurts the government given that it is not able to raise as much tax as it could, if everybody or a substantial portion of Indians paid income tax. It also means that the government has to borrow more in order to meet its expenses, and this pushes up interest rates.

It is also not fair on those Indians, typically the salaried class, who have no option but to pay income tax. What has also happened over the years is that instead of trying to expand the tax base, various governments have tried to milk those who pay tax, for more and more tax.

But not everyone is hurt because of black money. In fact, in case of home loans, banks and housing finance companies benefit because of black money. As Kaushik Basu, current chief economist at World Bank and former chief economic adviser to the ministry of finance, writes in his new book An Economist in the Real World - The Art of Policymaking in India: "A lot of the buying and selling of homes in India occurs with a part of the transaction being made in cash with no record kept of this in order not to leave a trail of evidence."

Basu then goes on to explain how this benefits banks and housing finance companies issuing home loans. As he writes: "You want to buy a house valued at Rs 100 from the private market. The chances are the seller will tell you that he will not take the full Rs 100 paid in cheque, but will ask for a part, maybe Rs 50 or Rs 60, in cheque with the rest paid in cash with no evidence of this payment. The latter is called a black money payment."

And how does this help? As Basu writes: "This helps the seller not to have to pay a large capital gains tax. Even many buyers want to pay partly in cash and to show the value of the house to be less than it actually is in order to avoid having to pay too much property tax."


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In fact, what Basu misses out on is the fact that in many cases buyers also have black money and they need to put this to use. And real estate is the best place to put it use given the totally opaque way in which the sector operates.

The black money payment essentially helps banks because the risk they take on in giving out the home loan, essentially comes down. How? "Since mortgage loans [i.e. home loans] can only be taken on the "declared" part of the house price, a house valued at Rs 100 would typically be bought with a mortgage of less than Rs 50. This means that when house prices [fall], unless the price drops [are] extraordinarily large, banks [will] not have a balance sheet problem," writes Basu. In simple English what this means is that unless home prices fall dramatically, the value of the home (which is a collateral for the bank) will continue to be greater than the home loan outstanding.

He further philosophises that "Economics is not a moral subject". "Often what is patently corrupt, like the pervasive use of black money can turn out to be a bulwark against a crisis."

In fact, Basu feels that the black money payments ensured that Indian banks did not have their own version of the subprime home loan crisis that hit the United States in 2008-2009.

Let's understand this phenomenon in a little more detail. The December 2015 investor presentation of HDFC, the largest home finance company in the country, points out that the average home loan that it gives out is Rs 25 lakh. The average loan to value of a home stands at 65%. This means that the average price of a home financed by HDFC stands at around Rs 38.5 lakh (Rs 25 lakh divided by 0.65). The borrower/buyer makes an average down-payment of Rs 13.5 lakh(Rs 38.5 lakh minus Rs 25 lakh).

Over and above this there is a black payment to be made as well. It is very difficult to estimate the average amount of black money that gets paid every time a home loan is taken on to buy a home. Let's assume that a black money payment of Rs 11.5 lakh is made. This means the real price of the home works out to Rs 50 lakh(Rs 38.5 lakh plus Rs 11.5 lakh).

Against this, HDFC lends Rs 25 lakh. Hence, the real average loan to home market value ratio stands at around 50%. This also when we assume that black money forms around 23% of the total value of the transaction (Rs 11.5 lakh divided by Rs 50 lakh). Black money payments in large parts of the country, especially in the northern part, can be considerably larger than this.

Hence, what this clearly tells us is that banks and housing finance companies end up lending half or less than half of the market value of the homes they are financing through home loans. And this makes it a very safe deal. Home prices need to fall by more than 50% for the value of the home to be lower than the home loan outstanding.

What also helps is the fact that home loans in India are recourse loans. This means that in case a borrower decides to default on the home loan by simply walking away from it, the lender can go beyond seizing the collateral (i.e., the house) to recover what is due to him. He can seize the other assets of the borrower, be it another house, investments, or money lying in a bank account, to recover his loan.

This along with black money payments explains why home loans are such good business for banks and housing finance companies. In case of HDFC, the non-performing loans formed around 0.54% of the individual home-loan portfolio. In fact, even when loans go bad, the institution is able to recover a major part of what is due and this explains why "total loan write-offs since inception [for HDFC] is less than 4 basis points of cumulative disbursements." One basis point is one hundredth of a percentage.

In case of State Bank of India, another big home-loan lender, the non-performing loans formed around 1.02% of overall retail loans. The bank does not give a separate non-performing loans number for home loans.

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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4 Responses to "How Black Money Helps Indian Banks Finance Real Estate"

nitin

Mar 3, 2016

This actually states that banks are more than happy in increasing their home loan portfolio and the real issue behind rising NPA's are only the loans given to large corporates. Is this also the reason behind institutional investors picking private banks over PSU banks as the retail book and retail growth of private banks are better than that of PSU banks.

Would like to know your view over the recent moves with regards to banking sector -
1.Recapitalization of 25,000 cr provided by Finance ministry (against a higher expectation). Is this sufficient?? OR is it true that even a higher amount of 70,000 cr would have not made a difference considering the size of NPA's which should be around 5-6 lac cr.
2.Recent announcement in Basel norms by RBI.

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Pavan S

Mar 2, 2016

The concept of Cash payments for buying property was there some years ago but not any longer unless the property is tenanted and not ownership. The tenanted property is neither accepted nor available with any banks as a co-lateral. The price fall of the real estate market has actually wiped off the need for any further black money transaction. Property purchases which involve builders will not have any cash component as the builder will already have huge borrowings from the banks and all sales (if any) will be to repay the bank. The private sector (where a builder is not involved) will have the parties create a higher valuation certificate (by bribing the officials) thereby getting the bank stuck in the event of a non payment. Overall the bank cannot be termed as safe under the current economic scenario.

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Anil

Mar 2, 2016

Hi Vivek,
are the NPA's of Banks included money given to farmers by government.

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A.N. Saripalli

Mar 2, 2016

Yes Vivek. This is the main reason why Indian Banks survived the sub-prime mortgage crisis and not because of the excellence in our systems. In fact even the statutory audit of our bank branches is a farce and a total waste of public money spent in audit fees. The Banks in their bid to compete to declare results force the statutory auditors of banks and their branches to complete the audits of branches in a matter of days calling it a Balance Sheet Audit. Think of it. 250 days of 7 hours of work of about a minimum of 10 staff at a small branch gets completed by an audit firm engaging a staff of 2 or 3 in a couple of days and the bank is charged an audit fee of around Rs.50,000/- for a report that is fit for garbage bin as it serves no purpose. The Bank's internal auditors do a far better job. It is not only housing loans that are thus protected by black money but all those other loans that are backed by collateral securities/guarantees with a recourse to immovable property. I had personally brought this to the notice of several offices involved in policy formulation but no one acknowledges. The closest I got to an acknowledgement was NASSCOM when they called for entries for innovation ideas that would change work systems. I proposed that advances in global ICT aided by GPS/GIS and India's IT resource prowess have the capability to address this issue provided the government has the will to address corruption and embrace change. My idea was that the government set up a LAND EXCHANGE and make it mandatory that all private land deals be routed through the exchange by enabling a mechanism wherein each property would bear a unique identity linked to a unique DEMAT account of the owner of the property. This would then bring the much needed transparency to the real estate market and more importantly offer the honest tax payers a means to acquire and hold properties with a guaranteed peace of mind. This will also aid the government in curbing land grabbing and fraud. NASSCOM's response was that while the idea has merit, I need to provide them with a working prototype to progress to the next stage. That was where I fell flat as there is no way I could provide them with a working prototype as it requires government willingness that would be hard to get. I guess CREDAI can still get together to establish a PRIVATE LAND EXCHANGE and upset the apple cart to force the governments to embrace it sometime down the line. If CREDAI does this, what it will effectively do is threaten the State Exchequers a loss of revenue as all properties developed by CREDAI members will be registered in the name of CREDAI and listed on the exchange and when a prospective buyer buys the unit, all he will get is a certificate entitling him to that unit and probably a mortgage of that unit in favor of the bank that loans the funds. So, effectively what will happen is when there is a second sale, you don't have to go to the Registrar again and when states sense this they will recognize the merits of having the EXCHANGE. Further it will only help the governments to collect the property taxes too by a direct debit to the bank accounts. I do hope we get there one day as it will result in the real estate market reflecting realistic prices as they are right now high because of the black money parked in them.

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