Wednesday, September 24, 2014

Real estate falls in a blind spot

There has been an increased focus on reforming the financial services over the last decade or so and improving its regulatory framework. At one level it is therefore somewhat inexplicable how similar approach has bypassed the real estate sector which accounts for single biggest investment in their lifetime for most people. Perhaps, the tangle is just too complex.

Recently, the competition commission has shown the resolve to pick up the threads in the interest of millions of customers who have invested heir lives savings in purchase of their homes.

Now, nearly all home purchase is financed from banks or finance companies. It is therefore important to examine the role of banks, financiers and the banking regulator. I believe RBI can take proactive steps which would be in the interest of customers and help de-risk the real estate sector. I have an article in Mint news paper today on this topic.

Real estate falls in a blind spot
Stronger regulation is required not just to protect consumers but also to de-risk the banking sector

Ashish Aggarwal

The Supreme Court’s recent order directing DLF to deposit Rs.630 crore as penalty has again put the spotlight on the lack of regulatory oversight in the real estate sector. Nearly all real estate is financed. It is therefore important that banks and the banking regulator, which seem to exacerbate the problem, examine their respective roles.

A key unfair term of the builder-buyer agreement is related to payments. In a construction-linked plan, builders require buyers to cough up 35-40% of the price at the start of construction. It is common to collect about 75% of the payment with only half the work being done. In other variations, buyers get an initial discount but end up paying 85-90% upfront with no serious commitment on the completion date. This encourages the builder to delay construction as he has realised bulk of the revenue.

The penalty for delay, if enforceable, kicks in after a grace period of six months and ranges from Rs.1-5 per sq. ft per month. If a buyer has paid Rs.50 lakh to the builder, at 10% interest, for a 1,500-1,800 sq. ft house, the cost of borrowing from the bank is much higher at Rs.23-27 per sq. ft per month. Moreover, many first time buyers also have to suffer the extra burden of rent due to the delay.

In effect, the buyer ends up paying for his home and also financing the builder’s working capital. If a three-year project is delivered in five, buyers—including the investor variety—might also not benefit from capital appreciation, as many of them might look for an exit. The investor variety also lose out on rental income for the period of delay. Now, all this cannot happen without the role of banks.

All builders have arrangements with banks. The banks review and approve the project as well as the buyer agreements before giving home loans. Perhaps it is convenient for banks to wink at the project and the one-sided agreement in favour of the builder as it allows them to disburse a much higher tranche initially and earn interest for the longest tenure.

Financiers also compete for business among themselves. With processes such as advance processing facility, the entire project is approved once and for all and the requisite due diligence by the financiers during construction is seldom maintained. To further cut short this process, financiers also approve projects based on approvals of other banks.

Builders also peddle a sense of assurance to the end consumer, making him a scapegoat. Many builders, after they have collected the full payment, get the buyers to move into apartments without an occupancy certificate (OC), and incomplete amenities. The OC is issued after the building has been completed as per the sanctioned plan. Banks know that OC is required but they release the final loan instalment based on the builder’s demand. However, the banks do penalize the buyer for any delay in repayment and not the builder for not completing the construction on time.

While builders play truant due to the regulatory blindspot in the sector, it should be possible for the banking regulator to monitor banks and housing finance companies and ensure the project approval and review is done based on objective scrutiny instead of short term commercial gains. The percentage of home loan disbursed by the bank should be directly in proportion to the work completed and not as per payment plan of the developer. The banks must effectively monitor this.

This would also make commercial sense to banks and the banking regulator in the medium to long term. A major risk in the real estate sector stems from builders taking bulk of the money from buyers early and diverting much of it elsewhere. This jeopardises the project’s cash flow, is expensive and harrowing for the buyer and can ensnare banks bearing the credit exposure. Overall, it exposes both real estate and banking to stress.

Builders need to mandatorily adhere to a model buyer agreement, which is approved by the Competition Commission of India (CCI). However, it might not be feasible for CCI to ensure compliance of its model agreement. With its order now being backed by the apex court, there is hope that builders might set their house in order.

However, it would not be advisable to rely on such hope alone. The Reserve Bank of India has in the past frowned upon subvention schemes of banks and builders, where the buyer suffers in case of delay in construction. RBI and the National Housing Bank should take proactive steps in ensuring that banks and housing finance companies play their role fairly and diligently.

This would be in the interest of customers and help de-risk the real estate and banking sector quickly.

Ashish Aggarwal is co-founder and executive director at Invest India Micro Pension Services.

Read more at:

Saturday, July 12, 2014

In defence of a unified financial regulator

The union finance minister has put his weight behind the FSLRC report in his recent budget speech. One of the key recommendations of the FSLRC is move towards a unified financial regular. One of the main criticism of this idea is that it would lead to creation of a 'bureaucratic giant'. Well, the FSLRC does not just stop at the recommendations, it takes into account the pitfalls in execution and outlines how the unified regulatory framework should be designed. The FM would do well to take the entire report into consideration and avoid a formation of a 'bureaucratic giant'!

There is a lot to bat for a unified regulator.

Therefore, the finance minister’s budget announcement to dust off the report that was submitted in March last year is a big step forward for India’s financial sector reforms. A tight financial services regulatory framework would have a real chance to expand our financial markets, implement an effective client protection framework and a credible financial inclusion road map.

I have an article in Mint outlining how a unified regulator would enable effective financial inclusion and customer protection.

In defence of a unified financial regulator

Read more at:

Monday, June 30, 2014

Review: Lottery's tax leg-up over pension!

Selling lottery has a tax leg-up over selling pension! This and some other quibbles for the FM to consider this budget:

  1. Exempt income from distribution of NPS & NPS lite from Service Tax (ST). Income from sale of lottery tickets is exempt from ST so why not income from sale of socially relevant products like NPS and NPS Lite?
  2. Make NPS and pension plan of mutual funds tax exempt on withdrawal. PPF & EPF are tax exempt on withdrawal & NPS and mutual fund’s pension plan should get the same treatment. This should be extended to all long term savings (incl. infrastructure bonds), of - 15 years & above.
  3. Extend NPS Lite Swawalamban benefit till FY 18-19. Currently available only till FY 16-17.
  4. Increase annual co-contribution limit to to  Rs 2400 pa, up from the existing Rs 1000 decided in 2010. Keep the Rs 1000 as min. savings eligible for getting the matching co-contribution.
  5. Offer Jan Shree Bima Yojana (JBY) free to NPS lite customers who have saved at-least Rs 1000 in the previous FY. Make this a scheme feature.

Thursday, June 26, 2014

Remove anomalies, update taxation of pension, insurance & savings.

Remove anomalies, update taxation of pension, insurance & savings. 
Budget time sets off a queue at the FM’s door for tax reliefs and benefits. While the FM can give tax relief to tax payers, poor perhaps need to be motivated directly as they are not in the tax bracket. 
One easy pick for the FM this year could be the NPS Swawalamban benefit - this is fast receding in its 'value' and for those joining in FY 14-15 would only be available for 3 years. 
The FM should extend this to 5 years to FY 18-19. Importantly, the annual co-contribution benefit of Rs 1000 was announced in 2010 and should now be increased.
With over 2.6 million NPS lite accounts, the FM should encourage focus on getting persistent savings outcomes. He could keep the eligibility levels at minimum Rs 1000 savings for the workers to get the Rs 1000 co-contribution but increase the matching co-contribution limit to at-least Rs 2400 pa (that’s just Rs 200 per month).  
He could consider also expanding the Jana Shree Bima Yojanan (JBY) and bundle it with NPS lite and subsidize the Rs 200 premium fully for the subscriber. JBY offers a sum assured of Rs 30,000 on natural death and higher compensation in case of disability or accidental death. The JBY cover could be made contingent on the subscriber contributing at-least Rs 1000 in the scheme in the previous financial year and should be made available to the worker for the full duration of the NPS lite scheme.  The annual insurance cover could help encourage persistent savings.
Encouraging low-income informal sector workers to save for their old age is probably the most challenging financial inclusion initiative. Promising matching contribution is a fair bet to motivate workers to save for their old age and is better than many other subsidies that may not create any lasting value. The FM should give it the required push and encourage savings by low income workers.
In this context, it might also be useful to relaunch the inflation index bonds in a retail format which are suitable for the low income workers and middle class in general. The bonds in their current form have failed to serve this purpose and failed. This will require some thinking and the usual approach of coming up with clever and complex stuff which no one might buy needs to be avoided.
Coming to the taxpayers, a person who was earning an annual income of Rs 5 lakhs nine years ago in year 2005 should today be earning Rs 9-11 lakhs pa, just assuming an 8-10% annual increment to keep up with inflation. 
However, the deduction available for investments under section 80C of income tax is stagnant at Rs 100,000 as was prescribed in 2005.  
If the FM were not to offer any real increase in the deduction but just update the limit for consumer price inflation, say at an average of 7.5%, it would need to be pegged at Rs 200,000 to represent the same value it did in 2005. 
The FM could however think of providing some real increase and peg the limit at Rs 250,000, which would make it aligned to about 10% year on year increase since 2005. 
The FM should accordingly review the list of eligible investments and make the sub sub-limits also meaningful. After all, the amount each of us can save would depend more on our income than the upper limit for availing the tax deduction. While at it, It makes sense to link this ceiling to the cost inflation index so that the FM could spare himself the task of updating this amount every year unless he wants to make a policy level intervention.
One important anomaly that the FM should set right is to bring NPS and pension plans under MF to the same footing as PPF and EPF, which are tax exempt on withdrawals. It would be worthwhile to make all long-term savings and pension scheme (and infra bonds) of 15 years and above exempt from tax at all stages. This could nudge the taxpayers to put away the much-needed sums for later. 

Well these are perhaps small tweaks here and there and the FM has many other big things to mind, perhaps there is no money to spare for increasing tax deductions and making long term savings and pension attractive. 

But then, even a housewife finds the money and method to do things which are important and required for her household. The FM surely would agree and perhaps deliver more than we expect.

Monday, June 09, 2014

Target 200-mn in NPS by 2019, club EPF into NPS & encourage reverse mortgage

I have been witnessing the pension reforms closely since 2003 and despite the mixed outcome in the last decade, there is so much that we can achieve in the next five years. I wrote an article in FE on what we should target.

Target 200-mn in NPS by 2019, club EPF into NPS & encourage reverse mortgage
Financial Express, June 9, 2014

It’s been a decade since the pension reforms were first dribbled out in early 2004 under the NDA regime. In 2014, as the ball shifts back to the BJP regime, it is an opportunity for the new finance minister to put the reforms back on track.
India has over 100 million elderly and this population will triple to 300 million by the time those at age 30 today turn 60. The last decade barely made a difference to the pension outcome of over 500 million workforce in the working age.

Civil servants’ pension reform has largely succeeded with 3.3 million central and state government employees now in a fully defined contribution (DC) system with pension assets (about R426 billion) invested in a mix of debt and equity. The old defined benefit (DB) and unfunded system where each retiree got a pension of about 50% of last pay has been successfully restricted to employees who joined before January 1, 2004.

But a few state governments are paying truant and the new regime at the Centre needs to focus on them. Maharashtra and Tamil Nadu joined the NPS long ago but are keeping the scheme funds in their public accounts instead of remitting the same to NPS. West Bengal and Tripura have not yet signed up. This is also an area where PFRDA, the pension regulator, has little influence.

Resting on a 1952 legislation, it is a challenging task to reform the Employee Provident Fund (EPF) but with a customer base of 50 million, it is an important cause. Measures like auctioning the fund management and moving forward on making the systems user-friendly could be counted as hits. However, well into 2014, there is still lack of assurance on maintenance of accurate data, with customer accounts even reflecting negative balances! The more important reform here is to look at integrating EPF into NPS.

The logic is evident. Private sector employees should be able to invest their mandatory provident fund in the NPS and benefits from scheme level choices and a largely glitch-free system architecture. With this, India can move closer to an integrated pension architecture with one pension account for a person irrespective whether one is in government or private service or is self-employed or switches career inter se. Here, the government should first put the NPS in order and ensure there is portability of account within NPS for the employees moving from government to private sector or vice-versa.

The Employee Pension Scheme (EPS) deficit (shortfall in scheme income as against its payout) has regrettably become a subject of debate with size estimates ranging from R500 billion to R100 billion. It would be a prudent to cap this deficit and shift the scheme to NPS for the new joiners.

Getting the NPS for private sector to scale up is an agenda that the government needs to pin up on its to-do list. With just 3,30,000 subscribers in five years after it was opened to public, it has nothing to show for. Here, the government needs to adequately invest in education and awareness and simultaneously fix the distribution.

There are other financial tools that seem to be promising solutions to strengthening the old age social security framework. Reverse mortgage, where one can loan one’s house to a bank and get a pension for life, is potentially one such solution. However, the idea of loaning one’s house is not an intuitive one and there are no clear models that India can potentially replicate. The finance ministry should take a crack at this, perhaps starting with the upcoming budget.

Finally, all of the above, even if done well, will not add up to eradicating old age poverty in India. The suggestion of a means-tested minimum pension (unfunded) or what is more commonly understood as universal pension is not necessarily a suitable one.

One could argue that our dependency ratio (percentage of number of elderly and children dependents per 100 working age population), at 53%, is expected to decline to 40% in the coming decade and our economy would presumably grow at a high rate—so we should aim for this. There is also merit in considering that the bulk of our population is poor and will not be able to save adequately on their own for their old age. The truth is that the western world with better finances is struggling with such systems and the math just does not add up over the long term. India will need to find its own solutions.

Latest data of NPS Lite, a scheme to motivate the poor to save for old age, shows that there are about 2.6 million subscribers with R8.1 billion corpus in four years. It seems to have had a decent start. The average account balance of R3,100 needs to be analysed. There is, however, a general lack of public data or discussion on how many of those who joined have continued to save in their second or third year. Driving persistent savings behaviour from a population with irregular incomes and lack of banking usage is the most important and difficult challenge here. The focus must grow beyond enrolments to outcomes, especially in socially-oriented pension schemes like the NPS Lite.

When he presents his first budget, the finance minister could look at extending the scheme co-contribution beyond 2017 and consider making the Swavalamban subsidy smarter as the present R1,000 annual co-contribution has had the unintended effect of limiting this scheme to becoming a ‘thousand rupee scheme’, where one gets R1,000 by investing R1,000 and the focus has shifted away from trying to save as much as possible.

It might also be a good time to review the product design and make it more attractive. For instance, bundling the NPS Lite with an inexpensive health insurance plan on the lines of RSBY could make it more appealing. Benefits of health cover are more immediate while pension plans take a long time to reap.

In the next five years, the government should target 100 million low-income workers in NPS Lite, 50 million informal private sector workers in NPS and give the 50 million EPF subscribers an option to migrate to NPS. Lastly, the finance minister and RBI should push for working a reverse mortgage model with at least 1 million participants to demonstrate its success.

Ashish Aggarwal

The author is co-founder and executive director at Invest India Micro Pension Services