India’s surprise seizure of a troubled Indian shadow bank is not expected to end the woes of its lenders, who face the risk of heavy writeoffs if Dewan Housing Finance Corp is declared a fraudulent account.
That is because the Reserve Bank of India requires banks to provision fully for their entire exposure over four quarters if it is found that a loan account involves fraud.
The decision on Dewan will be based on a final report by international accountancy firm KPMG on Dewan’s lending practices, which is due to be submitted soon, according to bankers with knowledge of the matter, who asked not to be identified further.
An interim KPMG study of Dewan’s books this year cited anomalies including 165 billion rupees (US$2.3 billion) of loans to entities connected to the company’s founders, equivalent to just under half of the banks’ total exposure of 380 billion rupees to the shadow lender.
“If Dewan is tagged as a fraud account, that will create significant additional provisioning requirement and will further dent the profits of banks,” CARE Ratings Ltd head of financial institutions Mitul Budhbhatti said.
A total writeoff would counter some of the optimism about efforts to contain the shadow banking crisis sparked by the Reserve Bank of India’s move on Wednesday to remove Dewan’s management and initiate bankruptcy procedures.
It would place an additional burden on Indian banks already struggling with US$130 billion of bad loans, one of the highest levels in the world.
Only about 55 billion rupees of provisions would be required if the KPMG report absolves Dewan of irregular lending, Budhbhatti said.
Dewan has been struggling to repay its loans as the spreading shadow-banking crisis has shut off new credit to the sector. The company’s shares are down more than 90 percent so far this year.
Lenders, headed by Union Bank of India, have formed a committee to discuss a debt resolution plan, which will have to be reviewed by a resolution professional once Dewan is admitted to the bankruptcy court. In February, they appointed KPMG to look into Dewan’s books following allegations by Indian Web site Cobrapost that the company had diverted funds to shell companies.
KPMG’s preliminary report, a summary of which was reviewed by Bloomberg News, said it was selected to look into Dewan’s accounts for the April 2015-to-March period to identify any “diversion of funds/misuse of funds outside the business/beyond the uses approved by lenders.”
Dewan disbursed loans and advances to “inter-connected entities” and “individuals having commonality with DHFL promoter entities” amounting to 197.5 billion rupees over the period of the study, with a total outstanding amount of 165 billion rupees on March 31, it said.
The preliminary report said that Dewan “could not provide a robust and well-defined tracking mechanism for end use monitoring of funds disbursed.”
More than half of the connected entities had minimal operations, the report said, although it added that further research was needed as to whether they constituted related parties under the Indian Companies Act.
One way of mitigating the fallout from Dewan, if irregularities are confirmed, is for banks to request special dispensation from the Reserve Bank of India to allow them to provide only for any amounts potentially earmarked as fraud, as opposed to the entire exposure.
Banks reported 957.6 billion rupees of fraudulent accounts in the six months ended on Sept. 30, according to the Indian Ministry of Finance.
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