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IL&FS Crisis: A Case Analysis

What is the IL&FS crisis?

Infrastructure Leasing & Financial Services Limited (IL&FS) is a fundamentally important Core Investment Company with the Reserve Bank of India and is engaged in the business of giving loans and advances to its group companies and holding an investment in such companies. IL&FS has a large number of group companies across various sectors such as Energy, Transportation, Financial Services, etc. IL&FS was initially promoted by the Central Bank of India, HDFC Limited, and the Unit Trust of India. 

It was incorporated in 1987 to provide finance and loans for major infrastructure projects.  They operate through a channel of 256 subsidiaries (23 direct subsidiaries and 141 indirect subsidiaries), including all subsidiaries, 6 joint venture companies, and 4 associate companies.

The shareholding pattern of IL&FS as on March 31, 2017, as derived from the Annual Report of the company for the year 2018 is as follows:

IL&FS crisis

IL&FS Group, which has approximately over Rs. 91,000 crores paying off debtors, faced a serious liquidity emergency. Between July 2018 and September 2018, two of its subsidiaries experienced difficulty in repaying credits and between corporate stores to banks/loan specialists.

In July 2018, the IL&FS was facing difficulty in making repayments due on its bonds. Further, in early September 2018, one of the subsidiaries of IL&FS Group was unable to repay a short-term loan of Rs. 1,000 crore taken from Small Industries Development Bank of India (SIDBI). Another Group company defaulted in repayments of various short and long-term deposits, inter-corporate deposits, and commercial papers.

IL&FS failed continuously to repay its debt and the possibility of a contagion effect in the financial market led the Central Government to move an application under Sections 241 and 242 of the Companies Act, 2013 before the NCLT, Mumbai Bench.

It sought the immediate suspension of the Board of Directors of IL&FS and the appointment of specified new directors, on the ground of massive mismanagement of public funds by the erstwhile Board. It was also alleged that the affairs of the company were being conducted in a manner prejudicial to the public interest. 

Further, in order to ensure a period of calm during the resolution process, a moratorium was sought qua, which initially was declined but later granted by NCLAT, IL&FS, and its group companies against certain creditor actions. The reason for seeking this moratorium was the impending threat of adverse legal actions by creditors and the absence of a legal framework to address the financial crisis of the IL&FS Group.

The Serious Fraud Investigation Office (SFIO) submitted an interim report in November 2018 by which the Central Government sought the impleadment of more persons as respondents in the original petition. NCLT in its order dated December 3, 2018., granted relief to the Central Government who filed an application for seeking orders, along with the additional respondents, to restrain them from mortgaging or creating charge or lien or creating third party interest or in any way alienating, the movable or immovable properties owned by them, including jointly held properties.

The NCLT in its judgment dated January 1, 2019, allowed the petition of the Central Government seeking re-opening of the books of account of IL&FS and its group companies for the past five financial years based on the prima facie findings of Institute of Chartered Accountants of India and the SFIO’s interim report.

NCLT’s Classification of IL&FS Group Companies on the basis of Solvency:

IL&FS crisis

Impact Of IL&FS Crisis:

  • The market indices, Sensex, and Nifty fell drastically due to the IL&FS crisis.
  • Defaults in payments by subsidiaries of IL&FS triggered fear of liquidity crisis in the financial markets.
  • Series of defaults by IL&FS and its group companies and downgraded credit ratings led to massive sell-off in shares of NBFCs.
  • Few Housing finance companies tanked increasingly in trade. This was because the IL&FS crisis triggered a panic which led to massive sell-offs in these stocks fearing like IL&FS other NBFCs could also face loan obligations going ahead.
  • Having defaulted on commercial papers, investors are trapped in further losses. Further what concerns the investors is IL&FS defaulted on short-term borrowings as inter-corporate deposits too.
  • Money market schemes, which were used by companies to meet their short-term funds, were eventually withdrawn by the investors and saw the biggest monthly outflow in September 2018 as the mutual funds faced redemption pressure.
  • As the panic and fear factor groomed around the market, the Indian financial market faced the worst liquidity crunch in a decade. Non-availability of cash in the market made the borrowings even costlier and hard of the NBFCs and other companies to raise funds.
  • Impact on infrastructure projects: The government of India has promoted a huge number of infrastructure projects like road projects, port projects, civil aviation projects, etc in collaboration with IL&FS. The major investor in infrastructure projects – the IL&FS has no funds or resources to finance these anymore.  So this would obviously have a detrimental effect on the infrastructure sector.

Whom to be blamed?

  • Board of Directors: None of the board of directors, including Independent Directors, did not take the regulatory action or speculated the scenario and they just walked out resigning. It could be attributed to the negligence of the higher authorities to the financial tragedy in the country.
  • Rating Agencies: The rating agencies rated IL&FS as an AAA company and this urged the investors to invest their money as it held the highest credit ratings.  IL&FS’s exposure to the infrastructure sector was highly risky. Even after the first default payments on its commercial payments, the ratings did not change. Credit rating agencies could have monitored the development of IL&FS more closely and in a timely manner, it would have allowed it for a more gradual change of rating, which in turn would have eased out the shock to the larger economy.
  • Auditors: During the statutory audit for FY 18, auditors had raised questions about the ability of the company to service the existing debt obligations. In response, IL&FS management submitted a statement, saying Life Insurance Corporation, one of its primary shareholders will be infusing fresh capital into the company. However, the management did not submit any further proof of such fund infusion.
  • Major Shareholders: The major shareholders of IL&FS – Life Insurance Corporation of India, Orix Corp, Abu Dhabi Investment Authority also failed to monitor the company that they had a major stake in.  According to the Indian Express report, the top risk management team did not hold any meeting for over two years, though red signaling was flagging over.  The chairman of the risk committee of IL&FS was Hemant Bhargava who was blamed to have overlooked the mess-ups. 
  • Reserve Bank of India: RBI might have registered early warning signals, but it kept quiet until the crisis started. It failed in its supervision and regulatory action before the crisis happened and considered itself a regulator only after the mishap.  RBI’s came into action after the defaults, after a considerable period of time, not before the crisis.  RBI would certainly be held responsible for its inefficiency in detecting early warning bells.
  • Government of India: The government of India never assigned a regulator for major NBFCs if they were cited to be in trouble. No laws or rules were mended for such firms to keep them regulated.  Bankruptcy code applied to the non-financial firms, but no systemic plans to regulate major financial firms.

Conclusion:

Even today, the banks still remain weak, mutual funds and pension plans still trying to overcome the losses, and with it, many more institutions trying to cope up with it have been affected directly or indirectly by the catastrophe that hit the Indian economy with the downfall of IL&FS. However, the Financial market has been stabilized. Recently The governor of RBI said,

Market financing conditions for NBFCs, which had become challenging, have largely stabilised in the wake of targeted policy measures.

RBI Governor of india

This article is written by Mahima Rathod and edited by Rupreet Kaur Dhariwal.

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