As the real estate sector evolved over the last decade so did its financing needs. Traditionally, banks have been providing funds towards project construction, while non-banking financial companies (NBFCs) have been contributed on a wider basis and acting as a supplemental channel of credit intermediation.

Over the years, NBFC funding to the real estate sector has undergone considerable evolution in terms of size, complexity and interconnectedness with the financial sector.

NBFCs too have undergone a systemic change post the crisis of September 2018, triggered by the collapse of IL&FS, after which many of them faced an existential crisis. Some could not recover at all. Many of those NBFCs have been very active in the real estate sector up until then.

NBFCs have been funding real estate developers across the lifecycle of a project, and their value addition has been primarily during the initial stages of a project, with existing regulatory guidelines barring banks from extending financing.

The regulator might have thought that NBFCs were taking a disproportionately higher risk, which seems a fair assessmment given the way the sector got impacted post the crisis.

Therefore, the Reserve Bank of India , vide its circular dated April 19, 2022, has stipulated that while approving loans involving real estate, NBFCs have to ensure that the borrower has been granted all requisite permission by the government/ other regulatory authorities for the underlying projects.

The above guideline has come into effect from October 1, 2022, and is applicable to NBFC-Middle Layer (non-deposit taking NBFCs with assets of more than ₹1,000 crore) and NBFC–Upper Layer (as published by the RBI from time to time). Post the above notification, NBFCs are restricted from financing projects which are not approved, or in simple language, projects which are at land stage. To simplify further, this means NBFCs cannot fund acquisition of land, where the primary source of repayment is an unapproved project/land.

This will lead to the realignment of the sector as NBFCs has thus far acted as a vital cog during the lifecycle of a project by extending funding at the nascent stage of the project or towards land acquisition.

The RBI guidelines seem to be a step in the right direction to ensure more equity infusion into projects even while ensuring that the risks are at manageable levels for the entire system.

In conclusion, regulatory steps such as these are mainly to nudge NBFCs to adopt prudent risk management practices and become more bank like. At the same time, they need to ensure that there is more skin in the game for the promoters in the underlying project through infusion of higher equity towards land acquisition and approvals.

Consequently, this would lead to better managed overall systemic risk.

The author is Business Head - Real Estate and Urban Infrastructure, Arka Fincap Ltd