RBI Considers Hiking Risk Weight for Commercial Real Estate Loans
The Reserve Bank of India (RBI) is contemplating increasing the cost of funds for the commercial real estate sector by up to 200 basis points. This potential move aims to preempt the formation of another bubble in the local property market. The central bank is exploring this measure to ensure financial stability within the real estate sector.
According to an RBI official:
“We are looking at a hike in the risk weight to the commercial real estate segment to 125% as a measure to ward off another bubble in the real estate segment and to ensure high credit quality”.
Currently, interest rates on most loans fluctuate between 7.5% and 12.5%, contingent upon the borrowing company's credit rating. The proposed change could increase loan costs for this segment by 75-200 basis points.
Impact on Land Development and Real Estate Firms
Bank financing for land development falls under the CRE (Commercial Real Estate) classification if lease rentals are the intended repayment source. This specific segment has recently exhibited signs of recovery following a quicker-than-anticipated rebound in the national economy from a demand downturn.
However, this measure could potentially negatively impact the financial well-being of some of the country’s largest real estate companies. These organizations previously resorted to selling land and ongoing development projects to fulfill cash flow obligations during tougher economic periods. A similar action taken by the Reserve Bank of India back in 2007 led to a substantial decline in property values. Although the central bank faced criticism for the decision at the time, the 2008 global financial crisis ultimately validated the RBI’s foresight and prudence.
Previous Risk Weight Adjustments and Current Concerns
Until mid-November of the previous year, the risk weight assigned to loans secured by commercial real estate stood at 150%. The banking regulator subsequently lowered it to 100% with an objective of stimulating credit flow to the sector, which was then grappling with a significant decline in demand. The current consideration to increase this could again introduce a strain in this segment. The chairman of a government-run bank, speaking on condition of anonymity, suggested that the substantial exposure of certain banks within the commercial real estate sector might be motivating the RBI to contemplate such a measure. He indicated that a considerable portion of the recent non-food credit uptake has been directed towards real estate. However, the chairman noted that a 25% increase in risk weight would likely have a limited effect on the broader dynamics of the real estate lending market. Recent trends in lending within the sector underline the potential risks and benefits tied to the central bank’s contemplated policy shift.