Tax sops on housing loans must

With the country's largest development financial institutions (DFIs) like ICICI and IDBI having been converted into banking entities, the term DFI has lost its relevance in the country. Institutions that today have replaced them in playing a vital role in long-term financing and project financing are the NBFCs, which have their relative specializations, for e.g. HDFC (mortgage loans), IDFC (infrastructure loans) and Mahindra Finance, Shriram Transport (auto loans).

The trend of segmental monopoly is now changing with banks entering long term finance and FIs also meeting the medium and short - term needs of the business masses. NBFCs are now recognized as complementary to the banking system capable of absorbing shocks and spreading risks at times of financial distress.

The RBI also recognises them as an integral part of the financial system and is trying to improve their credibility in the financial sector.

Industry Wish List

	Maintain the tax incentives on housing loans.
	Sec 80IB to be amended to permit real estate developers to avail benefit under section 10(23G)
	Provide NBFCs with tax benefits on NPAs as in the case of banks.

Budget over the years

Budget 2004-05	Budget 2005-06	Budget 2006-07

Stress on the rural housing sector and increased allocation for Indira Awas Yojana by Rs 5.3 bn to Rs 22.5 bn. Revised norms of repayment of rural housing loans by banks so that installments coincide with crop cycles. Tax exemption on interest on housing loans maintained at Rs 150,000 per year.	Encourage trading of mortgage-backed securities. Tax exemptions on interest paid on home loans to continue. The allocation to 'Indira Awas Yojana' (flagship rural housing scheme) increased from Rs 25 bn in the current year to Rs.27.5 bn in BE 2005-06. About 1.5 m houses to be constructed during the next year.	Leasing and hire purchase to be treated on par with loan transactions and interest and installment of principal amount to be abated in calculating value of the service Tax exemptions on interest paid on home loans to continue
[Read more on Budget 2004-05]	[Read more on Budget 2005-06]	[Read more on Budget 2006-07]

Key Positives

	Independent operations: The RBI has mandated that the exposure of a bank to a single non-banking financial company (NBFC) should not exceed 10% of the bank's capital funds as per its last audited balance sheet. This is to dissuade misuse of the NBFC structure to avoid compulsory regulatory requirements of a banking entity (e.g.: CRR, SLR) and save on costs. Also, the RBI proposed to limit the NBFCs promoted by foreign banks having presence in India. In this case, a NBFC, which is a subsidiary of the foreign bank's parent or where the foreign bank is having management control, would be treated as part of that foreign bank's operations in India and brought under the ambit of consolidated supervision.
	Co-branded credit cards and sale of third party products: The RBI has allowed NBFCs to issue co-branded credit cards (in consonance with banks) and vend third party products. Both these measures are expected to generate fee-based revenues for the NBFC, which they were devoid of so long.
	Tax incentive on housing loans: The tax incentive allowed by the finance ministry on housing loans in the previous budget propelled incremental credit offtake in the mortgage loans segment bringing the mortgage loan to GDP ratio to 3% from the erstwhile 2%.
	Tax benefits to FIs: The finance ministry proposed amendments in the tax laws to offer tax breaks to financial institutions (FIs) merging with banks (with retrospective effect). This was beneficial to FIs that have got converted to banks (IDBI and the like).
	Conversion into banking entity: The RBI has allowed NBFCs with a good track record and net worth over Rs 2 bn to convert into a commercial bank. However, the number of licenses to be issued may be restricted to two or three of the best acceptable proposals. Conversion into banking entity will enable the FIs to access low cost deposits and improve their margins.
	90 day NPA norm: Housing Finance companies have shifted to the 90 day norm of accounting for NPAs which has brought their risk appraisal system at per with that of banks.

Key Negatives

	Higher risk weightage: The risk weightage on mortgage loans has been increased to 125%, which has additionally burdened the capital adequacy ratio of HFCs.
	High borrowing costs: High cost of borrowings to housing finance companies (HFCs) and high stamp duty dampens growth rates. HFCs are also not yet given 'Universal Banking' status for offering wholesale and retail finances under one roof.
	Interest rate dampener: The interest rate movement in the short term is likely to be with an upward bias. Although a marginal hike will not trigger any sensitivity, a movement beyond 100 basis points may dampen incremental offtake.
	Growing competition: NBFCs as a class do not offer any products that are distinct from what the banks are capable of offering. NBFCs were historically strong in the retail and vehicle finance segment and they leveraged on local relationships to grow their business. However in the last 3-4 years banks have aggressively taken away market share both in the retail as well as the vehicle finance segment.

Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.