Realty firms may fail to meet the Reserve Bank of India’s (RBI) criteria for new bank licence applicants to be “financially sound with a successful track record of 10 years”.
The last few years were challenging for realtors. Most are still reeling under high debt, low market valuation relative to their liabilities and poor cash flows.
Despite some improvement in their finances in the past few quarters, developers still have poor debt servicing capability, as indicated by low interest coverage and ratio, and extremely low-return on equity. So, it may be tough for their promoters to convince RBI to issue them licence.
According to the norms, applicants’ business model and business should not put the bank and the banking system at risk due to group activities, which are speculative in nature or subject to high asset price volatility.
Real estate has become an asset play in recent years with investors, instead of real users, investing in properties. Many developers themselves seem to play this game, which is evident from the huge inventory of built-up or semi built-up projects lying on their books. At end-FY12, India’s top 28 listed real estate developers were sitting on inventory worth Rs 62,000 crore, more than one-and-a-half times their net sales. The figure would be Rs 1 lakh crore, if projects under construction and buildings available for lease rentals were included.
Financial ratios for the brokerage sector is a bit better, but brokerages are also facing financial headwinds. The dip in the equity trading volumes after the 2008 financial crisis forced many brokerages to turn to lending to maintain top line growth. This has stretched the balance sheet of many brokerages and led to a sharp decline in return ratios such as return on networth, while debt to equity is higher than in the past.
A brokerage on its own is agency business and doesn’t require much recurring capital. Religare Enterprises, one of the prime aspirant for a banking licence, had a debt to equity ratio of 3.8 in FY12, while its return on networth was negative. Ratios are a little better in case of Edelweiss Financial Services and IIFL, but not optimum.
In contrast, most of the pure play non-banking finance companies such as IDFC, M&M Financials, Shriram Transport Finance, Bajaj Finserve and Aditya Birla Finance have much better financial ratios and best placed to meet RBI’s fit and proper criteria.