DHFL Demise Highlights Funding Risk at Indian NBFCs: Fitch
Moneylife Digital Team 07 June 2019
Liquidity problems at Dewan Housing Finance Corporation Ltd (DHFL) and its reported failure this week to pay coupons highlight the funding challenges faced by India's non-banking finance sector, Fitch Ratings says.
"Issues in the non-banking financial companies (NBFCs) were already known to the market but DHFL became a focus point after the failure of Infrastructure Leasing & Financial Services Ltd (IL&FS) in September 2018," the ratings agency says, adding, "This also contributed to a sector-wide liquidity squeeze as investors became more risk averse. Indian NBFCs' liquidity is sensitive to market sentiment as their business models rely on short-term wholesale funding, which can dry up fast if market sentiment turns negative. Funding models of housing finance companies and NBFC loan companies, which have become increasingly reliant on short-term funding to fund longer-term assets, have been particularly affected by the liquidity squeeze."
According to the ratings agency, the liquidity pressures in NBFCs are in stark contrast to the banking sector, which has not faced significant liquidity pressure or deposit withdrawals, despite asset-quality and capital adequacy weaknesses.
The sector pressures have led India's top NBFCs to explore other sources of funding and to start positioning themselves to tap the US dollar bond market. "We expect Indian NBFIs to become more regular issuers in the offshore bond market as they seek to diversify their funding sources. If prudently managed, this should be credit positive as funding profiles are strengthened," Fitch says.
The funding squeeze has contributed to higher funding costs and a slowdown in loan growth for India's NBFC sector. NBFCs are an important channel for extending credit to the wider economy, given their extensive distribution networks, which are often more far-reaching across rural India than those of banks. The sector's role as a credit-provider became outsized as the Indian banking system was forced to deal with its weak asset quality. 
Banks, particularly public sector banks (PSBs), were undercapitalised and had limited capacity to lend more. NBFCs now account for nearly 20% of credit to the economy compared with about 15% five years ago.
Indian NBFCs fast loan growth in an environment of relatively benign interest rates was increasingly funded by short-term funding, in particular, commercial paper issued to the mutual fund sector. The banking system also is an important source of funding for NBFCs, driven in part by the regulatory push for banks to provide 'priority lending', with NBFCs being an important conduit for this.
Fitch says, "Both of these funding sources for NBFCs have become more risk-averse, which means that the sector is likely to face higher funding costs and a period of deleveraging, although the better-positioned NBFCs should still be able to achieve loan growth. The sector's reliance on short-term funding has reduced since late 2018 and some stronger NBFCs have shifted towards longer-term funding, such as term loans or negotiable certificates of deposit."
"We expect credit growth in India to remain slow, despite this week's interest-rate cut, as most banks are capital-constrained and NBFIs face tighter funding conditions," the ratings agency concluded.
Ramesh Poapt
5 years ago
TO ML: this is most clear case for ML to initiate investor protection efforts.
when investors invest in AAA securities and within 3-4 months, it is downgraded
to D, small investors may lose their hard earned savings. unrated/lower rated papers is
different story. but here (AAA) is ML remains silent for investor protection, it is
just shocking. though i am sure ML should have a plan for this. pl. take it up soon
or when the loss is sure.
Sucheta Dalal
Replied to Ramesh Poapt comment 5 years ago
Mr Popat, thank you for your comments. Let me clarify a few things. First, Moneylife, the digital magazine has done the maximum writing on DHFL. Some stories are for paid, premium subscribers. But you may want to read all of them.
Moneylife Foundation, which is a separate, stand alone entity, takes up financial literacy and advocacy. However, we operate with limited resources and expect that those who benefit from the magazine and free seminars will make fewer investment mistakes.
When you say take up issues, it is not clear what you mean. Moreover, those who invested and lost money should first have a complaint. We have not received a single complaint so far. So we are not sure what we are supposed to jump around about.
As for regulating Rating Agencies, that is something SEBI alone can do.
If you have specific thoughts and suggestions do write to [email protected]

Mohan Krishnan
Replied to Sucheta Dalal comment 5 years ago
Dear Madam,
I am an investor in UTI ultra short term and UTI savings fund and I received 2 emails (one for each) from UTI MF on 7th June (21:43) stating reduction in NAV of abt 1% due to DHFL investment gone sour.
No mention of apology or poor due diligence especially after IL&FS fiasco.
Will the AMC compensate this loss from their earnings and high salary and bonuses given to their investment managers.
Gangadhar Shanagala
Replied to Sucheta Dalal comment 5 years ago
Ms Sucheta Dalal, Isn't unfair that a rating companies say this? that too now, after the damage is done? Not just DHFL, rating companies have a role in almost every default so far and they go scot free.

Why can't SEBI or MCA overhaul the way system operates? If a company pays to a rating agency to get rated, I feel the outcome is manipulated in favor of the company. Nothing is "independent analysis" in such arrangement. Most surprising thing is all rating agencies act in cohort - they all simultaneously upgrade the rating and downgrade the rating. Reminds me mass copying - either all pass or all fail.

Instead, the change that should be brought in the system is that lending banks nominate a rating agencies and rating agencies be held responsible by the bank. For public deposits, the rating agency is to be held responsible by SEBI/MCA. If things go wrong rating agencies need to cough up fines.

There is a very good system that works in elsewhere in the world. Tos comply with Federal Aviation Administration (FAA) regulations, all companies operating in aerospace manufacturing, repairs and services appoint few of their employees as FAA representatives. These reps need to be certified by FAA on regular intervals. They report to FAA on regular basis and FAA monitors reps' performance related to safety incidents. Guess what, companies buy hefty insurance for its FAA representatives to cover the damages if there be any safety incident.

Similar system with appropriate variations need to be introduced in India for rating agencies, auditors, etc.. On a side note, this arrangement works also for appointing and monitoring Independent Directors in companies.

Best regards,
Gangadhar Shanagala
Pairs Trader
Replied to Gangadhar Shanagala comment 5 years ago
If FAA was so independent, how did two 787 maxes crash... For that matter how did Boeing even got the plane certified in the first place... Regulatory capture is what you call it. The problem is there everywhere?
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