Banks must fix realistic EMI ratio for housing loans

Business Line

In the competition to increase advances, many banks have reduced the margin to be brought in by borrowers to 10-15 per cent of the value of the asset. — Mohammed Yousuf


Non-performing assets are perhaps the major factor affecting the performance of most banks in India leading to higher provisions, reduced interest income and locking up of huge funds affecting return on assets, net interest income and consequently profitability.

According to statistics, NPAs as percentage of total advances has come down from 23.2 per cent in 1993 to 2.2 per cent in 2011. This, no doubt, is a commendable achievement. But this should not make one too complacent about NPA management.

One factor responsible for the reduction in NPAs in percentage terms, is the massive growth in advances during the period from Rs 1,69,340 crore in 1993 to Rs 33,05,632 crore in 2011. During the same period, NPAs have grown from Rs 39,253 crore to Rs 71,047 crore in 2011.The percentage increase in NPAs is much smaller compared to the percentage growth in advances.

Massive write-offs

While this is an encouraging feature this rosy picture is not all due to cash recoveries or upgradations. Massive write-offs are being resorted to every year by all banks in order to reduce the NPA figure. Besides, large chunks of NPAs are being sold every year to asset recovery companies like Arcil.

I am unable to hazard a guess as to what would be the actual quantum of NPAs in absolute terms if these figures are taken into account. The position would become murkier if asset classification is made system driven this year as is being contemplated. If we take into account the large number of accounts restructured in 2008-09 under RBI's special dispensation which are likely to become NPAs in the current year and the large amount of new NPAs that are likely to surface due to the lacklustre performance of various industries, the position is not all that rosy.

In this context, I would like to outline some major bottlenecks faced by banks in the recovery of NPAs and some practical suggestions and strategies for recovery/prevention of NPAs based on practical experience.

Stay orders by courts

A number of recovery applications filed by banks in Debt Recovery Tribunals and recovery proceedings under SARFAESI Act get unduly delayed mainly because of stay orders granted by some courts without jurisdiction. Even though both Acts specify the competent courts to be approached by the borrowers /guarantors in case of any grievances, stay/ injunction orders are often granted by some courts without jurisdiction.

Banks still have to abide by these stay orders as otherwise it would amount to contempt of court. To get the position rectified, banks have to approach a higher court which is a time consuming process making the entire recovery process infructuous.

It is to be examined whether the judicial officers can be advised by the Supreme Court that if they pass any orders against the provisions of the respective Acts, such order will be treated as null and void and ignored by the bankers.

Another major problem faced by bankers while initiating auction proceedings under SARFAESI Act is when the mortgaged residential property is occupied either by tenants or the owner himself. Since the prospective buyer of the property has to be given vacant possession, the bank has to approach the District Magistrate (Collector) or the Chief Judicial Magistrate for the eviction of the occupant. Very often, there is inordinate delay in securing such an order with the result the recovery process gets delayed indefinitely.

It is worth examining if a time limit can be fixed for the passing of order by the DM or the CJM on such petitions filed by banks.

In the case of housing loans and vehicle loans, the loan to value ratio is around 80-90 per cent. In the competition to increase advances, many banks have reduced the margin to be brought in by borrowers to 10-15 per cent of the value of the asset.

If the periodical interest is not serviced by the borrower and if there is no substantial increase in the value of the asset, the loan outstanding becomes more than the value of the asset within a very short time. In the case of a forced sale in such cases, banks are not able to realise the full outstanding in the advances. Banks have to examine whether it is prudent to reduce margin on advances to such an extent.

High EMI ratio

Another factor responsible for the spurt in NPAs in housing loans is the high EMI ratio. EMI ratio is nothing but the proportion of monthly repayment to the monthly income. This is as high as 60 per cent at present.

When the interest rate increases as has happened frequently, the monthly repayment commitment also increases, and the borrower is unable to service the loan resulting in the account turning NPA. Banks may do well to fix a more realistic EMI ratio of 40-50 per cent.

While considering housing loans to NRIs, banks normally convert the income in foreign currency to Indian rupees to calculate the EMI ratio. For example, if the monthly income is $10,000 and the current exchange rate is Rs 50 a dollar, the monthly income is taken as Rs 5 lakh and if the monthly EMI is Rs 1lakh, the EMI ratio is calculated as 20 per cent.

This is a facile assumption without taking into account the cost of living in the country of residence of the borrower.

In such cases, the amount required for normal living expenses in dollar terms in the country of residence has to be taken into account, and only the balance will have to be taken into account for the purpose of fixing monthly instalments.