DHFL demise imminent just like debt-ridden IL&FS: India’s regulators, raters failed to catch early signs of NBFC mess

Dewan Housing Finance Ltd or DHFL—a well-known home loan lender in the country—fears that its  days are numbered. The company has warned investors and clients that it may not survive as a going concern on account of failure to raise funds and meet payment obligations. That’s another way of telling investors that it is going bust and they (investors) should look for other ways to save money. These include banks, bondholders and even retail investors. DHFL has already defaulted on its payment obligations to the tune of Rs 2,858 crores that were due on 6 July and 8 July respectively. In the March quarter, losses to the tune of Rs 2,223 crore was reported as compared with a profit of Rs 134 crore in the year-ago period. On Monday, DHFL shares plummeted 31.77 percent to Rs 46.70, a 52-week low on the BSE in mid-session trade. On the NSE, shares plunged 32.62 percent to hit a one-year low of Rs 46.15. The bad news is that the DHFL mess isn’t happening in isolation. Nearly 165 mutual fund schemes have exposure to this company and banks hold about Rs 38,000 crore of debt. The failure of DHFL will leave painful memories for stakeholders, and investors in other NBFC stocks.  A resolution to the DHFL crisis won’t be easy as there are a large set of investors, not just banks governed by the Reserve Bank of India. DHFL, the lender to builders and retail customers, would have got a breather had some large investor shown interest to pick up a majority stake in the company. This hasn’t happened so far since investors may likely find the firm a super-risk bet. In such a scenario, there aren’t many options available on the table. [caption id=“attachment_6023581” align=“alignleft” width=“380”]  Representational image. Reuters.[/caption] As things stand, post-March quarter numbers, DHFL gives no hopes of its survival to investors. DHFL’s near-death and the IL&FS crisis that preceded it exposes the weakness of India’s financial sector watchdogs who failed to foresee the mess brewing in the country’s shadow banking system. In the case of both IL&FS and DHFL, rating agencies stepped in at the last minute to call out the nature of stress in these firms and warn investors about the impending defaults. Big raters such as India Ratings & Research, ICRA, and Credit Analysis and Research Ltd (CARE), had given IL&FS the highest rating of AAA, even when its subsidiary, IL&FS Transport Networks defaulted in June, as this Mint report reveals about  Sebi investigation on raters. Raters slashed top rating of IL&FS entities to junk after the defaults occurred. It doesn’t require a rating agency to state a company is in trouble after it has defaulted on payments. In the case of DHFL too, agencies did not seem to have any clue till the last minute. One of the raters had even offered top ratings to DHFL instruments until a few months before it started defaulting on payments. Rating agencies came into existence to warn stakeholders in advance about likely problems a company may face. But in the cases of DHFL and IL&FS and in a few others, they failed to do their job at the right time. The same is the case with the regulators–in this case mainly the Reserve Bank of India (RBI) and market regulator, Securities and Exchange Board of India (Sebi). This was also pointed out by former chief economic advisor, Arvind Subramanian last week when he said RBI failed to identify the IL&FS crisis, referring to the RBI financial stability reports of the last four to five years. Repeated failures of rating agencies and sector regulators to identify the stress in shadow banks tell us there is a need to take a deeper look at the way regulators/raters operate. It goes without saying that the accountability of the regulator is key for any healthy functioning financial system. Secondly, a DHFL-like episode reiterates the need for tighter scrutiny of India’s shadow banks just like commercial banks were subjected to with an NPA clean-up process in 2015. In the Union Budget, the proposal to give more power to the RBI t o regulate NBFCs and HFCs is interesting and important in the backdrop of a crisis-like situation in the NBFC sector. Such an exercise, as this writer has mentioned repeatedly, will help in a big way to dig out the stress remaining in the balance sheets of big and medium-sized shadow banks which are interlinked to rest of the financial system. DHFL’s collapse, just like IL&FS, exposes the gross inefficiency of India’s weak regulators, rating agencies. The question is, who will watch the watchdogs.