FALL OF IL&FS AND THE NBFC CRISIS

Infrastructure Leasing & Financial Services (IL&FS) is a non-banking financial company

(NBFC), or 'shadow bank'. It used to give loans to financial and development sectors such
as roads, tunnels, water treatment plants. Some of the projects it has helped develop are 9-
km Chenani-Nashri tunnel (India’s longest road tunnel), Delhi-Noida Toll Bridge, Ranchi-Patratu Dam
Road, Baleshwar-Kharagpur Expressway, Tripura Power Project, and Gujarat International Finance
Tech-City (GIFT). Their whole process was that they used to borrow money as loans
substantially from banks and other regulated lending sectors through the medium of
commercial papers on a mix of long term and a short term basis and lend the money
on huge infrastructure projects. The recent crisis was a result of massive loans from
lending institutions on short term process and gave loans on long term process
through commercial papers. The nature of commercial papers being such that the
loans sanctioned through them are unsecured. IL&FS had a payment default issue
because of bad asset liability management as the company couldn’t return the loan
amount to the bank and the assets for the development of which they gave loans
couldn’t be recovered or sold.

The major shareholders of IL&FS include state-backed Life Insurance Corp of India holding,

25.3 per cent stake, Housing Development Finance Corporation with 9.02 per cent, Central Bank

of India with 7.67 percent and State Bank of India with 6.42 percent. Other key shareholders are

the Japan’s Orix Corp, holding 23 per cent, and Abu Dhabi Investment Authority with 12.56 per

cent. The subsidiaries of IL&FS include transportation network subsidiary IL&FS Transportation

Networks Ltd (ITNL), engineering and procurement company IL&FS Engineering and

Construction Co Ltd and financier IL&FS Financial Services Ltd. Its 169 subsidiaries, associates and
joint ventures, make it too complex for any watchdog or credit-rating firm.

What are NBFC’s and what sectors do they fund?

NBFCs are financial institutions that are essentially engaged in the business of providing loans

and advances primarily to retail customers. Unlike the formal banking sector, they cannot accept

deposits from the public; they depend solely on wholesale lending and banks for their operations.

Two-wheeler loans, consumer durable loans, gold loans, vehicle finance and loan against

property are the segments where NBFCs have a very strong presence across the country and

enjoy a much larger share than the public sector banks.

After agriculture, the MSME sector is heavily dependent on NBFCs for loans and working

capital. Since banks cannot be present in every nook and corner of the country, NBFCs have

capitalized on their highly localized presence to grow their business on the back of strong rural

demand and the thriving SME and MSME sectors. Their local network and understanding of

customer profiles at a local level give them an edge over the banks when it comes to lending at
the micro level. Due to these advantages, NBFCs could rapidly scale their businesses where the

formal banking system was slow in lending. Also, the rising non-performing assets (NPA) crisis

in the overall banking sector made banks reluctant to lend to the perceived riskier sectors like

SME and MSME, thus helping NBFCs to gain market share. Real estate, also considered a highrisk

sector, depended heavily on NBFC funding as well.

What went wrong for IL&FS

As infrastructure became the central theme in the past two decades, IL&FS
used its first mover advantage to lap up projects. But the 2013 land
acquisition law made many of its projects unviable. Cost escalation also
led to many incomplete projects. Lack of timely action exacerbated the
problems. A plan to raise funds by selling stake to Piramal Enterprises
Ltd., controlled by billionaire Ajay Piramal, in 2015 was rejected by the
shareholders. That prompted the firm, which lent for projects that take
years to complete, to seek short-term funds, according to the director.

The slowdown in infrastructure projects and disputes over contracts

locking about Rs 90 billion of payments due from the government have
further worsened the condition.

The company piled up too much debt to be paid back in the short-term
while revenues from its assets are skewed towards the longer term. IL&FS
is sitting on a debt of about Rs 91,000 crore. Of this, nearly Rs 60,000
crore of debt is at a project level, including road, power and water projects.
In the process, it has built up a debt-to-equity ratio of 18.7.

IL&FS Financial Services fell short of cash and defaulted on several of its obligations. Even as

new infrastructure projects dried up, IL&FS' running construction projects faced cost overruns

amid delays in land acquisition and approvals. It defaulted on repayment of bank loans

(including interest), term and short-term deposits and also failed to meet commercial paper
redemption obligations. It reported that it had received notices for delays and defaults in

servicing some of the inter-corporate deposits accepted by it. Following the defaults, rating

agency ICRA downgraded the ratings of its short-term and long-term borrowing programmes.

The defaults also jeopardised hundreds of investors, banks and mutual funds associated with
IL&FS, and sparked panic among equity investors, even as several non-banking financial

companies faced turmoil amid a default scare.

The company piled up too much debt to be paid back in the short-term while
revenues from its assets are skewed towards the longer term.
IL&FS first shocked markets when it postponed a $350 million bonds issuance in
March due to demand for a higher yield from investors.
IL&FS Financial Services disclosed on September 6 that the commercial papers
(CP), which were due on August 28, could not be paid on due date and were settled
in full on August 31.
IL&FS Financial Services has about $500 million in repayments which are due in
the second half of this financial year while it has only about $27 million available.
According to a Reuters report, by the middle of September, IL&FS and IL&FS
Financial Services had a combined Rs 270 billion of debt rated as junk by CARE
Ratings and a further six group companies had suffered downgrades with a
negative outlook on another Rs 120 billion of borrowings.

In October 2018, the government constituted a new board as the old one was deemed to have failed
to discharge its duties. Kotak Mahindra Bank Executive Vice-Chairman and Managing Director Uday
Kotak, Tech Mahindra Vice-Chairman, Managing Director and CEO Vineet Nayyar, former Sebi chief
G N Bajpai, former ICICI Bank chairman G C Chaturvedi, former IAS officers Malini Shankar and Nand
Kishore were made members of the board.

In the first few weeks of taking over, the board appointed its

nominees on key subsidiaries, initiated austerity measures, began a full audit of standalone and

consolidated accounts, formed a core operating committee under Nayyar and started to work

towards a resolution plan. The board, thereafter, appointed Arpwood Capital and J M Financial

as financial as transaction advisors. It also roped in Alvarez & Marsal to maintain strict liquidity

controls, manage stakeholders and help develop a resolution plan.

IL&FS Crisis Highlights
The IL&FS crisis highlights certain points. Firstly the audit lapses by a reputed
auditing company which led to this liquidity crisis, powers, duties, and
authorities of the external auditors and the extent to which they can be held
liable for such audit lapses, Secondly the role and powers of State agencies
like NFRA, SFIO, SEBI, ICAI. The points to be pondered is whether any
preventive action was possible to stop the crisis. Thirdly about lack of laws to
regulate Non-banking Financial Corporation Sector and Housing Finance
Companies and the allowance of shadow banks to hold such huge monetary
portfolios and be involved in such vital development projects.