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Introduction

In countries where construction financing is a separate product, housing finance is not provided for under-construction projects. However, the State Bank of Pakistan (SBP) has developed guidelines to help mortgage providers provide housing finance for under-construction projects. The procedures mentioned by the SBP are extremely detailed and require many bureaucratic documents. This can have a negative impact on the adoption of the process as it will be costly and time-consuming. It can also be argued that some of the functions defined by the SBP fall in the ambit of a Real Estate Regulatory Authority (RERA). However, the guidelines also ensure that developers have all the necessary documentation and approvals before selling to anyone, thereby increasing transparency in the sector. Continue reading to understand the impacts of SBP regulations on the real estate sector of Pakistan.

State Bank of Pakistan as Regulator of Real Estate

The State Bank of Pakistan (SBP) plays a vital role in ensuring the financial sector’s stability. As a central bank, it has been entrusted with the responsibility to regulate Pakistan’s monetary and credit system under the State Bank of Pakistan Act 1956. As no aspect of any industry can act independently of the financial system, the real estate sector of Pakistan is also susceptible to policy shifts from financial institutions. Commercial banks have always remained reluctant to provide loans and mortgages based on allotment letters only. However, under the new SBP scheme, housing finance providers will give assurances to the purchaser that once the building has been developed according to the approved layout plan, the funds will be given to purchasing the unit, thereby allowing for financing of under-construction buildings, apartments, and homes. This will also limit the risk for financial institutions, as in the case where the developer does not complete the installation, the funds will not be discharged. The SBP has also laid out clear and extensive guidelines on multiple aspects of the process, such as checking necessary ownership documents and approvals by regulatory authorities. However, it has also stipulated that a No Objection Certificate (NOC) be obtained for every unit sold under the financed project. This is a peculiar detail that might cause many bureaucratic delays in the completion of the project.

Banks will also have to devise a selection criterion for project assessment and eligibility criteria for those developers who can apply to the program. The builder criteria may include the builder’s/developer’s financial soundness, track record, compliance background with legal and urban planning issues, and milestone completion on previous projects.  These builder’s/developer’s can be private or government entities. Furthermore, the banks will ensure a physical and legal inspection of all relevant documents such as title documents, NOCs, and approved site and layout plans. The selection criteria may also include access to schools, hospitals, transport, utilities, and marketability of the housing units. Once all verification has been done, the banks will sign a Master Financing Agreement (MFA) with the builder/developer. This agreement will include the construction plan, milestones, project completion time, and loan disbursement and repayment plan. The SBP has also stipulated that the mortgage provider for units under the project must be the same as the construction lender.

Possible Impacts of SBP Guidelines

The function of the central bank in any country is to strike the right balance between market structure and regulatory frameworks to ensure the functional efficiency of the economy. Over-regulation can suppress financial innovation, while an imperfect market structure can reduce the efficiency of the system and affect consumer interests. Regulations are introduced to change the behaviour of regulated institutions because unregulated market behaviour can lead to suboptimal outcomes.  A majority of commercial banks in Pakistan usually invest in government-backed securities as they offer high returns and large capital buffers. However, some of the conditions set by the SBP for approval of housing finance in under-construction projects indicate a foundation lack of confidence in commercial banks. It says that banks do not have the capacity and capability to assess the credit risk of construction projects. In contrast, a majority of these commercial banks have risk departments stacked with well-qualified risk professionals. Suppose the SBP pursues micro-management of housing loans on such a level. In that case, it is feared that commercial banks will prefer to invest in government-backed securities instead of economy-driving and consumer-serving products.

Furthermore, the builder and legal counsels should agree upon any agreeable structure for the security of purchase. In the case of defaulters, the builder usually has access to deposits made earlier and can use them to sell the unit at a discounted price later. Therefore, as long as the bank has completed due diligence, other approvals from authorities like NOCs should not be required for the sale of units. Moreover, dealing with delinquent purchases also falls under a real estate regulatory authority (RERA). Overall, the guidelines can bring a positive change in the real estate sector and increase the number of housing finance in Pakistan; however, the establishment of RERA in each province is vital for consumer welfare and bringing transparency to the real estate sector.

Conclusion

The State Bank of Pakistan (SBP) has initiated a new scheme that allows commercial banks to give housing finance for under-construction projects. However, the central bank has imposed several guidelines and processes for the approval of projects and developers. Tight guidelines and strict conditions can lead to a show of mistrust of commercial banks in their capacity for risk assessment. Furthermore, requirements like obtaining NOCs for each unit in a high rise are bound to increase bureaucratic delays in projects. Therefore, establishing a real estate regulatory authority is necessary for the real estate sector to release financial institutions from the burden of carrying out tasks of a real estate regulatory body.