Demystifying the crisis in il&fs

Dr D M Deshpande

What began as a financial crisis at a micro level in Infrastructure Leasing & Financial Services (IL&FS) is now threatening to spread its effect to NBFC’s (Non Banking finance Companies), pension and mutual funds, LIC and also the stock markets. There have been series of payments defaults by the said entity in the last few days. Though the government has been quick to act, by removing the Board entirely and replacing it by a new one, some damage seems to have already been done. Worse, there are signs that it will not be easy to control the fall outs of this sordid saga.

There are comparisons being made with Satyam, the coming down of which is still fresh in the memory. Both Satyam and IL&FS commanded high respect all around initially; but the comparison ends there probably. While Satyam was one entity, IL&FS is a complex combination of holding and several subsidiary companies, numbering 169. Unlike Satyam, IL&FS has mostly invested huge funds in several long term infrastructure projects. Again, though a private unlisted company, IL&FS had marquee members on its boards and public entities as major investors.  Interestingly, the parent company is not listed but three of its subsidiaries are listed and have not defaulted, well, so far. By not listing, IL&FS is not under the oversight of SEBI and also the Exchange Regulations. The RBI regulatory framework is confined to NBFC’s accepting deposits from the public; neither the IL&FS nor its huge subsidiaries come under the purview of the RBI.

Besides marquee names in the erstwhile Board, which by itself is a huge problem in India, major investors in IL&FS are big names in public and private sector in India and abroad. The LIC of India, Central Bank of India and SBI have sizeable stake with the former’s holding above 25% of the total; so do HDFC, Abu Dhabi Investment Authority and Orix Corporation. Why did they allow the situation to come to this pass? This is a peculiarly Indian phenomenon which raises larger question. Risks undertaken by a private entity get transferred to the government owned entities, logically to the treasury itself. It is a moot point but if all the capital were private, would it have encouraged such risky behaviour?

The crisis seems to be a combination of poor management, malfeasance (possibly) and systemic deficiency. By replacing the Board, the first one is being addressed; but down the line boards need be fixed/changed in subsidiaries of holding company. Also necessary is to change the immediate lower positions reporting to the Board. It is reported that the Government owes some serious money; it must be paid off expeditiously for a crisis hit firm whose liabilities are estimated at over Rs 91,000 crores! This will help in making overdue payments; more importantly, it will bring back trust and confidence in the new dispensation which is at the helm of affairs in IL&FS.

There isn’t much talk about malfeasance, yet. But there are pointers; they are quite significant. No company runs such a huge debt in one or two years. Even the intent of having so many subsidiaries raises uncomfortable questions. Then how come a handful of persons-in fact just three-Parthsarathy, Hari Sankaran and Sahu-were allowed to run the company as their private fiefdom? After all, even the government through its entities such as SBI, LIC and CBI had huge equity stake.

There are failures at multiple levels but the two are most glaring. One, the complete failure of all accounting and auditing-internal and external. The company is 31 years old and the auditor raised the red flag only this year. Were they complicit as in case of Satyam? Will there be an audit of auditors by the new regulator? Second, and this is worse, failure on the part of rating agencies which used all superlatives and gave high ratings to commercial paper and bonds issued by the company. These papers turned from ultra safe to junk grade virtually with in no time. Not only individuals but even institutional investors, relying on the assessment of raters have lost huge amounts of monies.   When will the raters be held accountable in India? S&P and Moody’s have been made to pay up in billions for their mistakes by the Federal and State authorities in the US.

The role of independent directors comes in to question. Nothing seems to have been learnt from the past be it Satyam or the global financial crisis. The company had luminaries serving it on the Board for periods ranging between six and 28 years. Instead of providing appropriate checks and balances and oversight, they have shown gross negligence in discharge of their basic duty and responsibility. There is no dearth of young sharp talent in the country; but the marquee name and abject surrender to hierarchical positions has been the undoing.

Just one example, the remuneration committee of IL&FS was headed by former LIC Chairman S B Mathur; he had no qualms about okaying over Rs.20 Crore salary to founder CEO Ravi Parthsarathy and Rs 7.8 crores to Hari Sankaran vice chairman and managing director. R C Bhargava (chairman of Maruti Suzuki) was also in the risk management committee; it is not known what the committee did but what is known is that it didn’t even meet for three years! All this at a time when the company was not exactly doing well; its debt had increased by over 90% between 2014 and 2018 and interest costs doubled during the period.

Perhaps it is time to address the basic and structural issue of funding of big infrastructure projects having long gestation periods. By the facts which have come to the fore so far, it is clear that short term funds have been used to fund long term projects. Lack of a well developed debt and bond market in India has been documented, lamented time and again; however, precious little has changed on the ground. Long term contracts, fiscal incentives, stamp duty and other levies such as securities transaction tax are a stumbling block. They need to be fixed; for, as long as this mismatch continues there will be more crisis happening in India.