Macro prudential rules and regulations

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1 ROYAL MONETARY AUTHORITY OF BHUTAN Macro prudential rules and regulations LOAN TO VALUE AND LOAN TO INCOME RESTRICTIONS [Draft]

2 Index Part 1. Introduction Short title Authorization Application Definitions... 1 Part 2. Statement of policy Purpose Scope Responsibility... 2 Part 3. Implementation and specific requirements Limits and requirements Reporting requirements... 6 Part 4. Corrective measures Corrective measures and sanctions... 6 Part 5. Effective date Effective date... 6 Annexure.1 Guidance Note... 8 Page i Royal Monetary Authority of Bhutan

3 Part 1. Introduction 1.1 Shorttitle Loan to value and loan to income restrictions 1.2 Authorization The Royal Monetary Authority is authorized to issue regulations under Article 8 (a) and Article 9 (h) of the Royal Monetary Authority Act of Bhutan 2010 in relation to prudential matters to be complied with by all Banks and Other Financial Institutions (OFIs) (collectively 'Banks'), or other institutions as the regulation may specify. 1.3 Application This regulation is applicable to all Banks and OFIs which are licensed by the RMA to perform their Banking/non Banking functions in Bhutan. 1.4 Definitions Terms used within this regulation are as defined below, or as reasonably implied by contextual usage: i. Bank has the same meaning as in the Financial Services Act of Bhutan 2011; ii. iii. iv. Other Financial Institutions (OFIs) refers to all financial institutions except banks over which RMA can exercise and perform the powers, duties and functions conferred upon the Authority by or under the Royal Monetary Authority Act of Bhutan, 2010; Borrower means any party ( individual / husband and wife/ any two or more persons /organization) applying for a credit facility; Residential property means land bought for the purpose of construction of a residential property, building, or tenentment wholly or principally constructed, adapted or intended for human habitation. This also includes house already constructed. The loan could be for developmental purpose or personal consumption. v. Commercial property means a building or land bought for the purpose of generating a profit, either from capital gain or rental income. This includes, inter alia, office buildings, industrial property, medical centers, hotels, malls, retail stores, farm land, multifamily housing buildings, warehouses, and garages; vi. vii. viii. Non commercial use any credit facility which is not meant for commercial use; Down payment refers to the payment which is made by the borrower/customer to cover the difference between the value of the approved loan and value of the asset to be purchased through loan. Fixed income means income that is received on a regular and periodic basis including wages and salaries; Page 1 Draft as on 17 th Feb Royal Monetary Authority of Bhutan

4 ix. Monthly debt obligation means the sum of the monthly repayment of the principal amount and interest rate on the credit facility; x. Variable income means income which is not fixed and includes fee, overtime pay, perquisite, allowance, bonus, gratuity, commission or other reward or remuneration in respect of or in relation to the office or employment of an individual, income from selfemployment and any fringe benefits; xi. xii. Loan to Value (LTV) ratio is defined as the ratio of loan amount to the appraisal value of the asset, which is being purchased with the help of credit facility from the bank; Loan to Income (LTI)is defined as ratio of total monthly debt obligation to that of monthly gross disposable income from all sources, expressed in per cent. Part 2. Statement of policy 2.1 Purpose In Bhutan, loan to value ratio has been used by commercial banks as micro prudential measure as part of their credit risk management policies. Any risk emanating from individual institutions (micro risk), if not contained, can lead to systemic risks. Hence, RMA is introducing LTV ratio as a macro prudential measure as to mitigate the risks of default due to fall in the value of the underlying collateral and to avoid any speculation in the asset /housing market which may lead to systemic risks Similarly, loan to income ratio criteria is being followed by commercial banks as microprudential measure to assess the repayment capability of the borrowers. RMA is introducing LTI ratio as macro prudential measure to ensure that households are not excessively leveraged. 2.2 Scope LTVshall apply to all credit facilities secured by residential/commercial properties. However, a Bank may establish internal LTVlimits and rules to other secured credit facilities LTI shall apply to all credit facilitiesprovided bybanks and OFIs which are licensed by the RMA to perform their Banking/non Banking functions in Bhutan. 2.3 Responsibility The entire responsibility of adhering to each and every component lies with the Board of the Bank / financial institution The Board of Directors of a bank shall as a minimum: i. Establish, assess and approve the LTV / LTI limits that will apply to its borrowers when granting credit facilities, as an integral part of the Banks / financial institutions credit risk management policy; Page 2 Draft as on 17 th Feb Royal Monetary Authority of Bhutan

5 ii. iii. iv. Review, at least once a year, the LTV / LTI limits applicable to credit facilities; Ensure, through audit and inspection, adherence to the LTV / LTI limits set out in the bank s credit management policy; Develop and implement information systems, procedures and techniques that accurately, identify measure and monitor adherence to the LTV/ LTI limits when granting credit facilities. Part 3. Implementation and specific requirements 3.1 Limits and requirements Loan to Value Ratio A bank shall compute the LTV ratio for a borrower who is applying for credit facilities by using the following formula: If two or more borrowers seek the loan, then LTV ratio shall be worked out by taking the ratio of total loan (sum of loan to each individual / borrower) to that of appraisal value of the underlying collateral The appraised value of the property shall be determined by an independent valuer who: i. is a member of a designated agency as approved by RMA, ii. iii. has no direct or indirect financial interest in the asset being financed with the loan amount; does not have any role in the approval of loan in the Bank / financial institution When asset purchased is the underlying collateral, the Bank shall ensure that the borrower has financial interest in the asset, which is being purchased with bank loan. For this, the Bank must ensure that the difference between the value of the asset and loan amount (known as down payment ) must be deposited first by the borrower. The Bank shall not disburse funds until and unless the borrower has brought his/her contribution i.e., the difference between the cost of the project and the loan extended by the bank In addition, the Bank must ensure that this down payment is from his/herown resources and this is not borrowed from any other financial institution including those not regulated by the RMA Banks shall take a written declaration from the borrower that whether he/she is applying to the bank for this loan for the first timeor whether the borrower has taken credit facilities for Page 3 Draft as on 17 th Feb Royal Monetary Authority of Bhutan

6 the same purposeat other financial institutions including those not regulated by RMA, together with valid proofs Banks shall take a written declaration from the borrower that whether same collateral isusedfor any other credit facility The bank shall consider disbursement of the loan amount in tranches depending on the risks In addition to the prescription of maximum LTV ratios, RMA may also prescribe the risk weights to be adopted for each category of borrower, if RMA perceives that credit risk may escalate in future due to some macroeconomic developments. Prudential Limits Limits on Loan to Value ratio for different categories of loan shall be as under: Loan given against fixed deposit shall have maximum LTV ratio of 90% Loan to value ratio shall vary by the size of the loan as outlined below: Loan Amount LTV Limit Non Commercial use Up to Nu. 5.0 Million 90% Nu 5 mn above but below Nu 10 mn 80% Nu above 10 million 70% Commercial use Up to Nu. 75 million 70% More than Nu. 75 million 60% In case of a loan for purchase/construction of asecond or any subsequent property, LTV shall not exceed 70% of the value of the property Each bank shall take a written declaration from the borrower whether he/she is applying for the grant of credit facility for purchase/construction of a second or any subsequent property In case of joint applications consisting of two or more borrowers for the purchase/construction of a residential property, LTV shall not exceed 70% of the value of the property Incase a borrower is not an individual but a company, a trust or a society, for the purchase/construction of a residential property, LTV ratio shall not exceed 70% of the value of the property. Page 4 Draft as on 17 th Feb Royal Monetary Authority of Bhutan

7 Banks shall ensure that both LTV and LTI condition is satisfied for any loan secured against property. Loan to Income ratio Loan to income ratio is the percentage of a borrower's monthly gross disposable income from all sources that goes towards paying his monthly total debt obligations A bank shall compute the LTI ratio of a borrower who is applying for credit facilities in accordance with the following formula: The total monthly debt obligations of a borrower shall consist of the sum of the monthly repayment instalments of all credit facilities granted by financial institutions including those institutions not regulated by the RMA The gross monthly disposable income from all sources, including the income from the collateral, shall consist of: Source of Income Fixed Income Variable Income Fixed and Variable Income Income to be considered for the purpose of LTI calculation 100% of average of past 12 months income Up to 70% of the average variable income for the past 12 months 100% of average past 12 months of income from fixed sources and up to 70% of average variable income for the past 12 months The LTI limit for various types of loan application is as follows: Monthly Income LTI Limit Single Application Up to Nu. 2.0 lakh 40% More than Nu 2 lakh 50% Joint Application(Husband and Wife) Up to Nu. 2.0 lakh 40% More than Nu 2 lakh 50% Joint Application (Two or more borrowers) Any amount 40% Page 5 Draft as on 17 th Feb Royal Monetary Authority of Bhutan

8 In case of joint applications consisting of two or more borrowers, a Bank shall: i. determine the monthly repayment installment of each borrower in a manner that is consistent with each borrower s monthly repayment capacity; and ii. ensure that the LTI ratio does not exceed 40 per cent The Banks shall obtain a written statement, with all documentary proofs, from each borrower regarding his monthly gross disposable income from all sources, all outstanding amount of credit facilities availed, monthly repayments towards them The Bank must ensure that the information given by the borrower under (3.1.21) is correct. The RMA shall prescribe various steps to be followed by the bank, including the selfdeclaration by the borrower or verification by the bank or both All Banks shall ensure the strict adherence to these LTV and LTI ratios while granting credit facilities, as a part of their credit management process through audit and inspection. In addition, the banks should also have necessary MIS in this context and review periodically the efficiency of the same. 3.2 Reporting requirements Each bank shall submit returns in respect of LTV and LTI in the form and frequency as the RMA may prescribe. Part 4. Corrective measures 4.1 Corrective measures and sanctions In alignment with extant statutory provisions, the corrective measures and sanctions may include, but are not limited to any of the following: iii. Issue of a formal warning to the Bank; iv. Written agreements with Banks/OFIs for undertaking remedial measures, including those limiting the operations of the institution engaged in financial services; v. Suspend access to credit facilities of the RMA; vi. vii. Suspend temporarily or permanently officers or directors from duties in the financial institutions; Revoke the license to operate. Part 5. Effective date 5.1 Effective date The circular comes into effect from ( RMA will decide this date and while taking a Page 6 Draft as on 17 th Feb Royal Monetary Authority of Bhutan

9 decision, RMA shall also consider the implementation of other macro prudential regulations) Page 7 Draft as on 17 th Feb Royal Monetary Authority of Bhutan

10 Annexure.1 Guidance Note Commercial banks in Bhutan have established internal limits on LTV and LTI as part of their credit risk management practices. LTV ratio helps to restrict losses in the event of default/decline in property prices by imposing a cap on the size of the loans relative to the value of the properties. Similarly, LTI is used to restrict excessive leverage of households and maintain the repayment capability of the borrowers. In this note, an attempt has been made to guide commercial banks on implementation of LTV and LTI. The following table illustrates the application of LTV and LTI. Loan to Value ratio: Case Loan Size Purpose Asset Type Type of borrower Maximum LTV A 5 million Non Commercial First Asset Single Borrower 90% B Any amount Non Commercial Second Asset Single Borrower 70% C 20 million Commercial First Asset Single Borrower 70% D 80 million Commercial First Asset Single Borrower 60% E Any amount Non Commercial First Asset Joint Borrower 70% Loan to income ratio: Case Disposable Monthly Income (In Nu.) Type of borrower Maximum LTI ratio A 1.8 lakhs Single application 40% B 3 lakhs Single application 50% C 3 lakhs Joint Application (Husband and Wife) 50% D 4 lakhs Joint Application (Husband and Wife) 50% E Any amount Joint Application (Two or more borrowers) 40% In this illustration note, we give below few cases of loan application and a few parameters, which are assumed. Given the parameters and LTV ratio and LTI ratio, let us examine how to process the loan application. Case A: Page 8 Draft as on 17 th Feb Royal Monetary Authority of Bhutan

11 Mr. X is a head of the household having five family members and except X no body is working in the family. His monthly net income is Nu. 62,000. He wants to avail a loan from the Bank ABC to construct a house worth Nu. 1,000,000. Mr. X is 28 years old and has no other income. He is prepared to pay a down payment of Nu. 125,000. Analysis: The bank fixes his monthly installment amount as Nu. 15,000, by taking 20 years as the period of the loan and the loan amount is Nu. 875,000. In this case loan amount sought by Mr. X is 875,000 (1,000, ,000) which is 87.5 per cent of the value of the property. This loan amount is less than 90 per cent as per LTV guidelines. Hence LTV condition is satisfied. In addition, we must see the adherence to LTI ratio. On the income side, for the loan amount of Nu. 875,000, the monthly installment is Nu. 15,000 which is 24.2 per cent of his monthly income of Nu. 62,000 which is less than 40 per cent. Hence, LTI condition is also satisfied. Assuming that, the Bank is satisfied with his income, availability of down payment etc., after proper verification, the loan can be sanctioned. Case B: Mr. K and Mrs. L (wife of K), apply for a housing loan of Nu. 3,500,000 to purchase a house. They are prepared to make a down payment of Nu. 275,000. They jointly earn a monthly income of Nu. 130,000. For a loan of Nu. 3,225,000 the monthly installment fixed by the bank is Nu. 70,000. This income comes from their monthly salary. They do not have any other assets. Lets discuss whether we can consider this loan application? Analysis: Down payment as a ratio of total loan is 7.9 per cent. Hence, LTV is 92.1 per cent as against 90 per cent as suggested. Monthly installment as a ratio of total income is 70000/ =52 per cent Since the LTI ratio is 52 per cent, which is above the maximum fixed (40 per cent), the LTI condition is not satisfied and the loan cannot be sanctioned. Page 9 Draft as on 17 th Feb Royal Monetary Authority of Bhutan

Macro-prudential rules and regulations

ROYAL MONETARY AUTHORITY OF BHUTAN Macro-prudential rules and regulations Debt to Equity ratio [Draft] Index Part 1. Introduction... 1 1.1 Short title... 1 1.2 Authorization... 1 1.3 Application... 1 1.4