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566 CCS-Retail Banking in India
566 CCS-Retail Banking in India
566 CCS-Retail Banking in India
BY
NITEESH JOSHI (0511173) SONIA AGARWAL (0511189)
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ACKNOWLEDGEMENT
We wish to express our heartfelt gratitude towards Prof. P.C. Narayan, whose invaluable guidance saw this project study being culminated successfully. We also wish to thank Prof. Prakhya for the time that he spent with us validating the regression study and providing inputs to come up with better results and Prof. C. Sen for his insights on retail credit off-take with variation in several macro-economic variables. Niteesh Joshi Sonia Agarwal
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TABLE OF CONTENTS
Abstract ............................................................................................................................... 4 Executive Summary ............................................................................................................ 5 Major Triggers for banks sharper focus on Retail Business.............................................. 6 Emerging Issues .................................................................................................................. 7 SWOT Analysis .................................................................................................................. 9 Market Segments and Industry Trends ............................................................................. 11 Housing Finance ............................................................................................................... 12 Indian Housing sector Brief Overview ...................................................................... 12 Growth prospects .......................................................................................................... 13 Market Trends............................................................................................................... 16 Analysis of the Home Loans Market ............................................................................ 18 Type of Borrowers in the housing market................................................................. 18 Risks to growth rates................................................................................................. 18 Effect of Interest Rate Changes on the Portfolio ...................................................... 19 Distribution Channels............................................................................................... 19 Innovative products................................................................................................... 20 Non Performing Assets ............................................................................................. 20 Cost of Funds ............................................................................................................ 20 Real Estate Pricing Bubble in Market............................................................................... 22 Analysis and Recommendations................................................................................ 24 Auto Finance..................................................................................................................... 27 Car and Utility Vehicle ..................................................................................................... 29 Key growth drivers.................................................................................................... 29 New Car Sales........................................................................................................... 30 New UV Sales............................................................................................................ 31 Used Car Finance Market ........................................................................................ 33 Increasing power of financiers...................................................................................... 33 Decreasing power of NBFCs....................................................................................... 34 Market Trends............................................................................................................... 35 Commercial Vehicle ......................................................................................................... 38 Private sector banks to continue to have larger market share ................................. 39 Market Trends............................................................................................................... 39 Two-Wheeler .................................................................................................................... 41
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Key growth drivers.................................................................................................... 41 Market Share............................................................................................................. 42 Market Trend ............................................................................................................ 42 Consumer Durables Finance ............................................................................................. 44 Salient Features ........................................................................................................ 44 Future View............................................................................................................... 45 Credit Cards Finance......................................................................................................... 46 Profitability and success Factors.............................................................................. 46 Retail Credit and Macro-Economic Variables.................................................................. 48 Determining Credit-Worthiness........................................................................................ 51 Need for a Credit Report System ...................................................................................... 52 FICO ................................................................................................................................. 55 Fair Credit Reporting Act (FCRA) ............................................................................... 56 Consumer Reporting Agencies.................................................................................. 56 Information Furnishers............................................................................................. 57 How FICO works? .................................................................................................... 57 Credit Information Bureau (India) Ltd (CIBIL) .............................................................. 59 Analysis and Recommendations ....................................................................................... 62 Annexure........................................................................................................................... 65 References......................................................................................................................... 67
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ABSTRACT
The term retail banking encompasses housing loans, retail deposit schemes, retail loans, credit cards, debit cards, insurance products, mutual funds, depository services including demat facilities and a host of other services catering to the needs of the individual customers. It can be seen that retail banking includes various financial services and products forming part of the assets as well as the liabilities segment of the Banks. In other words, it refers to taking care of the banking needs of individual customers in an integrated manner.
In India retail banking has become one of the most attractive segments for banks because of reasons that have been analyzed in this report. The primary objective behind the study was to find out if the growth in this segment in India of long term nature or is it more of a bubble nature. Even more importantly, we set out to discover the changes that India would need to implement if the tremendous growth in this field has to be sustained over the years.
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EXECUTIVE SUMMARY
Retail Banking has caught on in India only in past 5 years or so. While anything that relates to serving individual customers can be termed as Retail Banking, however for banks the primary business in India has come from Housing Finance, Auto Finance and more recently from Credit Card finance. The industry is still in its growth phase, with Indian banks learning more and more from the practices prevalent in well developed western economies. With Indias population and growing per capita income the retail banking is a huge avenue for revenues for the Indian Banks if only they can enhance and leverage their existing national presence and technological capabilities.
However, lack of proper infrastructure and regulation is posing a challenge to this growth. For banks to meet increasing demand for funds from individuals there would be a need to develop an active secondary market for various securitized paper. Without an active market to place say mortgage paper or credit card receivables, the banks would need to raise more and more capital in order to meet their CAR requirements to keep in tune with increasing loan portfolio size. For retail credit market to really take off in the country it is imperative that measures are put in place to develop the secondary markets and remove the current information asymmetry for quality of assets that exists in Indian market at present.
One of the most important steps in this direction would be set up independent credit rating bureaus in the country that would enable a credit score on individuals much like FICO score in US. Though CIBIL has taken up the responsibility to bridge this information gap since 2004, however, we still have a long way to go before the ratings actually become the criteria being used by banks for credit disbursement. Also, given the size of the country, just a single entity like CIBIL would not be sufficient to ensure a fair and accurate database of credit history. Steps need to be taken that enough number of rating agencies are in place and working together for banks to make well-informed decision before giving out credit. The independence and integrity of operations of such organizations would be a key determinant to success of retail banking in India.
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Advent of economic liberalization - The entry of globally reputed companies has offered world class products and services to Indian people. The desire for a higher standard of living coupled with increased purchasing power, consumerism, and a more willing attitude towards taking credit has resulted in a retail chase.
Low NPAs and good returns- The objectives of any commercial bank would be to build a profitable and healthy portfolio, with as big a clientele base as possible so that the risks are spread. Retail banking is a great solution to this problem with its potential to provide a decent return through low probability of NPAs. Also the credit risk is spread over a huge client base making it a great combination of low risk and high return.
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EMERGING ISSUES
Knowing the Customer The concept of MIS is relatively new to Indian banks even more particularly PSBs. In order that the product lines are targeted at the right customers present and prospective it is necessary that complete information about the customers is available to the banks. In this regard, the customer data base available with most of the public sector banks is not at all adequate at the moment to take its advantage for cross-selling of products. In this regard, there is an urgent need for setting up of a robust data warehouse from where meaningful data on customers, their preferences, their spending patterns, etc. can be mined. Cleansing and automation of existing data is the first step in this direction.
Technology Issues Retail banking required huge investment in technology in order to remain competitive. Apart from putting in customer relationship management system in place, investments in technology are necessary in order to successfully manage growing retail portfolio. The key to reduction in transaction costs simultaneously with increase in ability to handle huge volumes of business lies only in technology adoption.
Product Innovation Product innovation remains a major challenge to Indian banks. Retail banking calls for catering to individual based requirements and though bank after bank is coming out with new products, not all are successful. Banks need to come out with products suiting the needs and requirements of different types of customers. Once again, customer profiling based on historical data is of essence. Banks should also try to modify features of the existing products in order to keep their demand up.
Pricing of Products - Lot of players in the market are trying to win a larger market share by simply under-pricing the competition without evaluating their cost of funds involved, margins, etc. This can spell trouble for lot of banks if things start to go bad in future. The much-needed transparency in pricing is also missing, with many hidden charges. The situation cannot remain this way for long. With customers getting increasing more educated about the credit terms, its only a matter of time
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before accurate disclosures are required by the banks explaining their pricing of particular product.
Process Changes - In order to provide much needed improvement in customer service one of the basic requirement is simplified processes. The documentation issues have to remain simple both in terms of documents to be submitted by the customer at the time of loan application and those to be executed upon sanction.
Rural Orientation Most of the action retail front as of now is by and large confined to metros and big cities. There is still a vast market available in rural India, which remains to be tapped. FMCG companies have already taken the lead in showing the way by coming out with exquisite products, packaging and promotion, keeping the rural customer in mind. The PSBs are in a great position of strength when it comes to rural market because of their already existent extensive branch network. They can effectively leverage this to address the needs of rural customers in a big way.
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SWOT ANALYSIS
Strengths Its been statistically proven that a large chunk of low cost savings deposits and fixed deposits, contributed by retail segment, are considered less volatile as compared to other deposits. Non-volatility of these deposits helps the banks to comfortably draw their ALM strategies more particularly for longer tenure. Low level of NPAs - Tendency to default on housing loan is low as house is considered as the one of the most prized assets of an individuals life. However, tendency to default on other sub-segments of retail loan is comparatively higher. Retail finance provides a higher and rather consistent risk adjusted return to Banks due to low level of NPAs. The advances given for retail credit generally low credit risk since they invariably backed by tangible security in the form of mortgage of house/flat in case of housing loans and tangible security, check off facility, post dated cheques, etc. in case of other retail loans. Weaknesses High manpower cost, low productivity and lack of automation is still a cause of concern for the public sector banks which increases intermediation cost for them as compared to private sector banks/foreign banks. Longer tenure of loans, ranging from minimum 3 years to 15/20 years as against the average deposits of less than 3 years. This mismatch between the maturity period between deposit and loans increases the liquidity risk for the bank. At the same time, it is this difference that allows banks to be profitable due to spread difference. Also, the longer duration of credit increases the default risk since prediction for such a long tenure becomes less accurate. Absence of regulatory framework to ensure transparency as explained further in the report.
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Opportunities
Cross selling of products - The Banks now prepare database of their depositors to study the nature of transactions being routed through the deposit accounts with a view to ascertaining the lending requirements of their customers and thus come up with appropriate products that would address the credit requirements of individuals. Securitization of retail loan portfolio is something that has already started in India and is expected to grow much bigger. Nationalized Banks, being in advantageous position in terms of their geographical reach to a large number of borrowers, can continue to book fresh business, improve their customer base to cross sell their products and in due course off load the portfolio through securitization route depending upon their ALM position. The major hurdle in the whole scheme still remains absence of an active secondary market to trade securitization paper.
In the medium term, growth in retail lending is expected to outperform other segments due to greater reach of banks, increased use of technology (thereby reduced cost of intermediation) and a changing mindset in Indian urban middle class from save and pay to borrow and buy. The stigma attached to credit is fast disappearing in India.
The growth in retail lending is expected to continue at much higher rates in the time to come as the retail loans to GDP are still less than 5% which is lower than the other developed/developing countries.
Retail lending provides an opportunity to the Banks to offset the lower demand of funds from corporate sector in times of boom in equity markets.
Threats Incidences of concurrent borrowings are on increase in case of retail loans through the credit card / other routes. This is a cause of concern for the Banks especially since at present there is no way for banks to monitor this kind of misuse. The problem can be tackled only with sharing of data between all banks about the credit profile of their customers. The cost of maintaining low cost savings deposits is also increasing due to increased competition and increase in interest rates in past couple of quarters. The Banks are now compelled to provide free ATM/credit cards.
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The information has been collected from various sources, the primary being reports of Crisil and RBI
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HOUSING FINANCE
Indian Housing sector Brief Overview
Indian housing industry is marked by very high fragmentation with small builders in unorganized sector accounting for more than 70% of the houses being constructed. The government has recognized the importance of urban development to sustain the high economic growth and the investment marked for housing industry has been growing with every Five Year Plan. The estimated investment under Tenth Five Year Plan was Rs. 7263 billion. For organized players the market still remains mostly limited to urban areas and Tier I towns since demand from rural areas is likely to be met through Government spending. The banks would clearly be limiting their housing finance portfolio to the houses in the urban sector and therefore for the purpose of studying the growth in housing loans we need to consider only the urban housing development at present. The demand for financeable houses is expected to increase from 3.3-3.4 million units in 2003-04 to 4.74.9 million units by 2008-09 with the value of financeable houses increasing from about Rs 1,600 billion in 2003-04 to about Rs 3,000 billion in 2008-092. In India, housing finance as an industry emerged in 1977 with the establishment of Indias first housing finance company, Housing Development Finance Corporation Limited (HDFC). In 1987, the National Housing Bank (NHB) was set up as a subsidiary of the Reserve Bank of India (RBI) to regulate and provide refinance support to housing finance companies. At present, approximately 350 housing finance companies (HFCs) operate in the Indian market. Only 30 of these have been approved by the NHB for refinance assistance. The HFCs approved by NHB account for over 95 per cent of the assets of all the HFCs in the industry. The commercial banks were not allowed to provide housing loans directly to retail clients till 1998 and some banks launched subsidiaries for housing finance purposes to cater to this market. However, even after RBI allowed banks to enter this market directly most of the banks started to enter the field only in 2001-02. The private banks were the first one to recognize the potential of this market and were soon followed by foreign banks and
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then public banks. Today as the banks have captured a majority share in the housing finance market, most of them have merged the subsidiaries that they had set up earlier.
The market has grown at rate of about 40% from 1998-99 to 2003-04 at Rs. 569 billion. The growth is expected to continue at double digit rate given the strong economic growth on the back of IT boom.
The lending to the housing sector by the banks is done through 2 routes: Direct when the disbursements are made to retail borrowers for
The share of banks in the direct retail segment has been growing and growth in banks housing finance portfolio has been greater than growth in portfolios of HFCs, as analyzed in latter part of this report.
Growth prospects
The average age of a person buying a house has been decreasing sharply and is approximated to be 35-36 years at present. The increase in demand has been fueled by demand from lower age group with increasing income levels and ready availability of finance. The housing purchase decision in India is mostly still taken by male population. In view of the same, the urban male population elder than 25
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years (about the age when most marriages take place in this country) is perhaps a good proxy of the housing demand. Projection for the increase in housing demand based on this parameter is as shown below
Currently about 30% of Indian population belongs to 25-44 year age group and the % has been growing over the years clearly bringing out the tremendous potential that this segment has for banks. Along with financing the purchase of newly constructed houses, finance is also sought for resale/purchase of existing houses. The number of such houses is expected to go up to 1.23 million in 2008-09. India is fast moving in direction of nuclear families from the otherwise traditional joint family system. Increasing urbanization and migration for employment purpose are also narrowing down the average household size. This contraction signals significant demand increase.
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Increase in urban middle class- The Indian urban middle class disposable income has been on a rise continuously for past 5 years and is expected to reach Rs. 194000 by 2009-10. With the increasing income people have been more willing to take up credit to purchase the more expensive housing since the larger EMI payments become possible.
Increasing aspiration to own a house because of societal prestige issues and also the asset value locked in which is expected to appreciate in future. Also there has been a marked trend in the social acceptability of credit in Indian society. While few years ago taking up credit was taken to be a sign of financial instability, today it is viewed more as a mean to finance the desired increase in living standards.
The customer segment for retail housing portfolio can be divided between salaried and non-salaried customer. Non-salaried class includes self-employed population like lawyers, doctors etc. Banks have traditionally preferred to restrict their housing loan portfolio to the salaried employees only given the income stability. However there is a growing need of products designed to cater to selfemployed professionals.
There has also been a shift in consumer preference from rented houses to owned houses. The rising income level have and increasing rental rates, people are more inclined to build their own houses. Also, it is popularly believed that real
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estate prices in India would continue to rise for quite some time in which case several find owning a house as a highly profitable investment as well.
Fiscal incentives: In order to induce demand, the government has provided tax incentives to the borrowers that reduce the cost of borrowing, making the option of availing of a loan to purchase/construct a house more economical. Currently, interest payments up to Rs 150,000 on housing loans can be claimed as a deduction from the taxable income and annual principal repayment up to Rs 20,000 is eligible for a rebate from the tax liability. Also, an exemption of long term capital gains can be availed of in the case of re-investment in a second property.
Priority sector status to housing loans for banks : With RBI increasing the size of housing loan portfolio to be considered as priority sector lending and removing the geographical restriction placed earlier; banks have become more aggressive in giving out loans for this purpose.
Market Trends
Banks are becoming more willing to lend at high LTV ie they are supplying very high amount of the total financing required to make house purchase increasing their risk exposure. The average LTV value was as high as 66-70% in 2003-04. One of the reasons for this increase in increasing competition due to which banks have to try harder to make credit appear more attractive to the customers. The
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credit worthiness of the borrower is assessed by the bank based on age, income, dependents, earning family members, stability of income etc. The average LTV on loans is likely to show minor growth in near future as well. Some of the banks have been giving housing loans at more than 100% LTV in the guise of loans for the purpose of interior decoration or furnishing. Differential interest rates are charged on the two loans however the effective interest rate on the over all loan for a particular customer turns out to be lower than what he would have achieved had he tried to acquire credit from multiple sources. RBI has recently issued guidelines that forbids bank to lend at 100% LTV in order to reduce exposure. One of the tactics that the banks have adopted fairly successfully is increasing loan tenures leading to low EMI payments that attract customers. Since the overall payment of the loan remains same the banks are actually reducing their profit in term of NPV of loan repayment and hence the returns on loans have decreased. With rising interest rates, lenders will have to resort to either increasing the tenure of the loan or hiking the Equated Monthly Installment (EMI) for the existing floating rate borrowers. However, lenders first prefer to raise the tenure of the loan with a reasonable limit and then, if required increase the EMI to pass on the increased interest rate. If the latter option is exercised, the Installment-to- Income ratio (IIR) of the borrower could go up and impact his/her ability to service the loan. This could make the borrower susceptible to defaulting on his monthly payment obligations. IIR can be used to assess the risk profile of the lender portfolio. An increase in EMI affects the IIR of borrowers. The impact of interest rates on the credit risk depends on IIR of the borrower. For higher IIR, the credit risk increases because income available for maintenance of regular living standard goes down which can prompt default. For some private sector banks the percentage of portfolio with more than 50% IIR is much higher than the industry average hinting at the aggressive strategy adopted.
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re-evaluate their purchase decisions. However, the effect of this is likely to be limited since decision to purchase house in India is not an impulsive decision. The Indian public believes that housing value would undergo perpetual appreciation because of which they generally dont postpone decision to purchase house once they believe that they have enough savings.
Average ticket size for the loan has been on the rise because of rising real estate prices, increasing income levels and greater acceptability of credit.
Distribution Channels
Office branches SBI is way ahead than anyone else in terms of number and reach of its office complexes across the country. Direct Selling agents more powerful, increasing in popularity. Special Advantage to corporations like LIC where LIC agents can be trained into DSAs The increasing reach of banks to Tier II towns and to rural areas is likely to be a strong growth factor in coming few years.
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Innovative products
Increase in need for innovation in products since most of the players are offering similar schemes to the customers and currently the differentiation is based on customer service and counseling Some of the services on offer: flexibility to change from fixed to floating rate, progressive monthly installments (instead of EMI) for young borrowers with rising incomes, legal and technical advise
Cost of Funds
HFCs have historically relied on public deposits, refinance from NHB and funding from banks to meet their funding needs. But raising money through public deposits proved to be an operationally expensive affair, so HFCs slowly reduced their reliance on them. The larger HFCs have also started tapping the overseas market for funds3. Banks with access to low cost savings and current deposits have lower cost of funds especially since around 60-70% of the savings deposits are never withdrawn. However, ignoring the statistics, use of savings deposits to finance
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new loans increases liquidity risk of banks for which borrowing might need to be done in the call money market.
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The surge in foreign investment, more joint ventures between Indian and foreign companies, and the growth of Indias domestic industries have created more employment opportunities. With more disposable income, workers are spending more on consumer goods and services and buying homes. The real estate sector will continue to derive its growth from the booming IT sector, since an estimated 70% of the new construction is for the IT sector. As the tech boom spreads across the country, as more Indians buy homes, and as the economy grows at faster than 8% a year, real estate is attracting more investors, many of them from abroad. Merrill Lynch forecasts that the Indian realty sector will grow from $12 billion in 2005 to $90 billion by 2015. Also contributing to the strong growth has been the low interest rates environment that has prevailed in the country for past few years and easy availability of housing finance.
However, the extremely steep rise in real estate prices have led some to believe that there might be speculation coupled with land hoarding by developers driving the prices artificially high. If we consider changes in real estate prices from 2004 to 2005; India shares the top spot, along with Korea, with a 20 per cent hike in the last quarter of 20055, overwhelming the inflation rate many times over. While a portion of the current demand is real, at least a quarter of this is being driven by speculation (in some pockets of the country, as high as three-fourths of the sales are effected by pure investors). The
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http://economictimes.indiatimes.com/articleshow/1540301.cms http://www.hindu.com/pp/2006/07/08/stories/2006070800400800.htm
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low interest rates have prompted cash rich individuals to take up debt and invest in real estate and once prices hike up sell these assets before payment of first mortgage. These buyers are unlikely to be the end-users and, hence, real estate is fast becoming a speculative commodity. This has led to unaffordable price levels in many cities.
The prices have also come under pressure because of real estate developers slowing down bookings of existing projects in order to make larger profits6. The artificial supply scarcity further fuels the price hike. Lot of investors and developers have taken up projects without considering the economic sustainability the same. There are around 250 malls being developed in Bangalore, Gurgaon and Mumbai over next 5 years; and only 10% are expected to be successful. The absence of a secondary market has led to a classic information asymmetry situation and in India the real estate market is particularly opaque. It is likely that lot of investors would end up loosing big time when the price correction happens.
Eight years ago, real estate prices had hit the roof on the back of furious speculation and shortage of land. The bubble burst in 1996 as speculators desperately liquidated their holdings and prices tumbled by 40 per cent to as much as 80 per cent, virtually wiping out their entire capital. In every cyclical environment, a downtrend is inevitable. When the dream run comes to an end and prices fall, it leads to a decline in housing equity, borrowing and spending; also widespread defaults could generate a contraction in economic growth. The banks are sitting on huge portfolio of housing loans that have been given out for these over-priced assets and in case of defaults they are likely to suffer a tremendous setback.
And clearly the correction is not too far off in future. Interest rates in India have slowly started rising. That means that loans will be harder to get and service. The bubble can also burst due to new government taxes stemming from increasing crude oil and natural gas prices. Though, optimism about future salaries can still hold the prices up for some time to come.
http://www.rediff.com/money/2004/nov/08spec.htm
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Urban Development Ministry has recently started to put in some policies to curb speculative land deals7: The measure being considered is to force anyone in possession of urban land to construct within six months of purchase. Otherwise, the land concerned would be acquired by government agencies at existing floor-rates which, in most cases, are significantly lower than current market rates. In a bid to protect consumers, the urban development ministry is planning to create a statutory regulator for the real estate sector. A real estate commission will be set up to frame guidelines and a code of conduct for proper conduct. Property dealers and architects will have to get themselves registered before doing business The commission is likely to be formed as part of the proposed real estate bill, which would institute a series of strict regulations for dealers/agents as well as developers. The bill is expected to be introduced in the winter session of Parliament. The proposed commission will also look into the earnings of the dealers and brokers. At present, they charge a commission of up to 4% from buyers and sellers, which are totally unregulated and not taxed.
Concerns about an asset-price bubble have led the Reserve Bank of India to raise the risk weights on real estate loans extended by banks, and mortgage rates have gone from 7.5% to about 9.5% as a result. That's still well below the 15% rates that most Indians were used to, but it's enough to raise questions about whether the speculation of the past year and a half, which has driven land prices up by 30% to 100% and real estate stocks up as much as 2,000%, may be coming to an end.
The real estate market is not as transparent as international practices require Typically lease terms are short and tenancies turnover frequently
http://www.inrnews.com/indianrealestate/2006/07/policy_measures_being_consider.html http://www.createum.com/consulting.htm
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Transfer taxes range from 4% to as high as 15% in some states and applicable on all transactions including leases Quality of building standards are not uniform across the country and not as stringent as in other more developed countries There is bureaucracy and possible delays in obtaining approvals which may be required at the local state level. Government's tax policies are not in tandem with the liberalization initiatives being undertaken in the sector. There are no substantial tax incentives for real estate development except in the limited circumstances. Even in these situations, the tax incentive windows have a short life left. The prevailing tenancy laws in India are not in favor of owners of the land.
The Urban Land Ceiling Act and Rent Control Acts have distorted property markets in cities, leading to exceptionally high property prices. Moreover, a high percentage of land holdings do not have clear titles.
Land in India is typically held by individual or families. This restricts organized dealing, and hinders transfer of titles. Land reforms are not in place.
In view of these risks associated with the current real estate markets it looks like the banks are sitting on brink of a huge disaster. Clearly the Indian market is at present not mature enough to see through the game being played by cash rich individuals and developers together. In line with the moves already put in place by Ministry of Urban Development and RBI, we believe that there is also a strong need to: Improve the information intermediation in the system wherein the assets can be priced accurately and their prices not be artificially hiked Consequently, develop a strong secondary market for mortgage paper in India so that banks can offload their risk in the market. The active secondary market is also a great mechanism to make sure that prices are better reflection of asset value. However, a lot of regulatory action has to be taken by the government and RBI before we can reach that stage. In order to develop this market there is also need to have independent credit rating agencies that can separately evaluate the true asset value to price the mortgage paper. In line with same, CRISIL has already come out with 2 rating
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Developers rating and Project Rating. Given the highly fragmented nature of real estate development in India it is necessary that more such organizations come into play so that industry benchmarks can be developed for comparison across the country.
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AUTO FINANCE
Three main sectors in this industry: 1. Car and Utility Vehicle finance industry 2. Commercial Vehicle finance industry 3. Two-wheeler finance industry Recently growth in disbursements was driven by9: Uptrend in used vehicle finance Changing consumer mindset towards availing of finance, leading to a higher proportion of vehicles sold being financed. Growth in demand for the underlying asset, driven by an increase in the affordability due to a higher loan-to-value, coupled with increasing loan tenures offered by financiers and increasing income levels. Growth in demand for higher tonnage / higher value vehicles due to highway development, leading to the emergence of the hub and spoke system of transportation. Higher level of funding the vehicle cost (inclusive of cost of body). Increase in penetration by the organized players in used vehicle finance and refinance. Salient features of this segment of finance market In sharp contrast to CDF, in terms of market share, banks continued to dominate the scene for car, CV and two-wheeler finance, while the market share of NBFCs continued to decline gradually. Auto Loan disbursements have larger tenures and are of bigger ticket size. The outstanding portfolio of the auto finance market recorded a healthy CAGR of nearly 23 per cent during 2001-02 to 2005-06 to reach Rs 1,048 billion in 2005-06. It is expected to decline approximately to 18 percent for the period 2006-2010. Power of the financiers on the upswing. The price reduction on cars, passed on by the manufacturers to the consumers has been mostly pocketed by them improving there profitability.
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The way ahead for the players is: To sustain growth, one must be strongly present in both the new and the old auto finance sector since there is a growing trend towards purchasing used cars (second hand cars). Increasing competition in the car and utility vehicle (UV) has ensured that the focus must shift from regional to a pan-India one. In case of commercial vehicles focus is shifting from small fleet operators (SFOs) or large fleet operators (LFOs) to a healthy mix of both
Mature markets, within the auto finance market are those where the loan to value (LTV) and proportion of vehicles purchased on finance have stabilized at high levels. Further, interest rates in such markets would have bottomed out and losses as well as tenures would have stabilized. The car, UV and CV finance markets exhibit all the characteristics of mature markets except the tenures in these markets have not yet stabilized. We expect the two-wheeler finance market to move the way the car, UV and CV finance markets did when they were in their growth phases. We expect interest rates in the twowheeler finance market to move southward over the forecast period. However, the decline in interest rates is expected to be marginal.10
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The potential car and UV finance market comprises new car finance, new UV finance and used car finance. The total market is expected to grow at a CAGR of 20.6 per cent from Rs 374 billion in 2005-06 to Rs 791 billion in 2009-10.11
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The new car and UV finance market, about Rs 293 billion in 2005-06, is expected to record a CAGR of around 16 per cent during 2005-06 and 2009-10 to reach Rs 528 billion.
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New UV Sales
The new UV market is likely to reach Rs 246 billion by 2009-10, recording a CAGR of 16 per cent. However, on account of the expected increase in the percentage of vehicles purchased on finance and an almost stable average LTV, the new UV finance market is expected to record a CAGR of 18.1 per cent, from Rs 76 billion in 2005-06 to Rs 149 billion in 2009-10.
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New UV Finance
During the late 90s, this finance industry witnessed consolidation with most of the NBFCs that had opened for financing auto loans, close down. Ever since, the share of the banks in servicing auto loans has been growing rapidly.
The share of the new private sector banks in the car and UV finance market has increased from about 32 per cent in 2002-03 to about 57 per cent in 2004-05. The share
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of the major NBFCs, which continued their operations in the car and UV finance market, has declined from about 26.7 per cent in 2002-03 to 19.8 per cent in 2004-05. In 200405, the top five players accounted for about 81 per cent of the disbursements compared to just 55 per cent in 2002-03.13
It was expected that passing on the entire price reduction to the customer by the manufacturer would have resulted in an additional demand for passenger cars, thereby resulting in an increase in the manufacturers profitability. However, since the financier has been able to pocket at least 52 per cent of the overall price reductions passed on by the manufacturer to the customer, it has resulted in slower growth in car demand and has deprived the manufacturer of improved profitability through economies of scale benefits. However, in doing so, the profitability of the financier, especially the two large private sector banks (ICICI and HDFC), has improved tremendously.
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The price reduction has been due to budgetary as well as non-budgetary reasons. The latter include price reduction on account of market forces.
During the easy liquidity situation in the economy up to 2004-05, NBFCs operating in the new auto (cars & UVs, CVs and Two-wheeler) finance market were able to lower their cost of funds by engineering their funding profile such that their borrowings were typically for the short-term (1 year and below), although their lending was typically for 3 years and above. However, in February 2006, when liquidity was under pressure, the financial engineering benefit that was accruing to NBFCs at the risk-free total cost of funds turned adverse.
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Unlike the Consumer Durable Finance Market, NBFCs are losing their share to the banks in the Car and Utility Vehicle finance market.
Market Trends
Average LTV for new cars to increase to 80 per cent by 2009-10 The average Loan-to-Value has increased from 74 percent in 2001-02 to 79 percent in 2004-05. It is expected to further increase to 80 percent in another 3-4 years. The metros have been sufficiently covered by the banks. It is the Tier-II and the non-metro areas where banks need to channelize their energies to increase penetration and develop markets.
The LTV varies according to the vehicle and can be as high as 90-95 per cent (exshowroom price) for some models. The mini (Maruti 800) and compact segments (Maruti Zen, Hyundai Santro, Tata Indica) enjoy a higher LTV compared to the other segments. The average LTV for the mini and compact segment is about 85 per cent and 80 per cent, respectively. The higher resale value available on these segments enables financiers to fund a larger part of the cost of the vehicle.
The higher end vehicles attract a lower LTV due to the following reasons: o The value of a high-end car depreciates faster than a low-end car once it moves out of the showroom. o The customer profile of this segment indicates that they prefer paying a higher amount upfront and taking a smaller proportion of the exshowroom price of the vehicle on loan.
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Source: Cris Infac Increase in the share of 5 and 7 year loans leading to a longer average tenure Till recently, the tenure for loans in this segment used to vary around 3 years. With increase in competition, the financiers are trying to encourage customers by giving loans for a longer duration and smaller EMIs, so that the loans become more affordable. Gross interest rate to the customer likely to decrease over the next 4 years Increasing competition has resulted in lowering of interest rates. The gross interest rate to the customer (GIRC) in the new car finance business has declined from 25 per cent in 1997-98 to 9.8 per cent in 2004-05. However, in 2005-06, the GIRC increased by an average 50-60 bps as financiers hiked car loan rates by 25 bps in October 2005 and then by 100 bps in March 2006 soon after the announcement of the excise duty cut on small cars in the Union Budget 200614.
It is estimated that due to further competitive pressures the GIRC will decline by around 50 bps during 2006-07 and 2009-10 despite a 25 bps expected increase in the yield on government security during the same period. Net interest rate to customers to be impacted by reduction in subventions
14
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Initially, the subventions that the financiers received from the manufacturers as well as the dealers, was passed on to the customers. This reduced the net interest payable by the customer since 90-95 per cent of the subvention was passed on. The manufacturers offer these in order to push sales of weak demand models. Additionally, increasing competition in this segment is expected to increase the subventions given by the manufacturers. The important point to note here is what percentage of this will be passed on to the customers. With the power of the financiers increasing and they pocketing most of the subventions given, the gap between GIRC and NIRC is expected to decrease. Also, will this result into increase in volumes sold. Yield to Financiers likely to increase over next 4 years The yield to the financier (YTF) had been constantly declining up to 2004-05 but in 200506, the YTF increased by 70-80 bps. During 2005-06 to 2009-10, it is expected that the YTF to rise by 1.9 percentage points. Taking into consideration the fact that the market structure has moved to a duopoly, financiers will be in a better position to negotiate with dealers and DSAs and, therefore, reduce payouts. Over the next 4 years, payouts to dealers and commissions to DSAs is also expected to reduce.15
15
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COMMERCIAL VEHICLE
The recent ruling of the Supreme Court in November, 2005, banning the overloading of trucks/medium & heavy commercial vehicles (M&HCVs), has the changed the former forecasts for the growth of the Commercial Vehicle Finance market. Prior to the ruling, the growth of sales volumes in this category was expected to slow down, the reasons being increased competition, high capacity growth, and a rise in fuel prices that would affect the truck operators profitability. After the ruling, the growth forecasts have been revised and the CV demand is expected to rise.
The key growth drivers for the CV finance market are16: The used CV finance market, expected to grow at a CAGR of around 18.3 per cent during 2006-2010. Increase in penetration by organized players in used vehicle finance and refinance. SC order banning the overloading of trucks coupled with stronger than expected GDP growth led by industrial and infrastructure growth. Growth in demand for higher tonnage/higher value vehicles due to highway development leading to the emergence of the hub and spoke system of transportation.
16
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However, financiers would be faced with certain challenges in the coming years. These include17: Likely decline in asset quality as players try to increase market share. Likely hike in fuel prices, without comparable change in freight rates. This will negatively impact the profitability of truck operators and in turn their credit worthiness.
The CV finance market is distinct from the car and UV finance market. While the car and UV finance market is concentrated in metros, the CV finance market is spread across National and State highways. Hence, banks and NBFCs require a sound origination and distribution network, both for new as well as used CV finance.
Market Trends
Average LTV to reduce over the next 4 years The LTV for this segment is expected to reduced, unlike that of the Car and UV segment. This is probably on account of the growing proportion of the small commercial
17
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vehicles (SCVs) and multi-axle vehicles (MAVs because of a very low portion of the body cost is financed). Average tenure to increase by 7 months The LFOs tend to replace their fleet within 3-4 years while the SFOs tend to do so in 4-5 years. In such a case, the tenure of the loans has increased from an average of 3-3.5 years to 3.5-4 years. Due to the recent capacity constraint and the need to pass on the fuel prices and freight rate increases, this industry underwent a change. The financiers responded to this by providing longer tenure loans, such that the EMIs reduced making it much more affordable and attractive to expand fleet. GIRC and NIRC to move up Till recently the rates had been declining but it is now believed that these rates have reached their lowest and will now rise due to the following reasons: o o Increase in the general interest rates The total amount of disbursements to SFOs and the first time users is expected to rise in the next few years. Considering their high risk profile, the banks will want to levy higher interest rate on the borrowings. The NIRC too will move in line with the GIRC since there is no practice of manufacturers passing on the subventions to the financiers. YTF expected to rise Though the yield to financiers had been on a decline since the past few years, the situation is expected to reverse. YTF is impacted by dealer payouts and commissions to Direct Selling Agents (DSAs).
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TWO-WHEELER
The youngest and newest segment of the three, this finance market is in the growing stage while the markets of the other two are in their maturity phase.
The sales growth in this segment is primarily driven by the increasing household income, easier availability of finance and the launch of new models and variants. Recently the supply of scooters had been affected by labor strikes for two of the biggest players. It is expected that the scooter sales will go up with relaxation of capacity constraints and entry of new players in the market.
18
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o
Regular launch of new models leading to consumers changing/upgrading their vehicles at a faster rate.
Market Share
The Two-wheeler market is a comparatively new market and is still in its growth phase. More and more organized players are entering this market. At present they have mostly concentrated on the urban and semi-urban areas. There is much room for growth in the rural areas where availability of finance for purchase of two-wheeler may result in very high sales volumes. Once the market grows and competition begins to build up, the industry will see consolidation.
Market Trend
Geographical Reach Going forward, players are expected to increase their focus on the semi-urban/rural markets. The risk profile of customers in these markets is higher as compared to the urban markets. Given this fact, we believe that though competitive pressures will force interest rates downward the decline in rates will be marginal. Average LTV and Tenure to increase If the banks expect to penetrate the rural market, they need to make their offering as attractive as possible. If the LTV is high and the tenure is longer, the payment of the loans will be much easier for the rural (or semi-urban) people thus giving them the ability to take up the loan. In these areas the sales will be more a result of push from the financiers than demand generated from the customers. Also, some innovative schemes that are already being pursued by some of the banks, like payment every two months instead of monthly, have helped penetrate this market. Proportion of vehicles purchased through finance The proportion of two-wheelers purchased on finance has increased over the past few years. With the increase in the ease of availability of finance, increase in the freshly
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graduated working class, increased reach to more geographies and highly attractive EMI schemes, this sector can look forward to a healthy growth. GIRC expected to decline over the next few years There can be two reasons to explain the GIRC declining in the next few years. Firstly, in order to reach out to the semi-urban and the rural classes whose ability to payback loans is very low, interest rates will have to be lowered to reduce their cost and attract them to take up loans. Secondly, increasing competition will ensure that each financier tries to offer the lowest rates possible, lowering the GIRC as a result. One point to note though is that this decline will be very marginal.
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Salient Features
Disbursements for Televisions, Air Conditioners, Refrigerators and Washing Machines constitute approximately 80-85% of the business for Consumer Durables Financing. Today these are no more considered luxury items. The market size of the consumer durables industry in 2004-05 (as per CRIS INFACs definition) was Rs 141.3 billion, which is expected to touch Rs 218.0 billion by 2009-10. Aggregate disbursements under CDF for the four consumer durables under consideration were Rs 36 billion in 2004-05, and are expected to grow at 10 per cent CAGR to reach Rs 59.3 billion by 2009-10. Unlike in other retail loan segments, this sector sees maximum business from the semi-urban areas. The organized CDF mainly consists of NBFCs rather than banks (include CDF in their personal loans). The CDF market is dominated by three major NBFCs . GE Countrywide Consumer Financial Services, CitiFinancial Consumer Finance India (formerly Associates India Financial Services) and Bajaj Auto Finance. NBFCs have an upper hand in this sector because: o Close proximity to the customers; better understanding of their psyche
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o
o o -
Well developed network that provides volumes to business Can charge processing fee and give loans at zero per cent interest rates
Reasons for banks not pursuing this sector aggressively : o o Loans are of shorter tenure (8-10 months) and smaller ticket size RBI has warned against zero-per cent interest rates
Future View
Banks to progressively get out of this space per se by providing this service under the personal loans only The disbursements to grow at roughly 10% CAGR for the period 2005-2010 o o o Lower growth in penetration Loan-to-value ratios reaching saturation levels Decline in average price levels of the durables
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Setting up of CIBIL in 2004 has helped banks to better access the financial history of borrowers and make informed decisions about credit worthiness before issuing credit cards. However, data from PSUs cant be relied upon to great
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extent because of lack of computerization till recent past. CIBIL is based on reciprocal sharing mechanism where only member who share their data would be able to access data from other banks. While the differential rates are not the norm currently in the industry, however if the credit rating mechanism proves to be successful in bringing down NPAs then its a matter of time before India also moves in the direction of lower rates to retail customer with better credit history.
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However, the concept of retail banking in India is relatively new and not much of historical data is available on an annual basis in order for us to derive a meaningful mathematical relationship. In order to obtain near 30 data points to validate the normality assumption for the data set we decided to take quarterly number. We deliberately introduced cyclicity in the data set by dividing available figures for each year into quarters in fixed proportions. The proportion of retail credit being disbursed each quarter was decided by analyzing the retail portfolio composition of ICICI Bank (largest retail bank in India) for 3 years, and applying the average weights for each quarter to the industry figures.
Variables considered:
Unfortunately figures for GDP or Employment levels arent really meaningful on a quarterly frequency. We therefore need to search for a proxy variable which displays a more immediate change in correspondence with the retail credit off take. We believe that one such variable is international crude oil prices. The oil prices in the international market end up effecting whole economy in a tremendous manner and it is a variable that is independent of monetary and fiscal policy of the local government. The rising oil prices can lead the government to increase its own deficit
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by controlling the domestic oil prices or it can pass to the public through an increase in inflation. In a mature free market, the rise in oil prices would inadvertently be associated with an expected rise in interest rate in order to keep a check on inflation. The difference would essentially arise from the fact that whether the rise in oil prices is because of increasing demand or an artificial supply deficit. A rise in oil prices because of increasing demand hints at a growing economy which in turn means that the income levels of people would be on a rise and they would be more willing to take up credit. However, increasing in oil prices are expected to lead to increase the interest rates in the country after lag of a quarter or so which in turn would again dampen the credit off-take. Sensex - the stock market in a country is generally reflection of the expectation levels in the economy and in public. A rising market index often hints a high optimism about the future. We believe that in India especially with low level of information intermediation, it is a lot easier for people to take sensex as an appropriate indicator of increase in future income and they would therefore be more willing to take up credit in order to finance their rising living standards. Interest Rates With fall in interest rates the credit off take would increase with low repayments that need to be made by individuals.
Based on these observations we ran a regression of quarterly figures (derived) for retail credit disbursed against WTI Brunt Crude Oil prices, Sensex and interest rate (Yield on 1 year Government Bonds). The model showed that all three variables are highly significant and overall can explain more than 94% of variation in the credit off-take. The importance of the variables based on standardizes beta values came out at Oil prices> Sensex> Interest rates Interestingly the coefficient of oil prices came out as positive, indicating that in India the credit off take has increased in spite of increasing oil prices. This is counterintuitive since the oil prices should fuel inflation which in turn would lead to increase in interest rates. There was a positive correlation with Sensex. A large part of the retail portfolio consists of housing loans. One of the major impacts that a rising Sensex would have is to increase real estate prices. In India, that has indeed been the case over past few years where a lot of speculation has taken place in the real estate market.
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Housing purchase decision is not something that people take on an impulse. People wouldnt postpone the decision to purchase house because they see interest rates going up by few basis points. The expected perpetual asset value appreciation holds great strength for Indian investors, which displays an immature market. The interest rates show a negative correlation as expected, thus a fall in interest rates would lead to increase in credit being taken up.
Also, in order to test hypothesis about Sensex affecting retail off take primarily because of rising real estate prices, we ran a regression with only housing loan portfolio against the sensex. The results showed that Sensex is a highly significant variable in determining variation in housing loan disbursed and alone explained more than 60% variation. Clearly the lack of information intermediation and absence of secondary market to trade mortgage paper to determine its fair value is leading to increasing speculative environment wherein people are willing to take up credit for investing in real estate thus artificially driving up the home prices.
For testing this hypothesis we conducted the study again for US market as well. We correlated the retail credit disbursed in US against NASDAQ Composite. We achieved a significant negative correlation between the two. In any mature market a rising stock prices would be lead to increase in interest rates leading to a decreased credit off-take. In Indian markets things have been going in opposite direction hinting that someone has been playing havoc with the markets. As long as we dont have a more rigid regulatory structure in place for credit system in this country such anomalies would continue to exist.
There are certain other factors which havent been factored in the current model which might lead to some level of distortion for eg: Increasing geographical reach of the banks to rural India and Tier II cities as a result of which the consumer base is increasing which is not necessarily related to any of the macro-economic factors we have discussed above Changing mindset of Indian consumers wherein credit is no longer considered a social stigma and people are more willing to take up loans in order to fulfill their aspirations
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DETERMINING CREDIT-WORTHINESS
In US, FICO score has been developed as a standard to determine the credit-worthiness of a person. It is an industry standard for calculating a reliability factor for people applying for credit. The score is a number that the creditors use to determine whether they should give the loan or not and what interest rates should be charged on mortgages, auto loans and credit cards, etc.
The score itself is calculated based on the information in your credit report. This report is used to check whether or not one is eligible to receive credit or not along with other information. Between your score and the report, ones financial health is dependent on maintaining a good credit rating.
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http://www.cibil.com/benefits.htm http://www.cibil.com/benefits.htm
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sound applicant discouraging him from further borrowing and lower rate to an unworthy customer while the bank bears higher risk. A credit score for the borrowers will make it easier for the banks to give credit to the borrowers at the interest rates which is appropriate for the risk they will suffer by lending.21 Credit grantors: The use of CIRs will enable loan officers to make objective and informed credit decisions quickly, competitively and cost-effectively. The use of CIRs will enable them to increase their lending volumes and improve the quality of their credit portfolios while reducing their delinquencies and loan processing costs. This will translate into improved profit margins. Borrowers: The widespread use of credit data will provide consumers with fast and easy access to the lending resources they need while reducing operating and risk costs for credit grantors. These reduce costs will be passed on to an extent to consumers with demonstrated credit performance in the form of lower interest rates. This easy availability of reasonably price credit will provide borrowers with the means to a higher standard of living.22 Securitization: There is a critical need for a vibrant secondary market to develop to help the banks finance further credit issuance. This can be done by developing the securitization market which will help banks offload their lendings from the balance sheet. For such a scenario to exist, the underlying asset (the loans themselves) should be well rated and their default risks calculated so that the investor is well aware and comfortable with the fund he is investing into. Improved management of Default risk and NPAs: This type of a system will also encourage the people against defaulting. Each person will instead try to improve his score by paying back on time so that he is charged a lower rate the next time he applies for a loan. This will improve the entire system and help the banks avoid making bad loans, reducing its Non-performing Assets (NPAs). Encouraging Taxpayers: If we link this with the PAN number (used to file for taxes), this could also help in encouraging individuals to report a correct figure of their income. If the income is higher, it will show that he is better positioned to repay the loan/EMIs thus giving him a reason to reveal his real income.
21 22
http://www.cibil.com/benefits.htm http://www.cibil.com/benefits.htm
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Introduction of Basle II Accord: With the enforcement of Basle II, the banks will be
required to maintain an additional market and operational risk charge. In such a case, the banks will need to be able to assess and rate their credit disbursements well; maintain a healthy credit mix minimizing the risk charge that entails.
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FICO
FICO is an acronym for Fair Isaac Corporation (traded publicly under the symbol FIC) and refers to the best-known credit score in the United States which is calculated using mathematical formulae developed by this company. The FICO score is primarily used in the mortgage industry, although some other lenders also use the FICO score. Banks and other institutions that use scores as a factor in their lending decisions may deny credit or charge higher interest rates to borrowers whose scores are below certain numbers.23 Fair Issac created the Beacon FICO score whose ratings range from 350 to 850, with the latter being the best rating and therefore resulting in lower interest rate charged. Below 600 the loan might be turned down or one might be required to pay very high interest rates.
The statistical models that generate credit scores are subject to federal regulations. The Federal reserve Boards Regulation B, which implements the Equal Credit Opportunity Act, expressly prohibits a credit scoring model from considering any prohibited basis such as race, color, religion, national origin, sex or marital status. The regulation also stipulates that if an adverse action is taken due to a bad credit score, then specific reasons have to be given to the individual. Ambiguity like failed to score high enough is not enough and the reason stated has to be more specific. Credit scores are designed to measure the risk of default by taking into account various factors in a person's financial history. Although the exact formulae for calculating credit scores are closely guarded secrets, Fair Isaac has disclosed the following components and the approximate weighted contribution of each is: 35% - punctuality of payment in the past 30% - capacity to used: the ratio of current revolving debt (credit card balances, etc) to total available revolving credit (credit limits) 15% - length of credit history 10% - types of credit used (installment, revolving, consumer finance) 10% - recent search for credit and/or amount of credit obtained recently24
23 24
http://en.wikipedia.org/wiki/Credit_score_%28United_States%29 http://en.wikipedia.org/wiki/Credit_score
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25
Current income and employment history do not influence the FICO score, but they are also weighed when applying for credit. For instance, an unemployed individual with no other sources of income will not usually be approved for a home mortgage, regardless of his or her FICO score.
25 26
http://www.myfico.com/CreditEducation/ http://en.wikipedia.org/wiki/FCRA
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liens or judgments may stay on a consumer's credit report - typically 7 years from the date of the delinquency. The 3 big CRAs (mentioned later), do not interact with information furnishers directly as a result of consumer disputes. At present, there are 3 major credit bureaus that carry information about the person and his credit. This results in each individual having 3 different scores if the data with the three agencies is different. These bureaus are: 1. TransUnion 2. Experian 3. Equifax
Information Furnishers27
An information furnisher, as defined by the FCRA, is a company that provides information to consumer reporting agencies. Typically, these are creditors, with which a consumer has some sort of credit agreement. (credit card companies, auto finance companies and mortgage banking institutions, to name a few). However, others may include collection agencies (third-party collectors), state or municipal courts reporting a judgment of some kind, past and present employers and bonders. These agencies have to report to the CRAs under the following guidelines: They must provide complete and accurate information to the CRAs The duty to investigate disputed information from consumers falls on them. They must inform consumers about negative information which has been or is about to be placed on the consumers credit report within 30 days. As a result of the FACT (Fair and Accurate Credit Transaction) Act, each resident is entitled to a copy of their credit disclosure from each of the CRAs once in every twelve months. However, this information does not contain the credit score which has to be purchased at a nominal price.
27 28
http://en.wikipedia.org/wiki/FCRA http://www.myfico.com/CreditEducation/
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FICO scores are the credit scores most lenders use to determine your credit risk. You have three FICO scores, one for each of the three credit bureaus Experian, TransUnion, and Equifax. Each score is based on information the credit bureau keeps on file about you. As this information changes, your credit scores tend to change as well. Your 3 FICO scores affect both how much and what loan terms (interest rate, etc.) lenders will offer you at any given time. Taking steps to improve your FICO scores can help you qualify for better rates from lenders.
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With the above scenario prevailing in the country, the credit off-take has greatly increased in the country. Along with that so have the competition and the defaulting on the loans. In such a case then, risk assessment becomes of prime importance. Comprehensive credit information about the borrower is essential to mitigate possible losses associated with such a scale-up.
As a solution, Credit Information Bureau (India) Ltd. (CIBIL) was set up in 2000. CIBIL launched its Consumer Bureau operations in 2004 with a database size of 4 million records from 12 members. The database grew significantly to over 20 million from approximately 30 members during 2005. Credit information reports from CIBIL enable banks to offer differential pricing to customers with a good credit record and reduce defaulters, thereby decreasing potential NPAs.30
In 2005, SBI and HDFC divested their equity stake in favour of significant data providers with representation from all the categories of credit grantors. ICICI Bank, Punjab National Bank, Bank of India, Central Bank of India, Union Bank of India, Bank of Baroda, Citibank, HSBC and Sundaram Finance now own shares in CIBIL. Additionally, international players - TransUnion and Dun & Bradstreet - own a stake and promote CIBIL. They have provided it with the requisite technological and software support. Currently, out of 125 credit grantors who have accepted membership to CIBIL, 75 members have started giving data on customers to CIBIL. Another 20 members are expected to give data soon. Data sharing is based on the principle of reciprocity, which means that only members who have submitted all their credit data, may access Credit Information Reports from CIBIL.31
29 30
http://www.cibil.com/web/overviewin.htm http://www.hdfc.com/17052005.htm 31 George Mathew for Indian Express, July 12, 2006
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CIBIL had by February 2006 amassed 42 million individual records from various banks and finance companies. Within the next 8-10 months, the figure is said to touch the 100 million mark. The credit score could be in the range of 400-800... where 800 is the best rating and 400 is the lowest with defaults. Every bank customer is rated in the US. The system will come to India also, S Santhanakrishnan, chairman of CIBIL said.32
The RBI in its recent ruling (2006) for credit information companies has allowed credit borrowers to have access to their credit history maintained by these agencies. But this will come at a price. The customers will have pay a nominal fee of Rs 100 to the company; the maximum fee being capped at Rs 500 by the apex institution. In its new set of guidelines, the apex bank has extended the gamut of specified users of credit information to include the Securities & Exchange Board of India (SEBI) and the Insurance Regulatory and Development Authority (IRDA), insurance companies and brokers registered with IRDA and SEBI. This also includes telecom services providers, rating agencies and trading members registered with a recognized commodity exchange.33
The system that is developing in the country is very much in line with the incumbent one in the US. The RBI guidelines seem to have taken inspiration from those existing there. Some of them include34: The credit information company must put in place suitable criteria to ascertain former's identity. It has been necessitated that the company divulging credit information must update the records at least within 15 days after being requested by an institution or a specified user. In case the specified user gets a report suggesting denial of extending credit to a prospective borrower, the RBI has asked companies to send the borrower a written rejection notice within 30 days of the decision. The notice will also have to include the reasons for rejection along with a copy of the said credit information report.
32 33
George Mathew for Indian Express, July 12, 2006 Business Standard, April 6, 2006 34 Business Standard, April 6, 2006
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It has asked user institutions denying credit, to provide the borrower the name of the credit information company issuing the report and any other information used in making the decision. The basic Consumer CIR broadly contains35:
Borrower information i. ii. iii. iv. Name Date of birth Identification numbers; e.g. PAN, Passport No., Voter ID No. Address
Account Information i. ii. iii. iv. v. vi. vii. viii. ix. x. Account type Ownership indicator Sanctioned amount Date Opened / Sanctioned Date of last payment Current balance Date closed Amount overdue Suit-filed status Days past due / Asset classification
35
http://www.cibil.com/web/consumer.htm
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Initial Corporate loans rating focus: CIBIL was set-up with corporate loan rating as its core activity. Consumer credit rating and corporate rating are inherently very different and thus the existing expertise in terms of resources and manpower may not be adequate for the individual credit system that they are trying to set-up. Time Horizon: The time it takes in India to implement a change or introduce a new system is very long. It will take atleast another 5-8 years before the credit rating reports and scoring to become the norm and be accepted as a standard. It will take a lot of effort and time for this system to reach a status that it enjoys in the more developed countries.
The following are some of the recommendations on how to further develop the above system in India. Require multiple scores: The concept of FICO gained popularity in the early 80s in US when Fair Isaac developed the score. In India, for such a system to develop, we need to have a similar standard in place. Though CIBIL is in the process of developing such a standard, it is necessary that more than one score standard should develop as to avoid wrong information being passed due to data asymmetry. If more than one score is developed, any inconsistency among the various scores will ensure the mitigation of making mistakes by relying solely on one score. Multiple Credit Bureaus: Presently CIBIL is doing credit scoring but that too is in the nascent stage. One agency is not enough to serve the entire population. If we are to develop a system that mitigates the information asymmetry risk, then we require more than one credit bureau like the way it is structured in the US. Autonomy of the Credit Bureaus: RBI should avoid interfering with the system. There is a need to develop independent agency/regulation to look after the smooth functioning. The banks themselves can take responsibility for entire thing. For example, the ownership of CIBIL lies with different scheduled banks and international credit bureaus. This will increase the efficiency of the agency and the main stakeholders of the system will be directly responsible for it. Regulatory Framework: One of the important pre-requisite is the establishment of an organization or a watchdog agency that keeps a check on the information sharing between the banks. Alternatively, this can also be achieved through an Act or through regulations which the RBI has proposed. This is needed to avoid any
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misuse of information. It is important that the data that is collected is accurate and there is little scope of tampering it. Also, there should be no bias in the calculation to favor one sector of society and purposely ignore another. Better Market Infrastructure: - if we are to develop the retail credit market in India with the kind of success that we have achieved in our Equity markets and to some extent even in our Foreign Exchange markets, we need to place a far better market infrastructure in place than one available at present. There is a severe lack of data points available if one is to make any kind of predictive model. In order for markets like credit cards to develop there is need of extensive information collection of customer profiles and that infrastructure is not in place. We need an organization which can do for Retail Credit market what NSE managed to do for Equity markets in terms of providing consistent and extensive set of data points for analysis and further market development. Development of a Vibrant Secondary Market: In order for this market to take off, there is need for development of a vibrant secondary market where the investors can be ensured better liquidity of their invested portfolio and the market forces ensure the quality of the underlying portfolio. The rated portfolio will ensure faster development of this market and boost the confidence of the investors to invest in the secondary market. The banks in order to increase the credit off take should be able to devolve its incumbent debt from its balance sheet and reduce bad loans and credit defaults. Securitization will help the banks to transfer risk and issue more credit to better rated customers (if the CIRs are available).
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ANNEXURE
1. Regression results a. Quarterly data of retail credit disbursed in India as the dependent variable b. Independent variables- Yield on 10 year government paper as a proxy for interest rates and average Sensex value for each quarter
Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0.9559 0.9137 0.9068 67.1595 28
ANOVA Regression Residual Total df 2 25 27 SS 1193215.7 112759.9 1305975.6 MS 596608 4510.395 F 132.274 Significance F 5.04364E-14
Standard Error t Stat P-value Lower 95% Upper 95% 69.278 3.479 0.00186081 98.34 383.70 5.966 -7.633 5.4749E-08 -57.83 -33.25 0.008 12.253 4.5826E-12 0.08 0.11
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Regression Statistics Multiple R 0.590 R Square 0.348 Adjusted R Square 0.340 Standard Error 177857.3 Observations 88
ANOVA df Regression Residual Total 1 86 87 SS MS 1.4498E+12 1.4498E+12 2.72046E+12 31633228714 4.17025E+12
t Stat P-value 38.380 6.86E-56 -6.770 1.5E-09
Intercept NASDAQ
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CCS Report
REFERENCES
1. CRIS INFAC for monthly reports for last 7 years on Indian Economy, Banking
and Retail Finance space
2. Indian Banks Association for IBA monthly journal providing useful insights
about challenges in front of Indian Banks to succeed in retail space
3. Rating reports published by ICRA, FITCH, CARE and Capital Intelligence 4. http://capitaline.com/ - online corporate database covering more than 10000
Indian companies for ICICI Balance sheets for past 3 years
7. http://www.hindu.com, http://www.indianexpress.com
discussions on real estate bubble and opaque nature of housing finance industry
9. http://www.myfico.com/CreditEducation/ - For information on FICO calculation 10. http://www.cibil.com/web/overviewin.htm - website of CIBIL 11. http://www.hdfc.com/17052005.htm 12. http://en.wikipedia.org For information about credit rating bureaus in US and FICO
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