Completion Report. Project Number: IND Loan Number: 1759-IND and 1761-IND October India: Housing Finance II Project

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1 Completion Report Project Number: IND Loan Number: 1759-IND and 1761-IND October 2008 India: Housing Finance II Project

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3 CURRENCY EQUIVALENTS Currency Unit Indian rupee/s (Re/Rs) At Appraisal At Project Completion National Housing Bank 31 August June 2007 Re1.00 = $ $ $1.00 = Rs45.9 Rs40.7 ICICI Bank Limited 31 August October 2007 Re1.00 = $ $ $1.00 = Rs45.9 Rs39.5 ABBREVIATIONS ADB Asian Development Bank ADS area development society BME benefit monitoring and evaluation CDS community development society CFI community-based financial institution DSCR debt service coverage ratio HDFC Housing Development Finance Corporation Limited HF I Housing Finance Project HF II Housing Finance II Project HFC housing finance company HFI housing finance institution HUDCO Housing and Urban Development Corporation Limited ICICI Bank ICICI Bank Limited JLG joint liability group LIH low income household MBS mortgage-backed securitization MFI microfinance institution NGO non-government organization NHB National Housing Bank NHG neighborhood group PCR project completion report RBI Reserve Bank of India RRP report and recommendation of the President SHG self help group SML Share Microfin Limited SPARC Society for Promotion of Area Resource Centre SPMS Sri Padmavathy Mahila Abyudaya Sangam SSNS SPARC Samudaya Nirman Sahayak TA technical assistance UEIF Urban and Environmental Infrastructure Facility USAID United States Agency for International Development

4 NOTES (i) The fiscal year (FY) of NHB ends on 30 June, and of the ICICI Bank ends on 31 March. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2007 ends on 30 June 2007 for NHB and 31 March 2007 for ICICI Bank. (ii) In this report, $ refers to US dollars. Vice President X. Zhao, Operations 1 Director General K. Senga, South Asia Department (SARD) Director T. Kondo, Country Director, India Resident Mission, SARD Team leader S. Singh, Financial Officer, SARD Team members R. Pande, Associate Financial Analyst, SARD N. Saini, Administrative Assistant, SARD

5 CONTENTS Page BASIC DATA i I. BACKGROUND 1 A. History 1 B. Scope of Operations 1 C. Relationship with ADB and Other lenders 2 D. Relevance of Design and Formulation 3 E. Related Technical Assistance 5 II. IMPLEMENTATION 5 A. Lending Policies 5 B. Characteristics of Subloans 6 C. Implementation and Internal Operation of Subprojects 8 D. Operational Performance of the Borrowers 12 E. Borrower s Financial Performance 13 F. Financial Statements and Ratios 13 G. Covenants 14 H. Performance of the Asian Development Bank 14 III. EVALUATION 15 A. Loan Appraisal 15 B. Implementation 16 IV. ASSESSMENT AND RECOMMENDATIONS 16 A. Evaluation Criteria 16 B. Relevance 17 C. Effectiveness in Achieving Outcome 17 D. Efficiency in Achieving Outcome and Outputs 18 E. Preliminary Assessment of Sustainability 18 F. Overall Assessment 18 G. Impact 19 H. Lessons 20 I. Recommendations 20 APPENDIXES 1. Project Framework Community-based Financial Institution and Non-Government Organization Subproject Profiles Details of Refinance and Direct Finance under the Project Policy and Institutional Action Plan Financial Statements of National Housing Bank Financial Statements of ICICI Bank Limited Status of Compliance with Key Loan Covenants 46

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7 BASIC DATA A. Loan Identification 1. Country India 2. Loan Numbers 1759-IND, 1761-IND 3. Loan Title Housing Finance II Project 4. Borrowers National Housing Bank (NHB) and ICICI Bank Limited (ICICI Bank), the successor of ICICI Limited 5. Amount of Loan $40 million to NHB and $80 million to ICICI Bank 6. Project Completion Report Number PCR:IND 1057 B. Loan Data 1. Appraisal Date Started 5 June 2000 Date Completed 15 June Loan Negotiations Date Started 22 August 2000 Date Completed 25 August Date of Board Approval 21 September Date of Loan Agreements 18 December Date of Loan Effectiveness In Loan Agreements 18 March 2002 Actual NHB 15 February 2002 ICICI Bank 20 December 2002 Number of Extensions for Four ICICI Bank 6. Terminal Date for Commitments In Loan Agreement NHB 14 February 2006 ICICI Bank 19 December 2006 Actual NHB 30 June 2007 ICICI Bank 30 June 2007 Number of Extensions One for NHB and ICICI Bank 7. Closing Date In Loan Agreements 30 June 2007 Revised for ICICI Bank 10 October 2007 Number of Extensions None

8 ii 8. Terms to the Borrower Interest Rate Maturity (number of years) Grace Period (number of years) Free Limit Repayment Terms As per the Asian Development Bank s (ADB s) market-based loan facility for US dollar loans. 25 years 5 years $2 million Amortized in semiannual installments over 20 years. 9. Interest Rate for Subloans Project envisaged market-based interest rates. Actual interest rates varied across lending channels. 10. Disbursements a. Dates Borrower Initial Disbursement Final Disbursement Time Interval NHB ICICI Bank 27 March December June October years 5 years Effective Date Original Closing Date Time Interval NHB ICICI Bank 15 February December June June years 4.5 years b. Amount ($ million) Name Last of the Original Revised Amount Amount Borrower Category Allocation Allocation Canceled Disbursed NHB ICICI Bank Project Expenditure Project Expenditure Total

9 iii C. Implementation Data 1. Number of Subloans NHB 2,830 1 ICICI Bank 25,730 (Approximately) 2. Sectoral Distribution of Subloans Housing Finance II Project, National Housing Bank Loan (Loan 1759 IND) Component Sector Projected Actual Amount ($ million) % Amount a ($ million) % Part B(ii) Refinancing HFI b Up to $32 No 80% loans to LIHs million more than Part B(iii) Supporting the CFI refinance scheme to refinance HFC 0.00 loans to CFIs for Part A (i) c housing subloans Support lending to LIHs for qualified housing proposals through intermediaries consisting of (i) CFIs and NGOs At least $8 million At least 20% CFI = community-based financial institution, HFC = housing finance company, HFI = housing finance institution, LIH = low income household, NGO = non-government organization. a This amount excludes front-end fees of $0.4 million. b HFI is a housing finance institution as defined in the NHB Act with the objective of providing finance for c housing. This component was incorporated vide amendment to the loan agreement dated 8 September 2006 and included together with Part B (iii) for satisfying the subloan distribution criteria. Housing Finance II Project, ICICI Bank Limited Loan (Loan 1761 IND) Component Sector Projected Actual Amount ($ million) Amount a ($ million) Part A(i) b Lending directly to LIHs that are beneficiaries of CFIs or NGOs, or indirectly to LIHs through CFIs or NGOs as intermediaries Part A(ii) c Lending directly to LIHs that are This figure corresponds to the loan of $7 million, which was originally disbursed under part B(ii). Subsequently, $0.78 million was reallocated from part B(ii) to part A(i), under which 576 loans were made.

10 iv Component Sector Projected Actual employees of public and private enterprises, or indirectly to LIHs through public and private enterprises Part A(iii) Lending indirectly to LIHs through state and local bodies Part B(i) Lending directly to LIHs CFI = community-based financial institution, LIH = low income household, NGO = non-government organization. a This amount excludes front-end fees of $0.8 million. b This component was revised to include direct lending to beneficiaries of CFIs or NGOs (loan agreement amendment of 3 November 2004). c The condition in the loan agreement restricting direct lending under part A(ii) to $10 million was removed (loan agreement amendment of 3 November 2004). 3. Subloans Above Free Limit ($2 million): Nil 4. Project Performance Report Ratings NHB Ratings Implementation Period Development Objectives Implementation Progress (i) From December 2000 to May 2001 S S (ii) From June 2001 to February 2002 S U (iii) From March 2002 to December 2005 S S (iv) From January 2006 to April 2006 S PS (v) From May 2006 to August 2006 PS S (vi) From September 2006 to January 2008 S S PS = Partly Satisfactory, S = Satisfactory, U = Unsatisfactory. ICICI Bank Ratings Development Implementation Period Objectives (i) From December 2000 to May 2001 S S (ii) From June 2001 to November 2002 S U (iii) From December 2002 to February 2003 S PS (iv) From March 2003 to December 2007 S S PS = Partly Satisfactory, S = Satisfactory, U = Unsatisfactory. Implementation Progress

11 v D. Data on Asian Development Bank Missions a Housing Finance II Project, National Housing Bank Loan (Loan 1759 IND) Name of Mission Date No. of Persons No. of Person-Days Specialization of Members b Fact-Finding Mission 18 April 2 May c, j, k, Appraisal Mission 5-15 June c, j, k Inception Mission 29 April b, f Review Mission (1) 7 February b, f, k Review Mission (2) 24 April b, f, k Review Mission (3) 4 August b, f Disbursement Mission 1 2 September and 15 September f Review Mission (4) October b Disbursement Mission 18 and October f Review Mission (5) 7 and 13 April b, d, f, k Disbursement Mission July f Mid-term Review Mission 30 June 8 November b, d, f, k a Review Mission (6) 2 February b, f, k Review Mission (7) 13 September b, f Review Mission (8) 11 April 14 May b, h, i, k Project Completion 9 27 May b, k Review c The mission details provided here are based on the review of project files. b a - engineer, b - financial analyst, c - counsel, d - economist, e - procurement or consultant specialist, f - control officer, g - programs officer, h - resettlement specialist, i - environment specialist, j - urban development specialist, k - onward for other categories. c The project completion review mission comprised Tetsu Ito, Senior Economist (Financial Sector) and Mission Leader; and Shalini Singh, Financial Officer. Ruchira Pande, Associate Financial Analyst, and Neha Saini, Administrative Assistant, assisted the mission.

12 vi Housing Finance II Project, ICICI Bank Limited Loan (Loan 1761 IND) Name of Mission Date No. of Persons No. of Person-Days Specialization of Members a Fact-Finding Mission 18 April 2 May c, j, k Loan Appraisal Mission Loan Inception Mission 5 15 June c, j, k February b, f, g Review Mission (1) 19 February b, k Review Mission (2) 9 19 June b, k Disbursement Mission 9 19 June f, k Mid-term Review Mission Review Mission (3) 24June 18 August November 3 December b, k 3 12 b, k Review Mission (4) 25 May k Special Loan Administration Mission 4 5 December b, k a b Review Mission (5) 11 April 14 May b, h, i, k Project Completion 8 21 May b, k Review (PCR) b a - engineer, b - financial analyst, c - counsel, d - economist, e - procurement or consultant specialist, f - control officer, g - programs officer, h - resettlement specialist, i - environment specialist, j - urban developm ent specialist, k - onward for other categories. The project completion review mission comprised Tetsu Ito, Senior Economist (Financial Sector) and Mission Leader; and Shalini Singh, Financial Officer. Ruchira Pande, Associate Financial Analyst, and Neha Saini, Administrative Assistant, assisted the Mission.

13 vii E. Related Loans Housing Finance II Project, National Housing Bank Loan (Loan 1759 IND) Item Loan No. Date of signing of Loan Agreement Housing Finance (National Housing Bank) IND = India. Source: Asian Development Bank, Loan Financial Information System. Amount 1549-IND 25 September 1997 $100 million Housing Finance II Project, ICICI Bank Limited Loan (Loan 1761 IND) Item Loan No. Date of signing of Loan Agreement Industrial Credit and Investment Corporation of India Limited Second Loan to Industrial Credit and Investment Corporation of India Limited Private Sector Infrastructure Facility Project Urban Environment and Infrastructure Facility IND = India. Source: Asian Development Bank, Loan Financial Information System. Amount 778-IND 2 May 1986 $100 million 1072-IND 15 January 1991 $120 million 1480-IND 14 August 1997 $150 million 1720-IND 19 May 2000 $80 million

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15 I. BACKGROUND A. History 1. National Housing Bank. The National Housing Bank (NHB) was established in July 1988 under the NHB Act, 1987, to function as the apex body for housing finance. NHB is wholly owned by the Reserve Bank of India (RBI). Its three primary responsibilities are regulating and supervising housing finance companies (HFCs), 1 mobilizing resources for housing finance operations in the form of refinance and direct finance, and promoting development of HFCs. A major amendment to the NHB Act was made in 2000, which aimed to strengthen the regulatory and supervisory functions of NHB with respect to HFCs, including registration of HFCs with NHB. The amendment also included provisions to enable NHB (i) to directly finance housing finance projects, and (ii) to undertake mortgage-backed securitization (MBS) of housing loans. 2. ICICI Bank. The Government of India and the World Bank, among others, formed the Industrial Credit and Investment Corporation of India Limited (subsequently renamed ICICI Limited) in 1955 as a development finance institution to provide medium- and long-term project financing to Indian businesses. In the 1990s, ICICI Limited broadened its business scope by creating subsidiaries covering the complete spectrum of banking products and services. In 2002, in response to the challenges and opportunities resulting from liberalization of the financial sector, ICICI Limited merged with its commercial banking subsidiary, ICICI Bank Limited (ICICI Bank). For further details, refer to the project completion report (PCR) of the Urban and Environmental Infrastructure Facility (UEIF). 2 B. Scope of Operations 3. National Housing Bank. In its role as a housing finance provider, NHB refinances HFCs, commercial banks and cooperative sector institutions. NHB also directly finances housing projects of public housing and development agencies. In addition, it has extended financial support to housing schemes of community-based financial institutions (CFIs) and nongovernment organizations (NGOs). As a regulator, NHB regulates the deposit acceptance activities of HFCs, and sets prudential norms regarding their capital adequacy, asset classification, concentration of credit, income recognition, provisioning for bad and doubtful debts, etc. NHB supervises the operations of HFCs through on-site inspection and off-site surveillance. NHB has played a role in the development of a secondary mortgage market in the country. It launched the pilot MBS issues in India in August 2000, followed by 13 other MBS issues (with a total value of Rs8,630 million). NHB is also in the process of promoting a mortgage credit guarantee company. 4. ICICI Bank. At the time of approval of the Housing Finance II Project (HF II), the principal business of ICICI Limited comprised medium- and long-term project finance, corporate finance, leasing, and other types of financial and advisory services. Following the 2002 merger of ICICI Limited with ICICI Bank, the latter, as the surviving entity, became a universal bank providing a range of services, including retail banking (lending, deposits, and moneytransmission services), corporate finance, project finance, rural finance, microfinance, and feebased services. For further details, refer to the UEIF PCR (footnote 2). 1 2 HFCs are companies that are registered with NHB, and whose primary business (directly or indirectly) is the provision of housing finance. ADB Completion Report on Urban and Environmental Infrastructure Facility Project. Manila.

16 2 C. Relationship with ADB and Other Lenders 1. National Housing Bank 5. ADB operations with NHB. In 1997, prior to HF II, ADB provided a governmentguaranteed loan of $100 million to NHB under the Housing Finance Project (HF I), 3 for lending through government cooperatives, HFCs, CFIs and NGOs to individuals, with an emphasis on low income households (LIHs). ADB also provided advisory technical assistance (TA) 4 to evaluate NHB s operational effectiveness, develop benchmarks in key NHB operational areas, and develop NHB s medium-term business strategy. ADB also approved two TAs related to MBS in and 2005, 6 and investment in a mortgage credit guarantee company Funding structure of NHB. Rupee borrowings comprise the bulk of NHB s resources, with borrowings from outside India constituting about 2.3% of total debt in 2007 (ADB loans constituted 2.1%). The main sources for rupee resources include domestic bonds and debentures, some of which enjoy fiscal and/or regulatory incentives (e.g., priority sector and capital gains bonds), and borrowings from banks. The fiscal and regulatory benefits have decreased in recent years (for instance, the capital gains bonds scheme and priority sector status for bonds were withdrawn in 2006), and NHB is increasingly relying on commercial borrowings. 7. Other development partners. The United States Agency for International Development (USAID) is among NHB s other development partners. NHB borrowed $25 million under USAID s Housing Guarantee Program in to expand its refinancing operations. 2. ICICI Bank 8. In addition to the UEIF, ADB provided four other loans to ICICI Limited for various purposes, all of which were guaranteed by the Government. Following the 2002 merger, ICICI Bank s resources have shifted predominantly to public deposits, but it continues to raise funds through (i) issuance of rupee and foreign-currency bonds; (ii) equity from global and domestic markets; and (iii) external borrowings in international markets, including from multilateral lenders. Borrowings from multilateral and bilateral agencies have been relatively small, and have declined in recent years. The World Bank, USAID, and Kreditanstalt fur Wiederaufbau (KfW) are among the other multi- and bilateral agencies that ICICI Bank has partnered with. For further details, refer to the UEIF PCR (footnote 2). 3 ADB Report and Recommendation of the President to the Board of Directors on proposed loans for the Housing Finance Project in India. Manila. 4 ADB Technical Assistance to India for Strengthening Housing Finance Institutions. Manila (TA No IND, approved July 1997). 5 ADB Technical Assistance to India for Assessing the Role of Mortgage Backed Securities. Manila. 6 ADB Technical Assistance to the National Housing Bank and the Housing Development Finance Corporation of India for a Study on the Development of an Agency to Facilitate Issuance of Residential Mortgage- Backed Securities. Manila. 7 ADB India Mortgage Guarantee Company. Manila. The proposed investment was for $10 million under the private sector window. This was not implemented as the RBI did not introduce the required regulatory framework at that time. ADB is now in the process of resubmitting the proposal to the Board, with a proposed investment of up to $15 million, following improvements in the regulatory environment.

17 3 D. Relevance of Design and Formulation 9. Project design. According to the project framework (Appendix 1), the impact of HF II was to support human development by increasing the availability and affordability of housing finance to LIHs. 8 The expected outcome of HF II was to improve the living standards and quality of life of LIHs that lack access to affordable credit for housing and home-based incomegenerating activities. The project comprised four separate loans to the Housing and Urban Development Corporation Limited (HUDCO) ($100 million), Housing Development Finance Corporation (HDFC) ($80 million), ICICI Limited ($80 million) and NHB ($40 million). HF II consisted of three parts (A, B and C). Part A was designed to support lending to LIHs through intermediaries consisting of (i) CFIs and NGOs, (ii) public and private enterprises, and (iii) state and local bodies. Part B was designed to support lending to LIHs through slum networking and home-workplace schemes, leading to poverty reduction. Part C was designed to support lending to LIHs by (i) expanding the housing finance operations of HDFC and ICICI Limited to lend directly to LIHs through mortgage loans at market interest rates; (ii) expanding the refinance operations of NHB to housing finance institutions (HFIs) other than HDFC and HUDCO, thus enabling HFIs to increase their lending to LIHs; and (iii) supporting refinancing of HFC loans to CFIs through CFI refinance scheme of NHB. The outputs of HF II, as contained in the project framework, corresponded to these components. HF II further envisaged different lending targets for each of the Borrowers under the various components. HUDCO was solely responsible for the elements under part B above, and its withdrawal from the project resulted in these elements not being implemented. 9 The parts and components relevant to NHB and ICICI are indicated in paras and 25 respectively. 10. HF II also incorporated a policy and institutional action plan, with some actions covenanted in the loan agreement. Actions related to raising the corporate governance standard and implementing foreclosure regulations were covenanted for NHB; making improvements to the mortgage registration system was covenanted for both NHB and ICICI. 11. Rationale for the loan. The report and recommendation of the President (RRP) for HF II 10 noted that the housing shortage in India remained critical, especially for LIHs, despite policy and regulatory reforms to promote increased participation in housing finance and development. The absence of affordable credit for housing was identified as the principal constraint preventing low income families from improving their housing and living conditions. Although various CFIs and NGOs have helped low income families mobilize their savings and have extended housing loans, these efforts were insufficient in light of total LIH demand for housing finance. HF II sought to increase access by LIHs to market-based housing finance from formal and informal institutions in the housing finance sector. 12. Consistency with ADB s strategy. HF II was consistent with ADB s Urban Sector Strategy, 11 which sought to (i) strengthen linkages between formal and informal housing finance as a means to increase availability and affordability of housing loans to LIHs; (ii) promote microcredit programs for housing loans and home-based, income-generating activities, and support low-income shelter schemes; and (iii) provide technical advice and expertise in 8 LIH was defined as a household below a threshold income (Rs7,000 in June 2002, revised annually with the changes in the consumer price index as specified in para. 14 of the Minutes of the Loan Negotiations). 9 Part C was accordingly redesignated as part B in the loan agreements for ICICI and NHB. 10 ADB Report And Recommendation of the President to the Board of Directors on Four Proposed Loans to the Housing and Urban Development Corporation, National Housing Bank, Housing Development Finance Corporation, and ICICI for the Housing Finance II Project in India. Manila. 11 Asian Development Bank India: Urban Sector Strategy. Manila.

18 4 establishment of a secondary mortgage market as a means to increase the availability of capital for housing finance. 13. Consistency with India s development objectives. HF II was consistent with the Government s increasing priority on housing as reflected in the 1994 national housing plan, and subsequently in the 1998 national housing and habitat policy. HF II was also consistent with targets of India s 9th Five Year Plan, which included construction of 2 million housing units (700,000 in urban areas) annually over 5 years. The RRP noted that this target was short of the total estimated housing shortage of 40 million units at the time of appraisal. The purpose of HF II continues to be relevant today. The 2007 national urban housing & habitat policy, which was tabled in Parliament in December 2007, has affordable housing for all as its goal, with an emphasis on the urban poor. A technical group estimated the magnitude of the urban housing shortage to be around 25 million at the close of the 10th Five Year Plan ( ), with 99% of the shortage pertaining to economically weaker section and low income group. The working group on rural housing for the 11 th Five Year Plan estimated a rural housing shortage in 2007 of 47 million houses; families living below the poverty line accounted for at least 90% of the housing shortage. 14. Adequacy of appraisal. ADB approved project preparatory TA 12 on 8 November 1999 to identify sustainable, market-based channels and institutional arrangements for the delivery of housing finance to LIHs. Building on experience and lessons from HF I, the TA consultant report proposed a project with greater emphasis on strengthening linkages between formal housing finance institutions and the informal sector, including CFIs and NGOs, to down-market housing finance to LIHs and support innovative slum improvement subprojects. In contrast to HF I, which allowed some lending to middle- and upper-income households, HF II solely targeted LIHs. Moreover, lending targets were specified in the RRP to encourage lending through more innovative channels, which would require more time for implementation. The consultant report also identified a number of policy reform measures aimed at meeting the long-term objectives of the 1998 national housing and habitat policy, which emphasizes the need for the Government to adopt the role of a facilitator, rather than a provider, of housing. The project brief was prepared based on the consultant s report, and two loan processing missions were conducted between April 2000 and June The project formulation process appears to have been deficient in some respects. For instance, the success of NHB s CFI refinance scheme 13 (launched in January 1999) was limited by capacity constraints among CFIs and NGOs, and the high intermediation cost of HFI lending through these institutions. These issues were subsequently highlighted in the HF I PCR. 14 The processing mission failed to address these issues in the project design; doing so might have resulted in more rapid implementation and better achievement of outcomes of components involving CFIs and NGOs. Furthermore, the appraisal mission carried out a financial review of the Borrowers, but did not address the fact that the refinance operations of NHB lacked a system to track detailed end-borrower data (including income levels). This emerged as a major implementation bottleneck. In addition, an appropriate definition of what constitutes a LIH should have been determined at appraisal, and the income threshold adjusted appropriately for inflation from year to year (footnote 8). Moreover, in the case of the HF II ICICI Bank loan (Loan ADB Technical Assistance to India for Preparing the Housing Finance II Project. Manila (TA No IND, approved November 1999). 13 The CFI Refinance Scheme was developed under ADB TA for Strengthening Housing Finance Institutions (footnote 4). 14 ADB Project Completion Report on the Housing Finance Project in India. Manila.

19 5 IND), this threshold should have applied to the income of the borrower instead of the household, given the impracticality of assessing household income (footnote 22). 16. The discussions on the prevailing market conditions at the time of appraisal highlighted the issue of competitiveness of ADB s dollar loans, given the decline in interest rates for rupeedenominated loans in the domestic market. However, this risk was underestimated. HDFC and HUDCO did not avail of the loan because of the cost of ADB s funds compared to the interest rates available in the market. The signing of NHB and ICICI loan agreements was delayed because the cost of ADB funds, when swapped into rupees, appeared unattractive, particularly for lending through the CFI and NGO channel. 15 Moreover, NHB s partial cancellation of the loan in 2003 (para. 23) was also due in part to market conditions. E. Related Technical Assistance 17. ADB did not approve any TA in conjunction with HF II. II. IMPLEMENTATION A. Lending Policies 18. National Housing Bank. NHB s refinance portfolio has undergone significant changes during the last few years, with a shift in disbursements from HFCs to banks. HFCs accounted for 75% of disbursements in FY2001, followed by cooperative institutions (14%) and banks (10%); by FY2007 banks accounted for 80%, followed by HFCs (20%). The change in refinance composition reflects the recent growth in the housing finance portfolio of commercial banks. NHB s refinance to commercial banks is mostly of 3-year tenure, which is shorter than refinance to HFCs. NHB s refinance terms have also changed over the years in response to changes in market conditions. In addition to refinancing, NHB has also provided direct project finance to public housing and development agencies over the past few years. In conjunction with the implementation of HF II, NHB began exploring opportunities for direct lending to CFIs and NGOs and has provided assistance to some CFI projects. The refinance and lending activities of NHB underwent a major policy shift in with the introduction of risk-based lending. NHB rates clients using an in-house rating model, with exposure limits and pricing based on the rating obtained. NHB is focused on the unserved and underserved segments of the society through programs such as the Golden Jubilee Rural Housing Refinance Scheme, which aims to increase housing stock in rural areas. 19. ICICI Bank. ICICI Limited began diversifying its operations from project-based lending to corporate financing at the time of appraisal. In addition, as a part of its housing finance initiative, ICICI Limited set up ICICI Home Finance Company in 1999 as a wholly-owned subsidiary for provision of housing loans. During implementation, based on opportunities in the market, ICICI Limited merged with ICICI Bank and refocused its operations on retail and commercial banking. The size of ICICI Bank s housing finance portfolio as of 31 March 2008 was Rs585 billion, of which loans to the relatively lower income group (loans of less than Rs0.5 million) constituted 16%. The size of ICICI Home Finance Company s housing portfolio was Rs67 billion as of 31 March ICICI Home Finance Company has recently started focusing on large ticket (non-priority sector) loans and home equity loans. 15 The delay in signing of the loan agreements resulted in temporary unsatisfactory ratings in the project performance report for the two loans. Loan 1761-IND (to ICICI Limited) also received an unsatisfactory rating for the subsequent period due to a delay in declaration of loan effectiveness, as a result of ICICI Limited s merger with ICICI Bank.

20 6 B. Characteristics of Subloans 1. National Housing Bank Loan (Loan 1759-IND) 20. Specified distribution of subloans. The allocation of the loan as envisaged in the RRP is shown below. Table 1: Lending Targets by Project Parts Component Description Amount Part B(ii) Refinancing HFI a loans to LIHs Up to $32 million (80% of loan) Part B(iii) Supporting the CFI refinance scheme to refinance HFC loans to CFIs for housing subloans At least $8 million (20% of loan) CFI = community-based financial institution, HFC = housing finance company, HFI = housing finance institution, LIH = low income household. a HFI is a housing finance institution as defined in the NHB Act, which has as its objective provision of housing finance. Source: ADB Report And Recommendation of the President to the Board of Directors on Four Proposed Loans to the Housing and Urban Development Corporation, National Housing Bank, Housing Development Finance Corporation, and ICICI for the Housing Finance II Project in India. Manila. 21. During implementation, the CFI refinance scheme part B(iii) was not successful, and NHB actively explored opportunities for direct lending to CFIs and/or NGOs. Accordingly, ADB amended the loan agreement on 8 September 2006 to include in part A(i) support for lending by NHB to LIHs through CFIs or NGOs. Financing under part A(i) was included together with that for the CFI refinance scheme to satisfy the subloan distribution criteria. 22. Loan and subloan terms. The loan was guaranteed by the Government and was made from ADB s market-based US dollar lending window, with a maturity of 25 years, including a grace period of 5 years. All the subloans were rupee-denominated, but the terms varied across the lending channels, as discussed in the ensuing section C. As per the subloan financing criteria in the loan agreement, ADB financed a maximum of 80% of the subloans except in the case of lending by NHB to LIHs through CFIs and NGOs part A(i) which was eligible for 100% ADB financing. 23. Loan utilization and subloan distribution. NHB cancelled $32.6 million 16 and utilized $7.4 million of the $40 million facility. Prevailing market conditions rendered ADB loans relatively uncompetitive, leading to cancellation of $19.6 million in NHB fixed 17 the rupee cost of ADB funds through a structured swap that did not allow NHB to benefit from the falling domestic rates. NHB also had to re-price and reduce the cost of its loans to HFIs in line with market conditions. In addition, the lack of a system to track data on end-borrowers under NHB s refinance operations was an impediment to implementation of the HFI refinancing under part B(ii). Of the amount availed, $13 million (comprising a $10 million imprest advance and $3 million statement of expenditure portion) was refunded in 2004 because ineligible cases 18 were found to be included (para. 31). This portion was cancelled in 2005 after NHB determined it was unable to provide an adequate stock of eligible subloans. 16 $19.6 million was cancelled effective 15 September 2003 and $ 13 million was cancelled effective 15 September The interest rate was fixed for the first 5 years with some reset options thereafter. 18 Some subloans were found to be ineligible because (i) the income of the LIH exceeded the threshold, (ii) disbursements made prior to the effective date of the loan, (iii) subloans were made towards land purchases, and (iv) the amount claimed by NHB was higher than the amount disbursed by the HFC concerned.

21 7 24. Of the total amount disbursed, capitalization of the front-end fee was $0.4 million, disbursement under part A(i) 19 was $781,981 and under part B(ii) was $6,218,019. The share of part A(i) was thus 11.2%, and did not meet the 20% target as envisaged. 2. ICICI Bank Loan (Loan 1761-IND) 25. Specified distribution of subloans. The allocation of the loan as envisaged in the RRP 20 is shown below. The loan agreement was amended on 3 November 2004 to (i) remove the $10 million restriction in part A(ii) for direct lending to LIHs that are employees of public and private enterprises, and (ii) include under part A(i) direct lending to LIHs that are beneficiaries of CFI and/or NGOs. Table 2: Lending Targets by Project Parts Component Description Amount Part A(i) Lending to LIHs through CFIs and/or NGOs $10 million Part A(ii) Lending directly to LIHs that are employees of public & private enterprises Up to $10 million Lending indirectly to LIHs through public and private enterprises At least $10 million Part A(iii) Lending indirectly to LIHs through state and local bodies $10 million Part B(i) Lending directly to LIHs $40 million CFI = community-based financial institution, LIH = low income household, NGO = non-government organization. Source: ADB Report And Recommendation of the President to the Board of Directors on Four Proposed Loans to the Housing and Urban Development Corporation, National Housing Bank, Housing Development Finance Corporation, and ICICI for the Housing Finance II Project in India. Manila. 26. Loan and subloan terms. The loan terms are as given in para. 22. As in the case of the NHB loan (Loan 1759), all the subloans were rupee denominated, but the terms varied across the lending channels, as discussed in the ensuing section C. As per the subloan financing criteria in the loan agreement, ADB financed a maximum of 80% of the subloans 21 under all parts except part A(i), which was eligible for 100% ADB financing. 27. Loan utilization and subloan distribution. ICICI Bank utilized the entire $80 million loan facility. The disbursements under various parts were part A(i): $8.38 million; part A(ii): $2.47 million; part A(iii): nil; part B(i): $68.35 million. Additionally, $0.8 million was withdrawn for capitalization of front-end fees. The difference between envisaged and actual distribution resulted from the constraints faced under the lending components of part A (paras ). The direct loans to LIHs under part B(i) were disbursed quickly, and this component enabled full utilization of the loan. 19 The entire $7 million was originally disbursed under part B(ii). Later in response to NHB s request, ADB reallocated $781,981 towards three subloans under part A(i) from part B(ii) on 29 June The loan agreement did not specify the distribution among the four components. However, the loan agreement required ICICI to submit at least two qualified housing proposals under each of the four parts of the project. 21 ICICI indicated in 2003 that, as per the prevalent market practice, it would be impractical to assess the income of the household. Based on ICICI s request ADB redefined LIH as a subborrower instead of a household. As a result of this change, the extent of ADB reimbursement to ICICI was reduced from 80% to 72% of ICICI s disbursements, to account for ineligible cases (household income more than the stipulated level), which were estimated at 10% of ICICI s disbursements.

22 8 C. Implementation and Internal Operation of Subprojects 1. National Housing Bank Loan (Loan 1759-IND) 28. Overall. The expected outcome was 27,000 loans to LIHs for home purchase or improvements; the expected impact was that 136,000 persons would benefit from the loans. The actual outcome of the $7 million loan originally disbursed under part B(ii) for refinancing of HFI loans to LIHs was 2,830 loans; the impact was that 14,000 persons benefited. 22 The $0.78 million loan that was reallocated from part B(ii) to part A(i) to support direct lending to LIHs through CFIs or NGOs, financed 576 loans benefiting 2,800 persons (footnote 23). The subloan financing criteria ensured requisite leverage by NHB. 29. Lending through CFIs and NGOs part A(i). NHB began experimenting with direct loans to CFIs and NGOs in The $0.78 million reallocated to part A(i) supported (i) Share Microfin Limited (SML) for repairs or extensions of dwelling units of 307 women members in Hyderabad; (ii) Sri Padmavathy Mahila Abyudaya Sangam (SPMS) for individual dwelling units located in Tirupathi, Andhra Pradesh of 122 women members; and (iii) SPARC 23 Samudaya Nirman Sahayak (SSNS) for a slum rehabilitation project benefiting 147 slum dwellers in Mumbai. The details of subprojects are in Appendix Although the loan utilization targets under Part A(i) were not achieved, this component made significant contributions by (i) bringing underserved segments of society, particularly those with no regular incomes and lack of physical access to the banking system, into the formal financial system; and (ii) establishing a linkage between formal and informal institutions in the financial sector. 31. Housing finance institution loan refinancing part B(ii). Implementation of part B(ii), based on the statement of expenditure procedure under free limit, proved to be challenging. NHB disbursed the project funds to the ultimate borrowers through 11 HFCs, and subsequently collected the subloan information. A number of discrepancies were found in the information submitted by NHB and detailed reviews revealed that a number of cases were ineligible (footnote 19), leading ultimately to a refund of a part of the disbursed amount. The HFCs that are subborrowers under the loan and the ADB loan amount are shown in Appendix 3. LIC Housing Finance Limited accounted for 34% of the refinancing under part B(ii). 32. NHB s refinance to the HFCs are at interest rates based on NHB s cost of funds, prevailing market interest rates and, after , also on the credit of the specific HFC. The rates for refinance extended out of ADB funds were the same as the rates for other refinancing. HFCs determined the rates of lending to the end-borrowers. Information on interest rates on HFC subloans to the target segment could not be obtained. 33. According to a benefit monitoring and evaluation (BME) study 24 of the NHB loan conducted in 2006, penetration of loans by HFCs to LIHs is generally poor. All LIH loans issued by surveyed HFC branches were covered under the NHB refinance facility. LIHs accounted for only about 2.2% of all loans and a mere 0.9% of overall approvals by the branches surveyed. The study suggests that there is no targeted approach to include LIHs under the policies of 22 As in the case of the expected impact, the assumption of 5 persons per household has been made. 23 Society for Promotion of Area Resource Centre. 24 ADB Benefit Monitoring and Evaluation Report for the Housing Finance II Project. Manila (Loan 1759-IND).

23 9 HFCs, and that credit quality considerations deter HFCs from substantive lending to LIHs. The report indicates that 14% of sampled HF II beneficiaries had incomes higher than the stipulated threshold, despite reviews by ADB and NHB to exclude ineligible borrowers. 34. CFI refinance scheme part B(iii). NHB s CFI refinance scheme was not successful due to the risks and constraints faced by the HFCs (i.e., higher credit risk, limited delivery channels, inadequacy of collateral, discontinuous and uncertain income streams of the ultimate beneficiaries, and high transaction costs). 35. Policy and institutional action plan. The implementation status of the plan with respect to NHB is in Appendix 4, Table A4.1. NHB generally undertook actions towards achieving the policy objective, although actions were delayed in some cases. Although NHB could not expand the refinance window for HFC lending to CFIs, it began direct lending to CFIs and/or NGOs to build linkages with the informal sector. The NHB Act was amended in 2000 to include provisions related to recovery of housing loan dues, but these provisions were not made operational as a consequence of enactment of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002, which provided simple procedures for mortgage foreclosure. 36. To improve the mortgage registration system, NHB and ICICI Bank formed a working group and submitted a draft report to the Government in The recommendations of the draft report included that (i) states reduce the stamp duty for equitable mortgages, (ii) the Government consider making registration of equitable mortgages compulsory, (iii) registration charges be reduced to facilitate and encourage registration; and (iv) state governments notify additional areas where equitable mortgage may be used. The project completion review mission could not obtain information on the status of implementation of the draft report, however. With respect to India s MBS market, it may be noted that after the pilot securitization by NHB, there have been several issuances by market participants. However, the MBS market has had limited success and the number of issues has decreased in recent years, due in part to legal and regulatory hurdles and a lack of long-term investors. In addition, MBS issues in India do not typically meet the true sale criteria under the Basle II norms. 25 A study is being undertaken as part of ADB TA (footnote 6) to NHB and HDFC that will include recommendations for policy and regulatory development and establishment of an agency to enable issuance of true sale residential MBSs. 2. ICICI Bank Loan (Loan 1761-IND) 37. Overall. The expected outcome was 58,600 loans to LIHs for home purchase or improvements; the expected impact was that 293,000 persons would benefit from the loans. The actual outcome and impact were 25,730 loans benefiting 129,000 persons (footnote 23). The subloan financing criteria ensured requisite leverage by ICICI Bank. 38. Lending through CFIs and NGOs, and to their beneficiaries Part A(i). Although ICICI Bank had identified working through CFIs and/or NGOs as one of its strategies to achieve financial inclusion, progress under this component was very slow. In the first 2 years of implementation, ICICI Bank established a partnership model that involved direct lending to members of CFIs and/or NGOs through a partnership arrangement, but did not envisage bulk lending to CFIs and/or NGOs on its own books due to inherent scalability and sustainability 25 The MBS issues would therefore not qualify for off-balance sheet treatment for capital adequacy purposes, as originators retain the junior tranches.

24 10 limitations. 26 The partnership model separates the CFI risk from the risk of the portfolio, and pricing is on the basis of the risk of the underlying assets rather than the intermediary s rating. Moreover, the exposure of ICICI Bank is not limited by the capital base of the CFIs and/or NGOs. 39. The loan was channeled through two subprojects, SML and Kerala government s Kudumbashree program. The subloans to members of SML for $0.455 million were approved in June The subloans (totaling $7.93 million) to several community development societies (CDSs) in Kerala organized under the Kudumbashree program were approved in November The CDSs acted as a channeling agency; security for the CDS subloans included a guarantee and a mortgage over the land and property of individual CDS borrowers. The details of subprojects are in Appendix 2. The subprojects covered 10,730 female subborrowers (2,830 in the case of SML, and 7,900 for Kudumbashree). 40. As in the case of the NHB loan, this component made a significant contribution by bringing an underserved segment of society into the formal financial system. Further, ICICI Bank was the first to offer housing loans under the Kudumbashree program; subsequently other banks also started lending to the target population. 41. However, the interest rate of the subloans to the Kudumbashree subproject CDSs (fixed at 7.25% for 80% of the loans and 8.75% for 20% of the loans, for a 10-year repayment schedule, including a 6-months moratorium), 27 does not appear to adequately factor in the risk premium and subproject cost of operations. The CDSs retained a margin of 1% or less, which is insufficient to cover their cost of operations. The present subloan terms call into question the subproject s long-term financial viability. ICICI Bank began lending for housing finance under the Kudumbashree program in FY2005, with the bulk of the lending occurring in FY2006 and FY2007, with a slowdown in the last year. ICICI Bank is now concentrating on strengthening the financial management capacity of the CDSs, implementing data tracking systems for individual borrowers, and improving collections Lending through public and private enterprises, and to their employees Part A(ii). From the time of project approval, the demand for bulk loans by employers had decreased significantly, with employees preferring to borrow directly from commercial lenders. The reasons for this included a reduction in market interest rates, changes in the tax treatment of employee loans, 29 increased mobility of employees, and expansion of mortgage finance markets. ICICI Bank consequently partnered with companies to provide direct individual loans to employees under its work-site arrangement, wherein employers provided employee information, access to their premises for holding spot camps, and sometimes an agreement for repayment via monthly salary debits. ADB disbursed only $2.47 million (against an RRP target of $20 million) under this component, with participation by 1,040 LIHs. 43. Lending through state and local bodies Part A(iii). During loan appraisal, HUDCO was lending to state and local bodies to finance construction of low-cost dwelling units. HF II therefore included state and local bodies as another credit delivery channel. ICICI Bank worked 26 ADB accordingly amended the loan agreement in November 2004 to include direct loans to beneficiaries of CFIs and NGOs under part A(i). 27 Other banks offered similar rates, although some were floating interest rates, with current rates of up to 9%. 28 As of March 2007 overdues under the Kudumbashree program were Rs4.55 million (against a total outstanding of Rs million); in March 2008, overdues were Rs21.71 million (against a total outstanding of Rs million). 29 Since the time of project processing, subsidized interest rates on employers loans have been subject to taxes, making it unattractive for employers to provide subsidized staff loans.

25 11 on several proposals for assistance to housing board and state housing corporations in Andhra Pradesh, Karnataka, Rajasthan and Tamil Nadu, and attempted to develop good bankable structures to meet the housing needs of LIHs. However, ICICI Bank did not lend any funds under this component, mainly due to the poor financial track record of these entities. 30 Moreover, during the implementation period, the states ceased to borrow for the purpose of providing housing finance. 44. Lending directly Part B(i). Disbursement under this component was rapid, and ICICI Bank met the RRP component target of $40 million in about 2 years of implementation. Total disbursement under this component was $68.35 million. 45. Disbursements under the direct lending components parts A(ii) and B(i) totaled $70.82 million, and benefited over 15,000 LIHs. Details of these components are given in Appendix 3. Most of the subloans were on a floating rate basis, with a current interest rate on 59% of the subloans at 11% 13%. The subloans were generally of long tenure (61% had a tenure of more than 16.7 years). The income distribution (Appendix 3) indicates that direct lending did not reach households with incomes below Rs5,000 per month; 97% of the targeted beneficiaries were salaried, and 3% self-employed. In most cases (77%), the primary applicant was male but co-applicant was female; only 10% of primary applicants were female. Most of ICICI Bank s business in this segment is in the smaller cities or rural areas, because the house prices are high in urban areas. The western states of Maharashtra and Gujarat accounted for 45% of loans, and southern states for 19%. Although some states with poorer socio-economic indicators (such as Madhya Pradesh and Uttar Pradesh) accounted for 20% of the subloans, the eastern and north-eastern states were not included. 46. A constraint faced in distribution of subloans in this category was the assessment of creditworthiness of the borrower due to the lack of banking practice and income documentation, which is needed for underwriting. ICICI Bank has experienced high delinquency (about 2.5%) among LIH borrowers, compared to its overall housing finance portfolio (delinquency of 1%). This may be attributed to lower ability of LIHs to withstand income shocks, and their higher vulnerability to inflation increases (LIH incomes have not kept pace with inflation). Interest rate increases over the past few years have impacted floating rate loans, resulting in higher equated monthly installments or longer loan tenures. The rise in delinquency in the lower income category over the last 2 years caused ICICI Bank to change its credit norms to improve borrower quality. 47. Policy and institutional action plan. The status of implementation of the plan relevant to ICICI Bank is in Appendix 4, Table A4.2. ICICI Bank took all the actions included in the plan. ICICI Bank has set up systems and procedures for lending to members of CFIs and/or NGOs, and is undertaking ongoing improvements (e.g., CDSs in Kerala). With respect to improving the mortgage registration system, ICICI Bank established a working group as envisaged, outlined the terms of reference and facilitated meetings. These efforts yielded a draft report that was presented to the Government (para. 36). 30 The project required that the subborrowers have an adequate financial position and financial control, so that operations are sustainable and there is a good audit trail for verification of end use.