With public sector banks reducing interest rates on home loans up to Rs 20 lakh (Rs 2 million), housing finance companies (HFCs) might be under pressure to follow suit in order to stay competitive.

HFCs are complaining that the cost of funds is showing no signs of easing as banks are still charging around 13 per cent, which is higher than their average lending rate.

For instance, LIC Housing Finance [Get Quote] Company (LICFC) and Housing Development Finance Corporation [Get Quote] (HDFC [Get Quote]), which commands over 70 per cent of HFCs' market share, charge around 11.5 per cent, whereas Dewan Housing Finance Company charges between 12 and 14 per cent to customers.

The weighted average cost of working funds for HFCs is around 300 basis points higher compared to public sector banks. Now, HFCs' lending rates -- which is higher by 50-100 basis points compared to public sector banks -- are expected to further go up by 225 basis points to 350 basis points (for loans up to Rs 20 lakh) following this new package.

"We need to figure out ways for cheaper finance as there is no option left for us but to reduce interest rates to remain competitive and protect our market share," said an HFC CEO, who refused to be named.

With the proposed cheaper window from National Housing Bank, HFCs are expected to come up with a counter strategy to protect their market share.

"We are waiting for details of the package to understand its impact. We will decide on our counter strategy in a couple of days. However, apart from the proposed NHB fund, we need to explore other alternative avenues of cheaper finance as well," said LIC Housing Finance Director and CEO R R Nair.

According to industry estimates, HFCs constitute over 40 per cent of the Rs 120,000 crore (Rs 1,200 billion) housing finance market and share of these companies with respect to the incremental market share is likely to fall to 15 per cent at the end of 2008-09 from around 25 per cent during 2007-08.