In Times of Gloom

Vastav Ratra
Sep 13, 2019
4 min read

IL&FS: God’s Hand Gone Rogue?

As the extent of scam and the full list of projects attributed to the now-bankrupt (and seemingly on recovery path) Infrastructure Leasing & Financial Services (IL&FS) unfolds, one only wonders whether IL&FS was serving as God’s omnipresent hand gone rogue or was given to holding Ravi Parthasarathy’s cigar forever. For once though, it seems that the other hand – the Congress’ – is not mired with blood of massive disruptions caused by IL&FS’s upheaval.

IL&FS Group, a major shadow investment bank, was created in 1987 through the efforts of Central Bank of India, Unit Trust of India and HDFC. A shadow bank is an organisation which generates credit but is not subjected to oversight. Why? Because unlike your bank, they do not take deposits from the citizens. It was envisioned as an investor in country’s infrastructure, and a look at its projects would give a feel of fulfilment of purpose. From Gujarat’s GIFT city – the first smart city in the country – to tunnel projects connecting Ladakh and Kashmir, IL&FS and its allied subsidiaries had permeated every state’s infrastructure projects.

Headed by Ravi Parthasarathy, the company romped in major shareholders. Until last year, the government owned 40% of the shares, which were unevenly distributed between SBI and LIC. 35% shares were in foreign hands, including big-wicks like Mitsubishi and Abu Dhabi Investment Authority.

In 2016, the IL&FS Group received accolades for having raised the first masala loan – a foreign loan in Indian currency. It received a loan of 300 million dollars from Export Development Canada – a Canada-based trade financier. Foreign loans are usually given in US dollars, and the interest is paid in dollars as well. Consequently, receivers of loan are exposed to volatility in currency. In a masala loan, this risk is taken on by the investor, and the company saves in hedging costs.

The Crash

In the monsoon of 2018, however, none of its reputation could rescue the IL&FS from defaulting on payment of interest and living up to the commercial paper obligations to repay debt within one year. It was known that the company had been taking short term loans to finance its long term liabilities, but now it had started to default on its short term liabilities as well. The loans had a tag of whooping Rs. 91,000 crore, and there was no end of plight in sight.

What Went Wrong?

How did IL&FS reach here? The failures of IL&FS are attributed to an inefficient high-level management, which was incapable of completing any projects on time. The delays in completion of projects meant that the costs incurred greatly exceeded the initial calculations, thereby reducing the company’s profitability. This was coupled with a change in land acquisition laws in 2013, which only inflated the costs and delayed the projects further. All this co-existed with elephantine remunerations to the top management, even as the corporation struggled under unbelievable debt.

Ripple Effects

The default on the huge loans sent tremors of Lehman’s magnitude across India’s financial sector. Companies like DHFL and Bajaj FinCorp saw their share prices plummet, and there was unease in the citizenry whose mutual fund portfolios had substantive investments in IL&FS projects.

The company decided to mitigate the crises by raising Rs. 4,500 crore through a rights issue. A rights issue is essentially the issuance of new shares to the existing shareholders in order for the company to raise money to deal with financial crunch. This proposal invited great criticism from Congress, who felt that the government should not use the money invested by over 38 crore Indians in LIC to bail-out a company with massive foreign share-holdings, as LIC was being projected as the buyers of the new shares.

Since nothing went through, the Group and its subsidiaries declared bankruptcy, and stalled its myriad development projects across the country. As an evidence of its harm, the Gurgaon Metro – owned and run by IL&FS – is also anticipating a halt on September 17, 2019.

The Government’s Response

For once, the government is not trying to run away from its responsibility. In their latest budget, they showed some willingness to deal with the challenges raised by shadow banks. The government has set aside Rs. 1 lakh crore, to provide partial credit guarantee to the Public Sector Banks (which continue to reel under their own pressures) to buy over the assets of shadow banks. However, the struggle seems to not end soon.

Lessons from the Collapse

Shadow banks function outside the regulatory framework. Since they do not take deposits from households, there are largely free of regulations on liquidity. Historically, the vacuum of regulations fed these banks and they grew into massive groups, just like IL&FS. Their websites would boast of multi-million dollar projects, and their CEOs would act like Big Brothers given to Gatsby’s living. Their aim was simple – to show their lenders that they are “too big to fail”. The 2008 financial crisis – seeing how such bodies can ultimately kill the economy while they themselves bleed to death – has significantly altered the lens through which one looked at some of these groups and corporations. India, however, is learning this lesson at a slower pace.

We do not just need government guarantees to infuse investment in NBFCs, we also need a greater regulatory framework. The government needs to disincentivise excessive expansions by shadow banks, and work towards drafting roadmaps to ease conversion of these institutions into banks, or prompt mergers with banks. Only when such foresight is put in place, we would be able to secure ourselves and the economy from a financial melt-down initiated by NBFCs.

– Vastav Ratra