Home loans likely to hit capital adequacy: Crisil

The aggressive growth in retail housing loan portfolio is likely to hit the capital adequacy of Indian banks under the Basel II norms due to higher risk weights. The private banks may witness a higher impact than their public sector counterparts.

Factoring the risks attached to home loans, the Reserve Bank of India has prescribed a higher risk weight of 100 per cent for residential housing loans with LTV ratio of more than 75 per cent, under its final Basel II guidelines.

The weighted average RWA based on the new LTV-linked risk weights for housing loans works out to around 90 per cent. This is higher than the existing flat risk weight of 75 per cent and will result in capital impairment for the banking system.

The capital adequacy in the retail housing portfolio will decline as underwriting standards remain aggressive. The impact will be different for private and public sector banks, Crisil said in a report prepared for a global conference being organised by Indian Banks' Association and FICCI in Mumbai on September 12-14, 2007.

An analysis of banks at the end of March 31, 2006, showed that retail housing constituted about 25 per cent of the total advances of private banks, while it was about 10 per cent for PSBs. If these proportions are maintained, the new guidelines will result in a decline of around 25 basis points (bps) in capital adequacy for private banks, while the decline for PSBs will be more manageable at just over 10 bps.

The analysis assumes that banks will assign risk weights to their housing loans depending on LTV ratios at the time of sanctioning the loans. However, if LTV ratio is decided using the current market value of the properties financed and the current loan amount outstanding, rather than the value at the time of sanctioning the loan, the negative impact on capital adequacy could be lower. The impact may even be positive.