9/24/2019 NBFC Crisis - Case study on IL&FS - Xamnation

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NBFC CRISIS – CASE STUDY ON IL&FS

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NBFC Crisis – Case study on IL&FS

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Last Updated on November 25th, 2018

See also: NBFC crisis in India

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BACKGROUND
In 1987 IL&FS was formed by three financial institutions, Central
Bank of India, Housing Development Finance Corporation
(HDFC) and Unit Trust of India (UTI), to provide loans for major
Send
infrastructure projects. After few years two big international
institutions, namely Mitsubishi (through Orix corporation Japan)
and the Abu Dhabi Investment authority bought the shares of
IL&FS. Subsequently, Life Insurance Corporation India, Orix
and ADIA became its largest shareholders, a pattern that
continues to this day.

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Infrastructure Lending and Financial Services (IL&FS) has more 2 months ago

than 250 subsidiaries. IL&FS has financed some of the largest

infrastructural projects in India – for e.g. Chennai-Nashri tunnel
(longest road tunnel in India) & is considered as a pioneer in PPP
projects. IL&FS was envisioned to provide long term big
infrastructure loans which the banks were reluctant to provide.
From July to September 2018, two subsidiaries of IL&FS’s
reported having trouble paying back loans and inter corporate
deposits to other banks and lenders, resulting in the RBI
requesting its major share holders to rescue it. Recently,
Government of India has taken control of IL&FS’s, after it failed to
pay off debt payments. Since this move by the government there
has been an increase in volatility in the stock markets. A new
board was constituted as the earlier board was deemed to have
failed to discharge its duties. The new board consists of Kotak
Mahindra Bank managing director Uday Kotak, former IAS
officer & Tech Mahindra head Vineet Nayyar, former Sebi chief G
N Bajpai, former ICICI Bank chairman G C Chaturvedi, former
IAS officers Malini Shankar and Nand Kishore. 
IL&FS has been recognized as systematically important
institution due to the size of Infrastructure projects it funds. If
IL&FS fails then there will be repercussions in various fields like
agriculture, education, health, sanitation etc.

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REASONS FOR FAILURE OF IL&FS

Lack of regulators
Rating Agencies – The rating agencies gave IL&FS an
AAA rating and this encouraged investment in the company
but now they have changed the rating of IL&FS as junk.
Shareholders – Major shareholders failed to monitor the
company that they invested in.
Board of Directors – All the senior officers have resigned
from their posts.
RBI – RBI is considering itself a regulator today but it could
have monitored the situation before the crises unfolded.
Government of India –It never properly assigned any
regulator.

Source and use of funds

Increase in interest rates of short term borrowings.
Loans skewed in the long term – Most debts that IL&FS
had to pay off were short term while the loans it had
granted were majorly long term.
Lacking transparency in financial position and too many
loans to own subsidiaries.
No clear distinctions between public & private projects.

Complex company Structure

Too many subsidiaries – with more than 250 subsidiaries,
the auditing and monitoring of the company is difficult for
any auditing firm or regulator.

Ethical Issue
Crony capitalism – there have been known cases where
things were hidden deliberately & unviable projects were
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sanctioned to please the ruling parties.

EFFECTS OF IL&FS CRISES

1. Loss of confidence of investors.
1. Many mutual funds have invested in its Bonds,
Certificate of Deposits. The default and further fear of
default is contagious to all financial markets which
resulted in loss of money for many investors during
last few months.
2. Government decision to pump more funds to meet with
crises can result in widen of fiscal deficit which has adverse
repercussion on inflation, exchange rate, growth etc.
3. It can lead to diversion of funds which were meant for
social sector programs.
4. It leads to increased litigation in National Company Law
Board (NCLB) as shareholders decided not to allow further
defaults by IL&FS

SOLUTIONS
1. Simplifying the complex structure of IL&FS.
2. Making stringent laws to deal with lack of transparency in
both companies structure and finances as well as rating
agencies
3. Minimizing red-tapism, reducing paper work to avoid
stalling of projects.
4. Board of directors should be held accountable for such
major defaults and should be brought under regular audit
mechanism.
5. Auditing should be done by independent third party
auditors appointed by the government in consultation with
RBI and major share holders. This will ensure greater
transparency in auditing of financial records.
6. Bringing IL&FS properly under the ambit of SEBI or RBI.
7. Fast tracking land acquisition and environment clearances.
8. The government can look at disinvestment of deteriorating
assets rather than bailing them out from the tax payers
money

As it is rightly said “A stitch in time saves nine”. It is important that

the government takes corrective action before it is too late to
handle similar incidents.

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