Accept the Risks Linked with Real Estate: RBI to Banks

December 18, 2008	(Be the first to rate this story!)  Loading ...
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The Reserve Bank of India on Wednesday said that it is imperative for banks to manage balance sheet risks associated with real estate exposure. This becomes important “particularly in the current scenario of slowdown in the economy with its expected ramifications on real estate prices, given the historically positive correlation between economic downturn and its adverse impact on real estate prices,” the apex bank said. With the major portion of real estate exposure consisting of mortgage-related assets, which are long-term in nature and have dynamic cash flow characteristics, they become “risky ventures”, the RBI said in its Report on Trend and Progress of Banking in India, 2007-08, released here.

The recent global financial turmoil, caused by the mortgage market crisis in the US, has brought into focus “the dangerous inter-dependence between real estate cycles, bank crisis and the ultimate threat to financial stability”, it said. Anecdotal evidence suggests real estate prices rose 2-4 times during the past 3-4-years in different parts of the country, the RBI said. Real estate prices affect the economy primarily in two ways, it said. First, when prices are rising, the expectation of further appreciation is factored into the prices and this expectation stimulates demand for homes, which, in turn, spurs construction activity and aggregate demand.

Second, higher real estate prices increase household wealth, which leads to consumer spending. If real estate prices rise above the level than is justified by the fundamentals, too many houses will be built. “At some point, the correction would set in and asset prices then return to their fundamental values. When this happens, the sharp downward revision of asset prices can lead to a sharp contraction in the economy, both directly, through effects on investment, and indirectly, through the effects of reduced household wealth on consumer spending,” the RBI said. There is, thus, concern that rapid rise in real estate prices at some stage might have adverse effects on the economy, the apex bank said.

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