Loan-To-Value Ratio Has Been Declining In India

Banks have been cautious in sanctioning loans in the recent past. The proportion of loans with high loan-to-value ratio (LTV) -- the ratio of the loan value to the appraised value of a property -- has been declining since the financial year 2010-11. (The loan-to-value ratio is also calculated by dividing the loan amount by the price at which the property was bought. While calculating the loan-to-value ratio, banks may or may not include stamp duty, registration charges and other expenses involved in complying with government regulations.) Since the loan-to-value ratio is one of the tools that banks use to lower their exposure to risk, it means the lenders have become more risk-averse.

In 2010, the Reserve Bank Of India (RBI) had stipulated that banks should have an upper limit of a loan-to-value ratio of 80 per cent for housing loans greater than Rs 20 lakh, and an upper limit of 90 per cent for housing loans lower than Rs 20 lakh. But in 2015, the RBI allowed a loan-to-value ratio of 30 per cent for housing loans of up to Rs 30 lakh. The RBI revised the figure, perhaps because flats which cost less than Rs 30 lakh are considered affordable in large Indian cities. It may also have to do with the fact that the demand for houses has declined in the past two years.

When the LTV ratio is between 80 per cent and 90 per cent, banks need to set aside 50 per cent of the capital; they need to set aside only 35 per cent if the LTV ratio is 80 per cent. So, banks will become more hesitant to rent if the LTV ratio is high, because of two reasons. First, to set aside a higher fraction of the capital, banks need to make more provisions. Second, when banks set aside a higher fraction of the capital, it constraints their ability to lend to home buyers and other borrowers.

Since 2010, the proportion of loans with higher LTV has been declining. In fact, lowering the LTV ratio allows banks to have greater control over their portfolio. This also raises their ability to lend to home buyers.  When the LTV is high, home buyers are likely to buy houses which they otherwise would not buy. This will make sanctioning mortgage loans riskier for banks, and to a greater decline in housing prices in the long run. A lower LTV ratio, on the other hand, would lead to less volatility in real estate markets, and would make mortgage loans less risky.

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