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Module 3 – Management of Financial services

Housing Finance

Introduction

Housing Finance refers to providing finance to the individual / group of individuals for the
purchase, construction or related activities of house/flat etc. Till the mid 1980s’
responsibility of providing HF vested largely with GOI. The setting up of national housing
Bank (NHB), a fully owned subsidiary of RBI in 1988, marked the beginning of HF as a fund
based financial service in the country

Housing Finance System in India

Although there were a large number of agencies providing direct finance to individuals for
house construction, there was no well established finance system till the mid 80s in as much
as, it had not been integrated with the main financial system in the country. The setting up
of the NHB as the apex institution of HF in India, was the culmination of the fulfillment of a
long overdue need of the housing finance industry in India. The system has also been
characterized by the emergence of several financial institutions that have considerably
strengthened the organization of the housing finance system in India.

National Housing Bank

Genesis

•The Sub-Group on Housing Finance for the Seventh Five Year Plan (1985-90)
identified the non-availability of long-term finance to individual households on any
significant scale as a major lacuna impeding progress of the housing sector and
recommended the setting up of a national level institution

•The Committee of Secretaries considered the recommendation and set up the High
Level Group under the Chairmanship of Dr. C. Rangarajan, the then Deputy
Governor, RBI to examine the proposal and recommended the setting up of National
Housing Bank as an autonomous housing finance institution. The recommendations
of the High Level Group were accepted by the Government of India

•The Hon’ble Prime Minister of India, while presenting the Union Budget for 1987-88
on February 28, 1987 announced the decision to establish the National Housing Bank
(NHB) as an apex level institution for housing finance. Following that, the National
Housing Bank Bill (91 of 1987) providing the legislative framework for the
establishment of NHB was passed by Parliament in the winter session of 1987 and
with the assent of the Hon’ble President of India on December 23, 1987, became an
Act of Parliament

•The National Housing Policy, 1988 envisaged the setting up of NHB as the Apex
level institution for housing

•In pursuance of the above, NHB was set up on July 9, 1988 under the National
Housing Bank Act, 1987

•NHB is wholly owned by Reserve Bank of India, which contributed the entire paid-up
capital

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•The general superintendence, direction and management of the affairs and business
of NHB vest, under the Act, in a Board of Directors

•The Head Office of NHB is at New Delhi.

Preamble

The Preamble of the National Housing Bank Act, 1987 describes the basic functions
of the NHB as –

“... to operate as a principal agency to promote housing finance institutions both at

local and regional levels and to provide financial and other support to such
institutions and for matters connected therewith or incidental thereto ...”

Vision

NHB’s Vision derived out of the Workshop on ‘Aspiration Driven Transformation’

conducted for its Officers, and subsequently approved by the Board of Directors is as
follows –

“NHB ensures a sound and healthy housing finance system in India through effective
regulation and supervision of housing finance institutions. As a financial institution,
NHB is known for its commitment, innovation and quality of service, offering a broad
spectrum of financial products to address the needs of the housing sector with
motivated employees working in a congenial and participative work environment.

When people think of financial services related to housing, they think of NHB.”

Objectives

NHB has been established to achieve, inter alia, the following objectives –

a. To promote a sound, healthy, viable and cost effective housing finance system to
cater to all segments of the population and to integrate the housing finance
system with the overall financial system

b. To promote a network of dedicated housing finance institutions to adequately

serve various regions and different income groups

c. To augment resources for the sector and channelise them for housing

d. To make housing credit more affordable

e. To regulate the activities of housing finance companies based on regulatory and

supervisory authority derived under the Act

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f. To encourage augmentation of supply of buildable land and also building

materials for housing and to upgrade the housing stock in the country

g. To encourage public agencies to emerge as facilitators and suppliers of serviced

land, for housing.

Organization

NHB is a lean, officer oriented, professionally managed institution with its

headquarters in Delhi and offices in Mumbai, Hyderabad, Bangalore, Chennai,
Kolkata, Lucknow and Ahmedabad. It has 84 professionals at different levels. NHB is
committed to pursuit of excellence through innovation, doer work culture and
contemporary work practices with technology intervention. It has the following
Departments, apart from NHB RESIDEX Cell for handling residential index activities –

1. Regulation & Supervision

2. Refinancing Operations
3. Direct Finance Operations
4. Enabling Processes
5. Information Technology
6. Resource Mobilization and Management
7. Development and Risk Management
8. Board and CMD Secretariat

Regulation

In terms of the NHB Act, 1987, NHB is expected, in the public interest, to regulate
the housing finance system of the country to its advantage or to prevent the affairs
of any housing finance institution being conducted in a manner detrimental to the
interest of the depositors or in a manner prejudicial to the interest of the housing
finance institutions. For this, NHB has been empowered to determine the policy and
give directions to the housing finance institutions and their auditors.

Besides the regulatory provisions of the NHB Act, 1987, NHB has issued the Housing
Finance Companies (NHB) Directions, 2001 as also Guidelines for Asset Liability
Management System in Housing Finance Companies. These are periodically updated
through issue of circulars and notifications.
As part of the supervisory process, an entry level regulation is sought to be achieved
through a system of registration of housing finance companies.

NHB supervises the sector through a system of on-site and off-site surveillance.

Establishment of NHB & capital thereof

(1) With effect from such date as the Central Government may, by notification,
appoint, there shall be established for the purposes of this Act, a bank to be known
as the National Housing Bank.
(2) The National Housing Bank shall be a body corporate with the name aforesaid
having perpetual succession and a common seal with power, subject to the
provisions of this Act, to acquire, hold and dispose of property and to contract, and
may, by that name, sue and be sued

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(3) The head office of the National Housing Bank shall be at Bombay or at such
other place as the Reserve Bank may, by notification, specify

(4) The National Housing Bank may establish offices, branches or agencies at any
place in India, and with the previous approval of the Reserve Bank, at any place
outside India

4. (1) The authorised and paid up capital of the National Housing Bank shall be three
hundred and fifty crores of rupees:
Provided that the Central Government may, in consultation with the Reserve Bank,
by notification, increase the authorised capital up to two thousand crores of rupees.

(2) The Board may, on such terms and conditions, as determined by it from time
to time, issue the increased authorised capital to Reserve Bank, the Central
Government, scheduled banks, public financial institutions, housing finance
institutions or such other institutions, as may be approved by the Central
Government:

Provided that no increase in the issued capital shall be made in such manner that the
Reserve Bank, the Central Government, public sector banks, public financial
institutions or other institutions owned or controlled by the Central Government, hold
in aggregate at any time, less than fifty one per cent. of the issued capital of the
National Housing Bank.]

Management of NHB

(1) The general superintendence, direction and management of the affairs and
business of the National Housing Bank shall vest in the Board of Directors, which
shall exercise all powers and do all acts and things, which may be exercised or done
by the National Housing Bank

(2) Subject to the provisions of this Act, the Board, in discharging its functions, shall
act on business principles with due regard to public interest

(3) Subject to the provisions of sub section (1) and save as otherwise provided in the
regulations made under this Act, -

1[(a) the Chairman, if he is a whole-time director or if he is holding offices both as

the Chairman and the Managing Director, or

(b) the Managing Director, if the Chairman is not a whole-time director, or if the
Chairman being a whole-time director, is absent,]

shall also have powers of general superintendence, direction and management of the
affairs and business of the National Housing Bank and may also exercise all powers
and do all acts and things which may be exercised or done by the National Housing
Bank and shall act on business principles with due regard to public interest.
(4) The Managing Director shall, in the discharge of his powers and functions, follow
such directions as the Chairman may give

(5) In the discharge of its functions under this Act, the National Housing Bank shall
be guided by such directions in matters of policy involving public interest as the

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Central Government, in consultation with the Reserve Bank, or the Reserve Bank,
may give in writing

Business of the NHB

Subject to the provisions of this Act, the National Housing Bank may transact all or
any of the following kinds of business, namely:-

(a) promoting, establishing, supporting or aiding in the promotion, establishment

and support of housing finance institutions;

(b) making of loans and advances or rendering any other form of financial assistance
whatsoever for housing activities to housing finance institutions, scheduled banks,
state co-operative agricultural and rural development banks or any other institution
or class of institutions as may be notified by the Central Government;

(c) subscribing to or purchasing stocks, shares, bonds, debentures and securities of

every other description;

(d) guaranteeing the financial obligations of housing finance institutions and

underwriting the issue of stocks, shares, bonds, debentures and securities of every
other description of housing finance institutions;

(e) drawing, accepting, discounting or rediscounting, buying or selling and dealing in

bills of exchange, promissory notes, bonds, debentures, hundies, coupons and other
instruments by whatever name called;

(ea) buying, selling or otherwise dealing in any loans or advances secured by

mortgage or charge of the immovable property relating to scheduled banks or
housing finance institutions;

(eb) creating one or more trusts and transferring loans or advances together with or
without securities therefor to such trusts for consideration;

(ec) setting aside loans or advances held by the National Housing Bank and issuing
and selling securities based upon such loans or advances so set aside in the form of
debt obligations, trust certificates of beneficial interest or other instruments, by
whatever name called, and to act as trustee for the holders of such securities;

(ed) setting up of one or more mutual funds for undertaking housing finance
activities;

(ee) undertaking or participating in housing mortgage insurance;]

(f) promoting, forming, conducting or associating in the promotion, formation or

conduct of companies, mortgage banks, subsidiaries, societies, trusts or such other
association of persons as it may deem fit for carrying out all or any of its functions
under this Act;]

(g) undertaking research and surveys on construction techniques and other studies
relating to or connected with shelter, housing and human settlement;

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(h) formulating one or more schemes for the purpose of mobilisation of resources
and extension of credit for housing;

(i) formulating one or more schemes for the economically weaker sections of society
which may be subsidised by the Central Government or any State Government or
any other source;

(j) organising training programmes, seminars and symposia on matters relating to

housing;

(k) providing guidelines to the housing finance institutions to ensure their growth on
sound lines;

(l) providing technical and administrative assistance to housing finance institutions;

(m) co-ordinating with the Life Insurance Corporation of India, the Unit Trust of
India, the General Insurance Corporation of India and other financial institutions, in
the discharge of its overall functions;

(n) exercising all powers and functions in the performance of duties entrusted to the
National Housing Bank under this Act or under any other law for the time being in
force;

(o) acting as agent of the Central Government, the State Government or the Reserve
Bank or of any authority as may be authorised by the Reserve Bank;

(p) any other kind of business which the Central Government may, on the
recommendation of the Reserve Bank, authorise;

(q) generally, doing of all such matters and things as may be incidental to or
consequential upon the exercise of its powers or the discharge of its duties under
this Act.

Apart from the NHB, the other players in India in housing finance are:

• Central & State governments

• Housing & Urban Development Corporation (HUDCO)
• Insurance Organizations
• Banks
• Cooperative banks
• Specialised Housing Financing Institutions

Central & State governments

Till the mid 80s, the responsibility to provide housing finance rested, by & large with the
government. The Central Government has introduced, from time to time, various social
housing schemes. The role of the central government vis-à-vis these schemes is
confined to laying down broad principles, providing necessary advice & rendering
financial assistance in the form of loans & subsidies to the state governments & union
territories. The central government set up HUDCO (1970) to finance & undertake
housing & urban development programmes, development of land for satellite towns,
besides setting up a building materials industry.

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Housing & Urban Development Corporation (HUDCO)

The principal mandate of the HUDCO was to improve the housing conditions of the low
income group (LIG) & economically weaker sections. (EWS)

Incorporation

• The Housing and Urban Development Corporation Ltd. (HUDCO) was incorporated
on April 25, 1970 under the Companies Act 1956, as a fully owned enterprise of
the Government of India

• HUDCO focus on the social aspect of housing and utility infrastructure provision.
Preferential allocation of resources to the socially disadvantaged

• The effective span of HUDCO's omnipresent techno-financial umbrella could be

gauged by the fact that, on an average, one in every 16 houses in the country
has invariably availed HUDCO's financial assistance

• In spite of being commercial in its orientation, it continues to focus on sectors

which are more socially relevant rather than only on commercially viable and
profitable sectors. HUDCO's techno-economic focus, its high caliber human
resources, and its financial and project re-engineering capabilities has enabled it
to continue as an Institution par excellence in the field of housing and urban
development.

Objectives

• To provide long term finance for construction of houses for residential

purposes or finance or undertake housing and urban development programmes in
the country.

• To finance or undertake, wholly or partly, the setting up of new or satellite

town.

• To subscribe to the debentures and bonds to be issued by the State Housing

(and or Urban Development) Boards, Improvement Trusts, Development
Authorities etc., specifically for the purpose of financing housing and urban
development programmes.

• To finance or undertake the setting up of industrial enterprises of building

material.

• To administer the moneys received, from time to time, from the Government
of India and other sources as grants or otherwise for the purposes of financing or
undertaking housing and urban development programmes in the country

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• To promote, establish, assist, collaborate and provide consultancy services for

the projects of designing and planning of works relating to Housing and Urban
Development programmes in India and abroad.

Insurance Organisations

The LIC & GIC support housing activity both directly & indirectly. Besides subscribing to
bonds of the HUDCO & state housing boards, LIC grants loans for their rural housing
programmes & to public sector companies for construction of staff quarters.

Commercial Banks

The trend of commercial banks lending to individuals for housing in 1978 with the report on
the Role of Banking System in Providing Finance for Housing Schemes

Cooperative Banks

The co-operative banking sector consists of state co-operative banks (SCBs), district central
cooperative banks (DCBs) & primary urban co-operative banks (PUCBs). They finance
individuals, cooperative group housing societies, & others who undertake housing projects
for EWS, LIGs & MIGs

Specialised HF Institutions (HFIs)

There are certain institutions termed as Specilaised HFIs which cater only to the needs of
the housing sector. They can be further classified as housing finance companies (HFCs)
promoted in the public/private/ joint sectors & co-operative housing finance societies. A lead
player is HDFC Ltd. Others are SBI Home Finance Ltd, Canfin Homes Ltd, Indbank Housing
Finance Ltd, CitiHome & so on

GUIDELINES FOR EXTENDING EQUITY SUPPORT TO HOUSING FINANCE

COMPANIES

The National Housing Bank (NHB) issues the following guidelines to Housing Finance
companies (HFCs) which are housing finance institutions within the meaning of clause (d) of
Section 2 of the National Housing Bank Act, 1987 for their growth on sound lines and to be
healthy, viable and cost effective.

These guidelines are applicable to such of those HFCs who desire to avail of equity
participation from NHB. These guidelines shall come into force with effect from March 1,
2003.

ORGANISATION AND MAIN ACTIVITY

1. A HFC who desires to avail of equity participation from NHB under the scheme of NHB,
shall, among others :
(a) be a public limited company;
(b) provide long term finance for construction or purchase of houses in India for residential
purposes;
(c) invest 75% of “capital employed” by way of long term finance for housing.

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MINIMUM PAID-UP CAPITAL

HFCs should have a minimum paid up capital of not less than Rupees ten crores inclusive of
equity support of NHB or such other amount as may be stipulated from time to time by NHB
and/or the Securities and Exchange Board of India (SEBI) for listing shares on recognized
stock exchanges, whichever is higher.

SUBMISSION OF APPLICATION

HFCs desirous of financial support from NHB by way of equity participation shall submit their
applications in such form and furnish such information/statements etc., as may be required
by NHB for its consideration.

INVESTMENT IN LAND AND BUILDING

HFC’s investment in land and building shall not exceed the ceiling as prescribed in the
Housing Finance Companies (NHB)Directions, 2001 as amended from time to time.

BOARD OF DIRECTORS

NHB shall have the right to appoint two Directors on the Board of Directors of all HFCs
having equity participation from NHB. However, in case of a HFC having equity participation
from a bank/financial institution/Government and having on its Board of Directors two
persons as of such bank/financial institution/Government nominee directors, NHB shall
appoint only one Director as its nominee on the Board of such HFC. Articles of Association of
HFCs should contain necessary provision for appointment of nominee directors. Appointment
of Chief Executive of HFCs should be made in consultation with the NHB.

CREDIT RATING

NHB may stipulate minimum equity grading of a HFC where deemed appropriate.

SHAREHOLDER’S AGREEMENT

HFCs shall enter into a shareholder’s agreement with the NHB laying down covenants
regarding substantive issues like undertaking of new business, amalgamation, mergers,
takeovers, floatation of subsidiaries, investment in subsidiaries, appointment of nominee
directors etc. The covenants will also provide that if at any time in future, the promoters
want to buy the shareholding of NHB, they should offer a price which is not less than the
book value of the share as per the last audited balance sheet.

PRICING OF SHARES/COST OF INVESTMENT

In the case of new HFCs without track record of profitability and dividend making first public
issue of equity shares shall be subscribed by NHB at par and in the case of existing
companies price will be determined and approved by the Board of Directors of NHB.

Securitisation

THE CONCEPT AND BENEFITS

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The transactions between parties in the housing finance sector can be broadly classified as
those relating to ‘primary residential mortgage market’ and ‘secondary residential mortgage
market’. The primary mortgage market activity mainly comprises creation of mortgages as a
result of transactions between the borrowers and primary lenders. The primary lenders
create mortgages against loans provided by them to the purchasers of houses. The
mortgages held as assets, generate cash flows represented by repayments of both principal
and interest, on the loans.

The secondary mortgage market mainly involves the conversion of mortgages into tradable
financial instruments and the sale of these instruments to prospective investors. The cash
flows which come as repayments from the borrowers to the originators, can be transferred
to a third party with simultaneous transfer of assets to an intermediary agency (SPV)
designated for the purpose of managing the bought over pool of mortgages. These cash
flows are passed on to the investors by the SPV. In the process, the mortgages are
converted into securities which are tradable financial instruments and sold to investors. The
secondary mortgage market is thus made up of securities which are backed by mortgages
(MBS) and refers to the transactions between the issuers and investors.

Once the securitised mortgages are sold by the originators viz., the primary lending
institutions, they are either de-recognized in the originator’s books of account and
presented in a specific manner. All future transactions in the mortgage backed financial
instruments then take place in the secondary mortgage market, depending up the depth of
the market. The overall liquidity in the capital market and housing finance system would
increase with the number of transactions among investors in the secondary mortgage
market.

Securitization : Benefits

Supportive fiscal measures and the policies of Reserve Bank of India (RBI) have established
a systemic framework for specialised mortgage finance in the country and the sector has
been witnessing steady growth of over 28% in the past few years. In the recent past, with
the emergence of the capital market as the central pool of resources for sectoral
development, Securitisation not only offers a viable and sustainable market oriented
sourcing mechanism with the potential of integrating housing market with the domestic as
well as the international capital markets, but also brings in a range of specializations,
resulting in efficient and cost effective structures and practices.

• Improves Capital Adequacy Ratio (CAR) through transfer of risk weighted assets;
• Aids Asset Liabilities Management and helps long term source for deployment in
housing sector;
• Enables better spread management, and facilitates improvement of return on assets
and return on equity;
• Enables new source of fee based income;

THE TRANSACTION

The transaction involves:

a) Assignment and Transfer of a pool of housing loans along with the underlying mortgages,
from the primary lending institution to NHB.
b) Securitisation of Mortgage Debt: On acquiring the pool along with the underlying
mortgages, an express declaration of trust will be made by NHB in respect of the mortgage

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debt, appointing itself as the trustee for the benefit of the investors. Once the assets have
been declared property in trust (“the Trust”), the Trust will issue PTCs to investors.

STEP NO. 1

Authorisation for securitisation by originator: Originator to obtain authorisation from its

relevant internal highest authority for securitization its pool of home loans.

Intimation to NHB : The originator (HFC / Bank) to write a formal letter to NHB indicating its
intention to securitize its home loans with copies of relevant authorization of its relevant
authorities (for instance Board Resolution) and proposal to go ahead with securitisation of
its home loan portfolio with NHB’s SPV arrangement.

STEP NO. 2

SELECTION OF POOL OF LOANS

TIME FRAME: AS PER ORIGINATOR’S CONVENIENCE

• NHB’s Pool Selection Criteria (given separately) - the home loans should satisfy the
standards for being considered for selection in the Mortgage Pool offered for
securitisation.
• Identification of Geographic Locations for Selection of Loans –To begin with, loans
originated in Tamil Nadu, Gujarat (compulsory), Karnataka, Maharashtra, and West
Bengal may be considered.
• Initial Pool Size Decision (by Originator in consultation with NHB)
• Supply of Initial Pool Information to NHB

STEP NO. 3

DUE DILIGENCE & RATING OF THE MORTGAGE POOL (may be done simultaneously)

(a)
• Appointment of Rating Agency by Originator (for AAA(So) Rating) (in consultation
with NHB)
• Supply Pool Information to Rating Agency
• Commencement of Rating Process
• Award of Rating by Rating Agency

(b)
• Appointment of Auditors for Due Diligence Audit of Mortgage Pool (with consultations
between NHB and Originator)
• Verification of Mortgage Pool by Auditors for certifying Due-diligence (Auditors may
be Statutory Auditors of Bank/HFC or a Chartered Accountancy Firm)
• Completion of Due Diligence Audit and Certification by Auditors

STEP NO. 4

(MAY BE DONE SIMULTANEOUSLY WITH STEP 5, AS OFFER DOCUMENT IS A PART OF

MEMORANDUM OF AGREEMENT TO BE EXECUTED BETWEEN NHB & BANK)

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Appointment of Issue Arranger(s) by NHB – (On consultations between NHB and Originator)

Preparation of Offer Document by Issue Arrangers

STEP No. 5

EXECUTION OF MEMORANDUM OF AGREEMENT WITH NHB

• Draft Agreement to be sent from NHB to Bank/HFC
• Finalisation of Agreement by Bank/HFC
• Signing the Agreement by NHB and Originator

STEP NO. 6
• ISSUE OPENS
• RECEIPT OF APPLICATION MONEY BY NHB
• ISSUE CLOSES
• FINALIZATION OF ALLOTMENT BY NHB AND ISSUE ARRANGERS
• ISSUE OF ALLOTTMENT LETTER TO INVESTORS BY NHB (IMMEDIATELY AFTER
FINALIZATION OF ALLOTMENT)
• PAYMENT OF CONSIDERATION BY NHB TO ORIGINATORS (SIMULTANEOUSLY WITH
ISSUE OF ALLOTMENT LETTER TO INVESTORS)

STEP No. 7

PAY-OUTS TO INVESTORS ON STIPULATED PAY-OUT DATE(S)

STEP No. 8

DOCUMENTATION

• Execution of:

- Deed of Assignment
- Deed of Declaration of Trust
- Servicing and Paying Agency Agreement
- Any other Document(s)

• Registration of Documents (Deed of Assignment and Declaration of Trust) at the

Office of Sub-Registrar of Assurances
(NHB shall provide all legal and advisory support pertaining to execution of documents at
Gujarat. For the purpose of local coordination at Gujarat, the Originating HFC /Bank may
engage an advocate in consultation with NHB)

OTHER ACTIVITIES

• SUBMISSION OF MONTHLY MIS REPORTS TO NHB BY S&P AGENT.

• MONTHLY SURVEILLANCE BY CREDIT RATING AGENCY
• SEMI-ANNUAL AUDIT REPORTS SUBMISSION BY S&P AGENT TO NHB SPV TRUST
• PERIODIC INSPECTION AND AUDIT BY NHB SPV TRUST

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