Government may not participate in DHFL bailout; and rightly so

In the last few months, there have been strident calls for the government to intervene and sort out the DHFL mess. The problem is more than a year old. At one time, DHFL was considered the most aggressive home finance company although its valuations were always at a discount to the big names. Problems at DHFL started when IL&FS began to default in the middle of 2018. This not only led to bad investments for DHFL but it spiked the cost of funds for most NBFCs. The sharp spike in bond yields gave a clear indicate that default was a real possibility.

Does DHFL need a bailout?

There are two ways to look at the DHFL case. Firstly, DHFL does represent a major systemic risk. It has total loans and bonds to the tune of Rs.102,000 crore.  This includes banks, insurance companies, provident funds and even retail investors. Most banks have also been supported by the government through recapitalization and hence any further support looks unlikely.  In case of the other investors, it was a purely investment decisions and the losses will surely hit their books. But that may not really warrant government intervention at this point of time. Of course, there is the case of clients of DHFL but these are builders and they will benefit when the real estate completion package is worked out. Like in the IL&FS case, the government wants to find a resolution rather than bailing out DHFL.

Issue of moral hazard

The bigger concern for the government is that of a moral hazard. For starters, if the government intervenes to rescue DHFL at this point of time, it may have to do the same for many more such cases that come along in future. To that extent, it would set a bad precedent in the market. Secondly, the problems at DHFL (like in the case of its sister HDIIL) appear to be a mix of bad business decisions and willful fraud. The first priority of the government would be to use the ED, the SFIO and forensic teams to determine the extent of money that has been lost and the extent that has been siphoned out. Unless there is clarity on this front, the government would not be too keen on bailing out. After all, bailing out a private business that makes reckless business decisions is only an incentive to perpetuate such practices. The government is right in staying away from this case.

 Letting losses happen

DHFL is a test case of a company that was fundamentally flawed but managed to leverage the valuation currency. That is hardly a sustainable scenario. The best option is to monetize the assets of the company, repay the stake holders in a proportionate manner and take strict action against erring promoters. The government is right that it should set an example and not create an unhealthy precedent for the future!