Indian Financial Institutions (FIs) are fast getting their act together to counter stiff competition from the banking entities.

They are also gearing up to transform themselves into 'Universal Banks', to capitalize on the opportunities available in the sector with the opening up of the Indian economy.

While some of the major banks are also now catering to demand for long-term and project finance, FIs remain the conventional sources of the same. With most FIs being converted to banks (ICICI [Get Quote], IDBI and the like), the term FI has now remained restricted to NBFCs and HFCs. 

Budget Measures Encourage trading of mortgage-backed securities. Tax exemptions on interest paid on home loans to continue. The allocation to 'Indira Awas Yojana' (flagship rural housing scheme) is to be increased from Rs 25 bn in the current year to Rs.27.5 bn in BE 2005-06. About 1.5 m houses to be constructed during the next year.  Budget Impact Housing Finance Companies are expected to witness higher credit growth on the back of continued tax sops. Besides, the move to provide a fillip to mortgage-backed securities trading is a big positive from a long-term perspective. There may not be any direct impact of the government's thrust on rural housing. However, increased lending to the rural housing sector may not be ruled out.  Sector Outlook The budget measures are expected to augur well for the housing finance companies and improve their credit disbursals. Also, trading in 'mortgage backed securities' will provide a higher impetus to the growth of the sector.  Industry Wish List Maintain the tax incentives on housing loans. Housing finance companies (HFCs) are seeking level playing field after the aggressive entry of banks into the sector. This is due to the fact that HFCs are not allowed tax exemptions against provision for non-performing assets (NPAs) unlike banks and financial institutions.  Budget over the years Budget 2002-03 Budget 2003-04 Budget 2004-05 Deduction for interest payable on housing loans for self-occupied houses even where such houses are acquired or constructed after March 31, 2003. Capital gains exemption is provided in section 54EC of the Income-tax Act to bonds issued by the National Housing Bank. The NHB will launch a Mortgage Credit Guarantee Scheme. Tax exemption on interest on housing loans maintained at Rs 150,000 per year. Tax breaks on specified housing projects have been extended till 2005. Reduction in the interest rates on all small savings schemes by 1%. The government has stressed on the rural housing sector and has raised the allocation for Indira Awas Yojana by Rs 5.3 bn to Rs 22.5 bn. RBI to revise the norms of repayment of rural housing loans by banks so that installments coincide with crop cycles. Tax exemption on interest on housing loans maintained at Rs 150,000 per year. [Read more on Budget 2004-05]
Key Positives Tax benefits:  The finance ministry proposed amendments in the tax laws to offer tax breaks to FIs merging with banks (with retrospective effect). This will be beneficial to FIs that have got converted to banks ( IDBI and the like). Conversion into banking entity:  The RBI has allowed Non-banking finance companies (NBFCs) with a good track record and net worth over Rs 2 bn to convert into a commercial bank. However, the number of licenses to be issued may be restricted to two or three of the best acceptable proposals. Conversion into banking entity will enables the FIs to access low cost deposits and improve their margins. Lower capital requirement:  The RBI has reduced the capital adequacy requirement of NBFCs as far as lending to the housing sector is concerned. The RBI has reduced the capital requirement to 50% from the earlier 100% and this has helped the NBFCs to increase their exposure to the housing sector due to availability of a higher quantum of capital. Policy benefits:  HFCs are exempted from paying withholding tax on foreign currency borrowings. This enables HFCs to tap foreign markets to raise funds at lower cost. Enhanced foreign participation limits:  FII limits for HFCs and financial institutions have been increased to 49% from earlier 40%. Automatic foreign direct investment in NBFCs is also allowed up to 100%.		Key Negatives High borrowing costs:  High cost of borrowings to housing finance companies (HFCs) and high stamp duty dampens growth rates. HFCs are also not yet given 'Universal Banking' status for offering wholesale and retail finances under one roof. Interest rate dampener:  The interest rate movement in the short term is likely to be with an upward bias. Although a marginal hike will not trigger any sensitivity, an upward movement in inflation, leading to a parallel rise in interest rates may put the current credit growth on hold. Growing competition:  NBFCs as a class do not offer any products that are distinct form what the banks are capable of offering. NBFCs were historically strong in the retail and vehicle finance segment and they leveraged on local relationships to grow their business. However in the last 3-4 years banks have aggressively taken away market share both in the retail as well as the vehicle finance segment. Banks due to their low cost of capital have been able to offer services at lower cost to the consumer. Going forward if interest rates rise, NBFCs will be hit hard as banks will continue to remain more competitive.

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