The Reserve Bank Of India (RBI) has released a draft on Wednesday, proposing to review the definition of commercial real estate (CRE) exposure to be followed by banks to closely align it to Basel II definition. Any exposures towards a banks’ acquisition of units in SEZ may not be treated as CRE exposures, said RBI. There are restrictions on the transfer of such units and they require government permission, the speculative activity in the sale and re-sale of units is unlikely to be there. Hence, such cases are more like financing of industrial units or projects, explained RBI.
Any loans extended to builders towards construction of housing buildings, hotels, hospitals, condominiums, shopping malls, office blocks, etc, meant for sale/leasing will be classified as CRE exposures.
In such cases, the source of repayment in normal course would be the cash flows generated by the services rendered by the hotel and the hospital. In the case of a hotel, the cash flows would be mainly sensitive to the factors influencing the flow of tourism, not directly to the fluctuations in real estate prices. In the case of a hospital, the cash flows in normal course would be sensitive to the quality of doctors and other diagnostic services provided by the hospital. In these cases, the source of repayment might also depend upon the real estate prices to the extent the fluctuation in prices influences the room rents, but it will be a minor factor in determining overall cash flows. In these two cases, the recovery in case of default may partly depend upon the sale price of the hotel/hospital.
The loans extended to entrepreneurs, against the security of factory land and building, for purchase of the plant, machinery and raw material will be part of CRE exposures.
A few banks have formulated schemes where the owners of existing real estate, such as shopping malls and office premises, have been offered finance to be repaid out of the rentals generated by these properties. Such finance may or may not be secured by the mortgage of the underlying properties. In case it is unsecured, the repayment will be sensitive to the fall in real estate rentals and there would be no source of recovery in the case of default. In case the loan is secured by the mortgage of the underlying property, both, the repayment and recovery would depend upon property prices. Thus, these exposures would need to be classified as CRE exposures.
Working capital loan and term loan to acquire machinery for an industrial unit, where the land and building is taken as collateral, will not be classified as CRE exposures.
