RBI suggests scrapping 80:20 upfront loans schemes; bankers, developers not happy with the move

The Reserve Bank of India has suggested scrapping banks from giving upfront loans for under-construction projects through schemes like 80:20. Providing such loans help a bank as they are classified as mortgage and not construction finance which is considered a risky business by the RBI and requires higher provisioning. The builder to gains as home loans are far cheaper than construction loans.

However, bankers and developers are not happy with the RBI move. According to bank sources, nearly 25% of loan disbursements for new flats in Mumbai are under such schemes. While builders said the RBI’s move would hit economic growth, HDFC chairman Deepak Parekh had recently spoken out against such schemes.

“As a basic tenet, construction finance entails higher risks and, therefore, such risks have to be built into the pricing. Construction finance should not, through any innovative structuring, be available to developers at the rate of interest being offered on individual home loans. Further, to pay upfront construction finance to developers even before the ground is broken is dangerous,” Parekh warned.

Many developers have been banking on funds generated by these schemes to complete and deliver their projects. “The RBI’s latest suggested guideline to lending institutions with regards to the 20:80 and related schemes can prove to be yet another blow to the residential real estate industry. This comes at a time when construction costs have risen sky-high and the cost of funding is crippling, so it is unlikely that this will lead to a reduction in prices,” Kishor Pate, CMD, Amit Enterprises Housing Ltd.

Established developers with the capacity to complete projects on the basis of their own resources and traditional funding will still be able to honour their commitments to their customers. “But the shakeup that the industry is experiencing now is going to make it very hard for new entrants to gain a foothold,” Pate added.

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“Builders who had been relying on this scheme to generate project funding will be hit hard if banks abolish it. Since this would effectively raise the cost of project capitalization even higher, there is no question of a correction in prices as a result of this move,” Anil Pharande, chairman, Pharande Spaces, said, adding that the builders can only hope that the reverse does not become a reality instead.