How This RBI Move May Trigger Greater Demand For Affordable Homes

In its Fourth Bi-monthly Monetary Policy statement on September 29, the Reserve Bank of India (RBI) announced to reduce the minimum risk weight for individual home loans in the affordable segment from the current rate of 50 per cent. "With a view to improve affordability of low-cost housing for economically weaker sections and low-income groups ... it is proposed to reduce the risk weights applicable to lower value but well-collateralised individual housing loans," the RBI statement said.

The central bank has yet to issue detail guidelines and the rate reduction in this regard.

Simply put, when the minimum risk weight for individual home loans in the affordable segment is lowered, banks will have to set aside less capital for loans in this segment. This would lead to availability of more funds for the segment.

The calculation

The minimum risk weight is the amount of capital banks and home finance companies have to set aside while extending home loans. The risk weight is calculated on the capital adequacy ratio (CAR) . CAR is the measure of a bank's financial strength expressed by the ratio of its capital to its risk-weighted credit exposure. For banks, currently, the capital adequacy ratio is nine per cent, and for home finance companies, it is 12 per cent.

At the current rate of 50 per cent of minimum risk weight, for instance, if a bank lends Rs 1 crore to a home owner, it should set aside Rs 4.5 lakh. At nine per cent, the total amounts comes down to Rs 9 lakh, 50 per cent of which has to be set aside as the minimum risk weight. By the same calculation, if a home finance company lends the same amount, it should set aside Rs 6 lakh.

What does it change?

When banks and home finance companies have more money to lend to people in the affordable segment, this will lead to a greater demand for real estate in India. Many consider the RBI announcement a sound decision, as home loans are secured by collateral; risks associated with such loans are low. Banks and home finance companies would not have to rely on fresh infusion to capital to lend out to home buyers.

At a higher risk weight rate, banks are expected to raise their capital base even as their loan book grows. Achieving greater profits and raising fresh capital are the only choices banks have in a scenario like this. This leads to a slow growth rate in the real estate sector.