The collapse of a five-storey boys’ hostel in Delhi’s Satya Niketan killed seven people and injured several others. Two months ago, a fire in a Malviya Nagar building killed 23 people. Two years ago, the Old Rajinder Nagar basement flooding tragedy killed three UPSC aspirants. Every time something like this happens, especially in metropolitan cities, the prescription is familiar: enforce building codes better, conduct structural audits, crack down on illegal construction, and increase penalties.
Another school of thought says the answer is more construction: liberalise Floor Space Index (FSI), make land-use rules less restrictive, allow private developers to build faster. Occasionally, there’s the least useful answer of all: let the government take over building construction. But, there is a question sitting underneath all three arguments that gets surprisingly little attention: who is going to finance the buildings?
India does not merely need more or safer buildings. It needs a financial system capable of funding the enormous stock of buildings that urbanisation will require. Land is the largest component of this capital requirement. But our regulatory system imposes structural barriers on financing the acquisition of land by private developers.
Under the RBI’s banking regulations, banks may finance virtually every other stage of a development project, from construction to the purchase of completed homes., But, they remain largely barred from financing the acquisition of the land on which those projects are built. This restricts the scale at which Indian developers can realistically construct real estate in our cities.
The absence of seed capital for real estate development
Consider what happens when a developer decides to construct a large residential or commercial project. There is a fairly obvious sequence: acquire the land, obtain approvals, construct the project, lease or sell the completed asset, and eventually generate a stream of cash flows from it. The financial system should be capable of supporting this entire chain.
Indian banks can finance construction. They can finance individuals purchasing homes. They can finance factories, roads, and other infrastructure projects built on land. But, they cannot finance private developers acquiring the land on which residential and commercial projects are to be built. This is not a minor regulatory technicality. Land can account for 50-80 per cent of the cost of real-estate development in major Indian cities. Preventing banks from financing that component creates a structural hole in the financing chain.
Resultantly, developers turn to private credit, non-bank lenders, and other forms of financing, often at considerably higher cost, pushing up the cost of constructed real estate.
Historically, the financing vacuum around land has also provided fertile ground for unaccounted money and opaque transactions. There is a certain irony here. We worry about speculative land markets and the risks of real-estate lending. So we prohibit the banking system from financing a large part of the land-development cycle — and then leave the financing to parts of the financial system that may be more expensive and less transparent.
REITs show what financialisation can do
India has already demonstrated that real estate can be converted into a financial asset. The success of listed Real Estate Investment Trusts, or REITs, is an important experiment in this direction. REITs allow investors to own units backed by income-generating real estate rather than having to buy and manage buildings themselves. The model has worked particularly well for Grade-A office assets. India’s listed REIT ecosystem has grown to cover hundreds of millions of square feet of commercial and retail property, with substantial distributions to investors.
That said, so far, REIT investments have been concentrated disproportionately in commercial office assets. The much larger universe of urban real estate — rental housing, student hostels, healthcare, senior living, and other specialised assets — has barely been financialised.
Indeed, acknowledging the institutional funding gap in real estate, SEBI’s latest discussion paper on REITs published last month proposes allowing REITs to invest minority stakes in under-construction projects undertaken by developers. This is a step in the right direction.
REITs can only take us so far
Aggregating land parcels and building residential townships that can be rented out at scale is key to the viability of REITs as financial assets. This forces us to return to the ban on banks financing land.
Think of the capital stack for real estate development as a chain:
Land acquisition → construction → completion → stabilisation → rental income → REIT → long-term institutional capital.
India has been gradually building the downstream parts of this chain. REITs are most suited to come in once rentals and cash flows become visible. But there remains a financing gap right at the beginning. This gap is a significant barrier because urban land is often the single largest component of the cost of development.
Also read: Satya Niketan was not an accident. Delhi has a student housing problem
From prohibition to prudence
The prohibition on bank financing of land acquisition has understandable historical roots. It emerged in an era when Indian banking was state-dominated, land markets were opaque and fragmented, property records were weak, and policymakers were concerned that institutional credit would fuel speculation in land. But India’s financial system has changed.
Banking is more market-oriented. Real-estate regulation has changed. RERA has created an institutional framework for monitoring projects and ring-fencing customer money. Financial regulation itself has moved substantially toward risk-based supervision. The question, therefore, is no longer whether land finance is risky. The question is whether prohibition is still the best way to manage that risk.
Major advanced economies do not generally deal with the risks of land and real-estate lending through an absolute prohibition. Banks in countries such as the United States, the United Kingdom, Canada, Australia, Germany, and Japan can finance land acquisition and development, subject to substantial prudential constraints.
A better framework would allow banks to finance land acquisition for bona fide development projects, but only where the project has appropriate approvals, a defined implementation schedule, and meaningful promoter equity. Regulators could impose conservative loan-to-value ratios, higher capital requirements, milestone-based disbursement, commencement deadlines, and enhanced provisioning. They could restrict speculative land banking and impose sectoral or borrower-level exposure limits. Modern prudential regulation has developed these tools to deal with risky lending.
A financial market — where banks finance appropriately regulated development, REITs provide a route to long-duration institutional capital, and prudential regulation controls rather than prohibits risk — is as important as building more and safer buildings.
The lesson from India’s recent building tragedies should certainly be that enforcement matters. But there is a second lesson. India’s cities cannot be made safer, larger or more liveable merely by writing better building rules. Someone has to finance the buildings that comply with them. Regulation determines what can be built. Finance determines what actually gets built. And as India urbanises, Indian financial architecture will have to rise to this challenge. For starters, let’s abandon old tropes and taboos on land financing.
Bhargavi Zaveri-Shah is the co-founder and CEO of The Professeer. She tweets @bhargavizaveri. Harsh Vardhan is a management consultant and researcher based in Mumbai. Views are personal.
(Edited by Aamaan Alam Khan)