India: Expanding Housing Finance Market

The request for assistance was made by the National Housing Bank of India in 2006, with strong support from the World Bank’s housing finance team.  This project was aimed at stimulating the housing market for underserved segments of both the rural and urban population in India.

Background

The housing finance market has grown rapidly at a CAGR of 43% in the last few years. Growth has largely been in urban areas and to the middle to high income groups. This has primarily been driven by tax incentives on mortgage interest and principal payments, rising income levels and falling interest rates.

This growth has been further facilitated by the entry of commercial banks and regulatory changes enabling marketing of housing finance as a viable business proposition. Commercial banks have been able to price competitively because of a relatively lower cost of funds and have also increased penetration through an extensive branch network; albeit with a clear preference for urban areas and specific income groups. Regulatory changes on the other hand have ensured relatively soft interest rates leading to increased affordability of housing finance.

One of the key issues with the housing finance market in India is that the financing products have bypassed lower income groups. For much of the urban poor there may be fundamental issues of affordability of housing, but for a significant portion of lower middle income segments (income between 0.8k USD – 2.2k USD p.a.),  home ownership might be commercially viable (with minimum support or subsidy) if they could access housing finance.

The lack of access to housing finance has led to the following outcomes for these segments:

  • Inability to convert rental outflows into home ownership even though householders may have the financial capacity to service the loan
  • Forced accommodation in sub-standard housing because of inadequate access to quality housing from organized builders
  • Social issues surrounding forced accommodation in poor living conditions and sub-standard housing; often in multi-family dwellings
  • Use of credit from informal/ unorganized channels often at a significantly higher rate or a significant cash component in residential purchase

In the rural context, at the time of the project, the majority of the families were living in substandard housing – both in terms of durability and living conditions. A potential reason for the neglect of this group was the success of Housing Finance Institutions (HFIs), Nonbank Finance Companies (NBFCs) and Commercial Banks in targeting the higher end consumer groups. Since housing finance to this segment has been growing at a CAGR of 43%, there was lack of an immediate business imperative for these financial institutions to consider market expansion into other consumer groups.  This was compounded by concerns [real or perceived] about creditworthiness, ability to repay, smaller loan sizes etc.

Since there was lack of a pressing need for HFIs, NBFCs and Commercial Banks to reach out to this group, it was necessary for a nodal agency to take the lead in developing a program to stimulate housing finance to this segment and to coordinate its implementation. Given NHB’s objectives and the fact that it interacted with all the relevant industry participants, it was ideally suited to be this agency.

Technical Assistance

Housing finance solutions vary widely depending on the target demographics within countries and from one country to another. Nonetheless, this project demonstrates some principles that could be relevant in many other situations around the world. The consultants analyzed all groups of the urban poor and initially found potential structures to assist urban, low- to middle-income employees; this group had a demonstrable income that was a starting point for satisfying bank credit risk, provided the cash-flow could be ring-fenced. In time it was expected that mechanisms would be developed to allow informal sector workers (often with higher but non-provable incomes than many employees)to obtain housing, including those in rural communities.

The consultants conducted many surveys of potential borrowers, potential lenders, real estate developers, and large-scale employers. They essentially adopted a holistic approach to the problem: it was clear that borrowers could only afford small residential units; real estate developers needed sales assurance if they were to gamble their land-bank on low cost small units that might generate lower per unit profits; banks needed comfort on the credit risk of low-income borrowers; large-scale employers wanted to provide assistance to employees to buy.

The solution to funding this group (maximum income about $300 a month), representing about 30 million people in India, involved dealing with land purchase and permits, borrowers, employers, real estate developers and banks. Small residential units were designed – some as small as 300 square feet (but still attractive to the target group because they were modern, sanitary and freed them from reliance on often difficult landlords). Sufficient numbers of the target group were signed up and committed to purchase and borrow before building started. Large-scale employers were identified to ensure mortgage payments could be deducted at source from employee borrowers and paid over to the lenders. Banks were now satisfied that their mortgages would be serviced and real estate developers were satisfied that on completion their buildings (usually 4 storey apartment buildings without an elevator) would be immediately sold. With this structure, the banks were also willing to provide construction finance to the developer. Several pilot projects were launched to prove the concept. By the end of 2008 several large developers copied the structures designed in this project and completed some major residential developments for the low income urban poor – they found the market attractive, because although profit margins per unit were lower than the higher income markets, the turnover was significantly faster and the certainty of “quick” profit much greater.

Lessons Learned

  • This type of project (and its follow on pilots) can (and did) deliver an enormous pay-back out of all proportion to the cost of the technical assistance and it should therefore be replicated wherever an appropriate opportunity arises- not only in other parts of South Asia.
  • The time frame was longer than the average FIRST project by about 12 to 18 months and the cost was more than double the average FIRST project. Whilst this runs counter to some of FIRST’s own stated operating criteria, which include funding technical assistance for short sharp interventions and filling gaps not provided by others – it may be considered that the impact was so significant to justify the divergence.
  • The holistic approach, based on a patient and detailed survey of all parties that need to be involved in delivering affordable housing for the poor, is probably a vital approach if seeking “market-based” solutions that do not involve the public sector. (It may well be that some Government involvement would be needed to facilitate access to finance for other demographic segments e.g. informal sector urban workers or rural sector).
  • The consultants were the local (Indian) arm of a major international management consulting group – in-depth knowledge of the market and culture, combined with high calibre staff, able to network at high-levels, was also a major contributing factor to success in this case.
  • World Bank housing finance team were actively involved (delivering some workshops) and supportive throughout – another major success factor.

Reports

The Final Report of the consultants is disseminated. Since then as referred to above the pilot projects were launched with successful outcomes as demonstrated by other private sector developers entering this market segment.