[It was published in Republica, January 25, 2012, p.6]
The slowdown in real estate and housing sector, which was enjoying unnatural growth thanks to high remittance inflows and easy credit from bank and financial institutions (BFIs), is affecting pretty much every aspect ranging from land transaction to restaurant and dance bar business to political donations. The investors and BFIs are increasingly worried about the future of this sector and banking industry.
Nepal Rastra Bank (NRB) has been gradually rolling out a number of corrective policy initiatives aimed at defusing risks faced by BFIs and real estate and housing sector. Meanwhile, Ministry of Finance (MoF) recently introduced a ‘relief package’ to prop up this still overheated sector. The short-term, trigger happy measures of the MoF will not revitalize the realty sector and the BFIs will still be in troubled waters. Importantly, it won’t address the core problems.
The MoF extended the deadline for reducing real estate and housing lending to 25 percent of total credit until mid-July 2013 and raised personal home loan threshold to Rs 10 million. Fearing excessive risk to BFIs, the NRB last year directed them to bring down their exposure to realty sector to 25 percent, from about 30 percent, of total loan portfolio. It also restricted personal home loan at Rs 8 million.
But, the BFIs were not in a position to comply with these directives and hence the NRB extended compliance deadline for few more months. Still, the BFIs were unable to adjust their loan portfolio according to the directives of the NRB. The MoF, on recommendation of High Level Financial Sector Coordination Committee, stepped in to provide a short-term reprieve to the BFIs and real estate sector.
Another important decision was to allow developers to categorize regular apartments as service apartments. This will modify composition of loan portfolio of BFIs by allowing them to change loan headings of apartments from real estate to service sector. Moreover, the MoF has decided to offer housing loans at concessional rates to all civil servants and office bearers of constitutional bodies. It is also mulling over opening the apartment sub-sector to foreigners.
These measures have reduced regulatory compliance burden of BFIs, indirectly encouraged them to lend more money to real estate and housing sector, and ultimately might help prevent further downslide in prices. But, they do nothing to address the core problems—unhealthy competition among too many BFIs and correction of overly inflated real estate and housing prices.
The rapid growth in the number of BFIs in the absence of proportional rise in depositor base and diversification of banking portfolios led to cutthroat competition in enticing depositors (institutional, government and individual) and borrowers. The BFIs competed unhealthily to attract depositors, who enjoy steady source of remittance inflows, by offering flamboyant and unsustainably high interest yielding deposit schemes. The little distinction in playing field for all categories of BFIs, which were allowed to swell to over 220 (including 31 commercial banks, 89 development banks, 79 finance companies, and 21 micro-credit institutions) by the NRB, amidst limited investment opportunities led to concentration of lending to one particular sector—real estate and housing.
To reap quick returns, the BFIs showed little prudence to appraise if the borrowers would be able to honor interest and principal payments on time. After all they have compulsion to lend (both short term and long term) more money in order to give returns on deposits to short term depositors, who are constantly in search of BFIs offering high interest.
Hence, money continued to flow to real estate and housing sector— estimated to be over Rs 120 billion—without much scrutiny, leading to multifold rise in their prices in matter of months. People took out loans to purchase inflated real estate and housing assets. Land transaction peaked at local land offices and investors and agents became millionaires overnight. But, it was just a bubble. It started to lose air when growth of remittance inflows slowed down in 2009 as a result of the global financial and economic crises. All of a sudden real estate and housing prices tumbled.
Half constructed buildings, unsold land plots, and ‘ghost apartments’ were apparent. The BFIs jacked up lending rates, further putting pressure on borrowers. They were unable to recoup interest and principal payments on time, leading to a liquidity crunch. Fortunately, with prudent interventions by the NRB, there is now liquidity surplus in the market.
Given this backdrop it is clear that the crises were engendered by unhealthy competition among BFIs and unnaturally high growth of real estate and housing prices. The postponement of deadline to meet the lending threshold to this sector will neither resolve the core problems nor avert a potential banking crisis. It will only delay the inevitable consolidation of BFIs and correction of real estate and housing prices. Furthermore, shifting headings of loans from commercial apartments to service apartments is a clever way to enable BFIs to comply with 25 percent loan threshold.
It makes no difference to borrowers’ ability to honor interest and principal payments on time and the BFIs’ ability to recoup them. The BFIs have already put up around 1000 units of land and housing for auction in the second quarter of this fiscal year. Even though the starting prices are below than what the BFIs would expect, they are still not finding buyers. The president of Nepal Finance Companies’ Association argues that as much as 75 percent of real estate sector borrowers are not honoring interest payments. At the end of the day, the loans might be stacked up in the non performing loans (NPLs) category of the BFIs. Note that high NPLs means unhealthy state of BFIs, which might require restructuring at the cost of taxpayer’s money or with donor’s assistance like it was done with the two largest state-owned commercial banks.
The plain fact is that there has to be consolidation of BFIs and correction of real estate and housing prices. The government has to offer adequate incentives for BFIs to go for merger and acquisition. When the entire future of banking industry is in line, we should not be quibbling over tax holidays, management positions, and overly high capital requirements.
Meantime, the banking industry should also diversify its loan portfolio, ensure sound corporate governance, introduce innovative packages and seek investment opportunities outside of the handful of traditional sectors. Taking stock of the paucity of investment opportunities for BFIs, the NRB recently outlined opportunities and made it mandatory by mid-July 2013 for them to lend at least 10 percent of total loan and investment portfolio to agriculture and energy sectors.
Regarding the real estate and housing sector, which contributes just over 8 percent to GDP, price correction is inevitable and the government has to let markets adjust to real price levels rather than trying to artificially prop it up. The political leaders and their financiers and supporters have substantial interest in this sector and without a rise in prices some of them will see their financial worth wipe off completely.
The MoF introduced ‘relief package’ not to correct markets, but to alleviate their hardship. There are even suggestions to prop up real estate and housing markets outside of the major cities. Other than pacifying party supporters and businessmen funding the political leaders, these measures will do very little to steer this sector in the right path. It is time to call off gambling in this sector and let markets determine the course this time.
[Published in Republica, January 25, 2012, p.6]