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Posted On: 2020-07-03 Author : R.S. Garg
1. Definition of Housing Finance Company

Paragraph 4.1.17 of the Master Direction –Non-Banking Company – Housing Finance Company (Reserve Bank) Directions, 2021 defines the expression “Housing Finance company” to mean a company incorporated under the Companies Act, 2013 that fulfils the following conditions:

  1. It is an NBFC whose financial assets, in the business of providing finance for housing, constitute at least 60% of its total assets (netted off by intangible assets). Housing finance for this purposes shall mean providing finance as stated at clauses (a) to (k) of Paragraph 4.1.16.
  2. Out of total assets (netted off by intangible assets), not less than 50% should be by way of housing finance for individuals as stated at clauses (a) to (e) of Paragraph 4.1.16.

Further, a company is treated as an NBFC if its financial assets are more than 50 per cent of its total assets (netted off by intangible assets) and income from financial assets should be more than 50 per cent of the gross income.

Paragraph 4.4 provides that if any question arises as to whether a company which is a financial institution, is a housing finance company or not, such question shall be decided by the Bank, having regard to the principal business of the company and other relevant factors and the decision of the Bank shall be final and binding on all the parties concerned.

Principal business criteria for HFCs as laid down above needs to be reviewed as the same is contrary to the enactments, legislative intent and established legal proposition and would do more harm than good to the housing finance sector.

Undoubtedly HFCs are sub-set of NBFCs and this position has always been so since enactment of National Housing Bank Act, 1987 providing separate regulation and supervision of such companies with a view to promote housing finance institutions in the country. The NHB Act defines housing finance institution, which also included a housing finance company as the one “which primarily transacts or has as one of its principal objects the transacting of the business of providing finance for housing, whether directly or indirectly.”

The expression “primarily” has been used in the sense of “mainly”. The dictionary meaning of the word primarily are mainly, basically, chiefly, fundamentally, mostly and generally. For determination of the companies falling under this category, it is necessary to lay down certain objective criterion. However, the criterion needs to be so evolved that it does not exclude the companies which are mainly or primarily engaged in the business of housing finance.

It may not be out of place to mention here that the definition in the NHB Act was inserted keeping in view the several benefits available to HFCs under the Income Tax Act ( e.g. Section 10(15)(iv)(g), 36(1)(viii), 80C(2)(xviii) etc.). This was also kept in view while inserting section 29C in the NHB Act.

It is also pertinent to mention here that keeping in view the above provisions, housing finance companies were hitherto being formed and registered and contributed to the growth of the housing finance sector by transacting 50% or more in the housing finance space and the rest in other businesses which incidentally in the case of such companies was again in financial assets i.e. in loans against property.

It is submitted that there was no distinction in housing finance between loans to individual and to developers/builders so long as it qualifies the above definition of primarily transacting the business of housing finance. Such distinction therefore is clearly against the legislative intent. Further, the Act refers to the conduct of business as the criterion and not the income. Therefore, stipulation of 50 per cent income from financial assets is also contrary to the legislation. In fact, considering the long term nature of housing finance business and return to the lenders, it may be difficult to fulfil this criterion.

The HFCs will be put to disadvantageous position vis a vis NBFCs in as much as NBFCs after acquiring 50 per cent financial asset are free to deploy the remaining in any other activity including even manufacturing whereas HFC would require 60 percent in the housing finance business and by experience we know that the balance normally HFCs put in Loan against property thus becoming 100 per cent financial company exposing themselves to more risk then NBFCs.

Considering the above in totality, we suggest that a “housing finance company’ should be defined to mean “ An NBFC whose 60% of the financial assets are towards housing finance as defined in Paragraph 4.1.16.”

2. Definition of Housing Finance

Paragraph 4.1.16 of the Master Direction defines ‘Housing Finance’.
The definition is exhaustive as it excludes what is not covered therein. However, it does not cover loans to HUFs. This need to be specifically covered as even Income Tax Act, 1961 extends concessions for the loans given to HUFs by lenders.

Further, to avoid any regulatory arbitrage, the definition of ‘Housing Finance’ should be applied across the board to all lenders viz., banks, RRBs, UCBs, HFCs and NBFCs.

3. Computation of LTV

Paragraph 19 of the Directions prescribe Loan to Value (LTV) Ratio for housing loans. The Note appended to the said Direction also prescribe how the LTV Ratio should be computed. In terms of the said Note, LTV Ratio shall be computed as a percentage with total outstanding in the account (viz. “principal +accrued interest+ other charges pertaining to the loan” without any netting) in the numerator and the realizable value of the residential property mortgaged to the HFC in the denominator.

The method suggested for computation of LTV ratio is essentially relevant for computation under Paragraph 6 relating to Capital requirement as certain risk weights have been prescribed on the housing loans sanctioned to individuals linked to LTV Ratio. It has nothing to do with computation at the time of sanction of the loan as there cannot be accrued interest or other charges at that stage. In fact the expression used “ total outstanding in the account” suggest a stage subsequent to that of grant of loan. At the time of grant of loan, it is the loan amount in the numerator divided by the realizable value of the residential property in the denominator which need to be within the prescribed limits.

Hence, the above should be omitted from Paragraph 19 and inserted suitably in paragraph 6 of the Directions to bring more clarity in the application of this Direction.

4. Commercial Real Estate- Residential Housing (CRE –RH)

Note (b) appended to Paragraph 12 of the Directions relates to CRE-RH. The last sentence i.e. “In case the FSI of the commercial area in the predominantly residential housing complex exceed the ceiling of the project loans, the entire loan should be classified as CRE and not CRE-RH”. The sentence in the present form causes confusion.

In fact the sentence should read “In case the FSI of the commercial area in the predominantly residential housing complex exceed the ceiling of 10%, the project loans should be classified as CRE and not CRE-RH”.

Attention in this regard is invited to Paragraph 4.7.5 of Master Circular- Finance for Housing Schemes to UCB dated 01.07.2015.

5. Asset Classification

Paragraph 8 of the Directions gives norms for asset classification. As per paragraph 8.1 classification of assets is to be done “after taking into account the degree of well-defined credit weakness and extent of dependence on collateral security for realization”. The assets are to be classified into Standard Assets, Sub-standard assets, doubtful assets and loss assets.

The expression “well defined credit weakness” is not defined but in commercial parlance include a project’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time or the project’s failure to fulfil economic expectations. They are characterized by the distinct possibility that the lender will sustain some loss if the deficiencies are not corrected.

The expression ‘Standard assets’ and ‘ sub-standard assets’ have also been defined. However, difficulty have arisen in the mechanical application of the definition of sub- standard assets by ignoring the fact that they are prudential norms and well defined credit weakness is also to be factored while classifying the accounts.

Any re-negotiation or re-schedulement has been classified as sub- standard assets though there was no default on the date of such re-negotiation or re-schedulement and it was done for reasons other than credit weakness in the account such as reduction in the rate of interest, sanction of additional loan, merger of two loan account to facilitate payment by the borrower etc.

Similarly, roll-over of inter corporate deposit which is for business consideration or standard market practice and without any weakness was classified as sub-standard asset.

The prudential norms are not intended to curtail freedom of contract between the lender and the borrower so long as there is no default and so long as the account is not showing any credit weakness.

The position need to be clarified in the directions to avoid any kind of case to case basis interpretation both by the HFCs as also by the Supervisors.

It will be better if restructuring is defined clearly preferably as in the case of NBFCs to avoid any possibility of mis-interpretation.

6. Re-Grouping of the Directions.

On going through the Master Directions, it is observed that directions on certain aspects needs to be re-grouped to enable the reader to have total view of the subject without going through the entire directions. In this connection, attention in invited to the following:

  1. Directions related to opening/closing of offices, branches, representative offices etc. ( Direction No. 39, 56 &93).
  2. Directions related to LTV( Direction No 3.1.4 &19).
7. Deletion of Master Direction No. 105.

Consequent to the issue of Notification No. S.O.2405(E) by the Central Government on June 17, 2021 notifying all housing finance companies registered under sub-section (5) of section 29A of the National Housing Bank Act, 1987 having assets worth rupees one hundred crore and above as financial institutions for the purposes of SARFAESI Act, the provision of direction 105 have become redundant and should be deleted.

8. Imposition of penalty by NHB/RBI

Penalties have been prescribed for non-compliance /breaches /violations of the statutory provisions including regulations, directions, guidelines, orders or circulars etc. issued by RBI/NHB under Section 49 to 52 of the National Housing Bank Act, 1987. The prescribed penalties include imprisonment or fine or both imprisonment and fine. Where the prescribed penalty is imprisonment or both imprisonment and fine, NHB/RBI itself or through its authorized officer is required to approach a Court for imposition of such penalty.

However, NHB/RBI have also been vested with powers to impose fines in terms of Section 52A of the NHB Act in lieu of the above penalties. Paragraph 114.1 of the Directions reiterates this position with regard to the power of NHB/RBI to impose such penalties by way of fines only for which also a procedure is duly prescribed in the statute.

These penal provisions need to be reviewed in totality as there are many aspects some of which are discussed below which needed to be looked into apart from the procedural part.

It is submitted that the procedure laid down under the other statutes governing financial sector Viz., SEBI Act, PFRDA Act etc. needs to be looked into to ensure that there is no scope of arbitrariness and rules of justice & fair play are applied in the matter of imposition of penalties by NHB/RBI under Section 52A of the NHB Act.

The salient features of the provisions of RBI Act and NHB Act which promotes justice and fair play are:

  1. Opportunity of hearing.
  2. In case of non-payment, RBI/NHB to approach Court for levy of penalty. However, role of court appears to be to not to adjudge the case but to issue a certificate based on the decision taken by RBI/NHB.

However, compared to SEBI & PFRDA Acts, RBI & NHB Act does not have :

  1. Provision for appointment of officer of certain level only to consider the issue of levying penalty.
  2. Factors which should weigh in imposing penalty
  3. Provision for imposition of penalty by officers other than in the supervision department
  4. Provision for appeal against the orders.

This need to be suitably provided.

As already stated that HFCs are also NBFCs and can be penalized under section 58G of the RBI Act. The prescribed quantum of penalty under the RBI Act and under NHB Act is different, the one under RBI Act being more severe. It is therefore necessary to remove any kind of uncertainty and clarify under which of the Act, RBI will resort to imposition of penalty, if the circumstances so arises.

Section 49(2), 49(2B), 49(2C) & 49(4) also provides for imposition of fines only on the HFC contravening the provisions of the Act/ directions etc. through the Courts. These penalties are much less than the one prescribed under section 52A. This position need to be reconciled and it should be made clear that in no case the pecuniary penalty under section 52A shall exceed the one prescribed under section 49.

A closure look at section 52A also reveal that the provision should have been “ (b) where the contravention or default is under sub-sewhere the contravention orction (2A) or clause (a) or clause (b) of sub-section(3) of section 49….” Instead of “ (b) default is under sub-section (2A) or clause (a) or clause (aa) of sub-section(3) of section 49….”

The unintended mistake has caused immense harm which is evident from the penalties imposed by NHB during the year 2020-21 and even made the 52A(a) absolutely nugatory. In our view, legislature has intended to impose heavy penalties only in cases of (a) where the business is conducted without registration (b) where deposit is received in contravention of any direction and (c) prospectus or advertisement is issued in contravention of any order as is evident from the provision of section 49(3)(a) and (b). Pending amendment to the Act, there is need to ensure that for violation of the provision of clause 49(3)(aa), the penalty is imposed under sub-clause (a) of section 52A(1) and not under sub-clause (b).

Further, the Act also refers to “where such default or contravention is continuing one”, the expression need to be clarified by examples or notes. For instance if a HFC accepts a deposit in contravention of direction, the offence is complete and it is not continuing till the time deposit is repaid warranting imposition of penalty for a continuing offence. In case of breach of a direction, it should constitute as if the offence is complete. However, in practice it is being treated as continuing one and penalties are being applied accordingly.

Limitation. There is no period of limitation prescribed under Section 52A of the NHB Act. Therefore, the period of limitation prescribed under the Code of Criminal procedure (Section 468) shall apply in terms of which the period is six months, if the offence is punishable with fine only. The position need to be clarified suitably both to the Companies as well as officials of the regulatory bodies so that timely action on violations can be initiated. If for any reason it is felt that section 468 is not applicable, then the limitation should be provided in the Act itself. This position should even apply to the offences under the RBI Act.

GST. The position of applicability of GST also need to be clarified as it is seen that NHB has collected GST even on the penalties levied by it which is neither goods nor any services rendered by it attracting the GST Act, while none of the other regulator has made such a collection.

9. Fixation of Timelines

For ease of doing business and bring certainty in the business, it is necessary that decision on regulatory permission/ approvals etc. are taken without undue delay, for which timeline need to be fixed in the Act/ directions. Some of the areas, where such timeline need to be fixed are:

  1. Grant of Certificate of Registration (Section 29A (4).
  2. Decision on Appeal against the order of rejection on application. (Section 29A(7)).
  3. Approval with regard to safe custody of securities (Proviso to Direction 40.1).
  4. Permission required under paragraph 45 of the Direction in the matter of acquisition or transfer of control.
  5. Permission to open representative office (Paragraph 56.3 of the Direction.
  6. Appropriation of Reserve Fund Created under Section 29C ( Paragraph 113.2 of the Directions).
  7. Issue of Tier II capital in foreign currency, redemptions and exercise of call option ( Annex II to the Direction).
10. Review of Supervision of HFCs

Finance (No. 2) Act, 2019 had integrated the regulatory function of HFC and vested the same in RBI like other NBFCs leaving supervision function with the National Housing Bank. This was a new structure in the financial sector where the regulation is done by the Central Bank and supervision is done by another statutory body.

With the issue of Master Directions with a clear direction (direction 114) that supervision of HFC will rest with NHB, an attempt is made to clarify the position of supervision of HFCs. However, the legal position remain the same i.e. both RBI and NHB has the power of supervision of HFC and thus HFCs are subject to dual supervision, which need to be avoided. In fact, Standing Committee of Parliament has made a specific comment while discussing the proposal for amendment to NHB Act that any kind of duality, whether in the matter of regulation or of supervision, should be avoided.

The above fact is also evident from the fact that approval required in certain matters (for instance acquisition/takeover of control etc) is required to be sought from RBI and not from NHB. RBI internally seeking comments from NHB before granting or refusing such permissions only add to delays in decision making by RBI.

As mentioned supra, RBI can impose penalties on HFCs under RBI Act as also under NHB Act and the two differ from each other. For this reason also there is need to synchronize the provision and vest all such powers in RBI under the RBI Act.

In the ensuing two years, it is seen that RBI has extended many provisions of number of directions which were applicable to NBFCs to HFCs in addition to reiteration of the provisions which were issued by NHB and were applicable to HFCs. However, ensuring compliance of all these provisions vests in NHB. This has given rise to possibility of two approaches being adopted in the matter of enforcement of these directions one by RBI while supervising NBFCs and another by NHB while supervising HFCs. A glaring example is the collection of GST on the penalties levied by NHB while RBI has not charged GST on the penalties levied by it on NBFCs. This need to be avoided and uniform approach need to be adopted.

NHB is also lender to HFCs and the lending has increased overtime. As of date over 60 HFCs are availing refinance from NHB. All these HFCs, which are mainly in the private sector are also availing financial assistance from banks. For the peculiar position enjoyed by NHB, lending by NHB to HFC is considered one of the criteria for financing by other lenders to such HFC. However, in case of some problem or mismanagement of HFCs, NHB is blamed both by the public as also by other lenders. This causes damage to the image of a supervisory authority and to the whole system of supervision in the eyes of public. The DHFL fiasco is a clear example of public perception where despite clear provision and agreements between DHFL and NHB, lenders, depositors and public at large has questioned the action of NHB in the matter of recovery of its dues, being also the supervisor of DHFL.

It may also be mentioned that the regulation of RRBs by RBI and supervision by NABARD stands on a different footing and cannot be treated as a good example of keeping supervision and regulation with two different entities as RRBs are also owned by Central Govt./State Government etc.

For the foregoing reasons, the present arrangement of supervision of HFCs needs to be reviewed at the earliest.

11. Simplification / Clarifications of provisions relating to Acquisition /Transfer of Control

Paragraph 45 of the Master Directions relating to acquisition /transfer of control refer to changes in the shareholding including progressive increases over time. From the current direction it is not clear from which date the same is to be reckoned e.g. from the date of issue of the current direction or from the date on which NHB had issued similar directions.

It is also not clear whether such approval will be required every time once the limit of 10 per cent or 26 per cent is reached OR once HFC has obtained approval, fresh approval will be required only when again there is a change of 10 per cent or 26 per cent as the case may be from the one approved earlier. Similarly, in the case of change of directorship also whether approval is required every time after once there is a change in 30 per cent of the directors excluding independent directors.

We suggest that fresh approval should be mandated only when again there is change of over 10/26 percent in the shareholding or 30% in the directors.

The above positions needs to be suitably clarified to remove uncertainty in this regard.

12. Applicability of clarifications issued by RBI to NBFCs also to HFCs.

RBI had issued clarifications from time to time with regards to its directions, guidelines and circulars issued to NBFCs. Many of these circulars, guidelines and directions have now been extended to HFCs. RBI should, therefore, clarify by means of a Circular that all such clarifications issued by it from time to time and applicable to NBFCs shall mutatis mutandis apply to HFCs.