The Reserve Bank of India (RBI) may have relaxed norms for lending to commercial real estate by banks, but prudence in lending still tops the central bank’s agenda.

RBI has asked banks to be cautious about the end use of funds lent to real estate companies to ensure that loans are for construction and not for refinancing the existing loans or paying back foreign shareholders or private equity shareholders who want to exit. The central bank has told lenders to take caution as an informal guideline, even as risk weights have been brought down for exposure to real estate.

The risk weight is a method for classification of assets on the basis of weightage allocated in proportion to the riskiness of the loan portfolio. The higher the risk weight, the higher is the risk. A few weeks ago, RBI brought down the risk weight on commercial real estate loans from 125 per cent to 0.4 per cent.

Banking sources said the boom in the real estate sector was primarily driven by foreign funds, mostly in the form of private equity, which had funded through direct equity or debt or a combination of convertible instruments.

“With a sharp downturn in the real estate sector, most of these equity-holders want to exit at this point of time, suffering a loss. This is because they are of the view that the situation might get worse. Therefore, RBI fears that the fresh loans given to real estate players should not get used for financing the debt or equity components of the finance by private equity players. This is the reason why the banks are so reluctant to finance real estate companies even when liquidity is not a problem,” said a banker active in real estate lending.

According to a merchant banker involved in structuring PE deals, most of the financing done by foreign funds or private equity parties carry a call option. The call option clause in the investment agreement provides the option to the PE to recall money if certain conditions are not met or if a situation turns adverse.

A director on the board of Vijaya Bank said there is concern over deteriorating credit profile of real estate firms and entities, including non-banking finance companies (NBFCs), which have funding exposure to them. Why should banks take extra exposure when chances of default may grow,” asked the Vijaya bank director.

“Given the sudden drop in demand in commercial real estate, some PE funds may not feel confident about the future of investments. Also, global parents of these funds have been hit hard by the financial crisis so they would like to retrieve money for investments,” a merchant banker added.

Popularity: 17% [?]