What is it?
It all started with a default in August on a ₹1,000 crore short-term loan extended by the Small Industries Development Bank of India (SIDBI) that led to a trail of several defaults in following weeks. To its many bond investors and business partners, it became increasingly clear that the complex financial conglomerate, Infrastructure Leasing and Financial Services (IL&FS), was facing a severe cash crunch.
How did it come about?
The crisis at the company may have become pronounced in the current financial year, but trouble had been brewing since 2016 when banks went slow on lending and IL&FS had to rely on short-term loans to service its debt even as it built long-term assets. This gave rise to a huge asset-liability mismatch. The IL&FS group has a total debt of ₹91,000 crore.
Why does it matter?
Since a significant amount of its debt was in the form of short-term loans from banks, mutual funds and non-banking finance companies, the immediate impact of its cash crunch was felt on mutual funds and NBFCs. On September 21, panic gripped the stock market after DSP Mutual Fund sold ₹200 crore-₹300 crore worth of commercial papers of Dewan Housing Finance (DHFL) at a discount. The DHFL stock tanked 42% on that day. Some other NBFCs also felt the heat as panic set in. The debt market was also not immune to the goings-on at IL&FS. Liquidity was already tightening in September owing to factors like corporate advance tax outflows and increase in festive season loan demand. The crisis at IL&FS further impacted liquidity and pushed short-term rates up by 50-100 bps within a week. To address the liquidity crisis in the debt market, the Reserve Bank of India freed up more funds for banks to lend and decided to infuse ₹36,000 crore of liquidity through open market operations in October.
The State Bank of India, the country’s largest lender, also stepped in to support with liquidity as it decided to triple its target for loan purchase from NBFCs to ₹45,000 crore for the current financial year. The government also stepped in to address the governance issues at IL&FS. Based on a report of the Ministry of Corporate Affairs, which indicated serious deficiencies in IL&FS, the holding company, and its subsidiaries, the government moved the National Company Law Tribunal to dismantle the board and bring in new members to avoid a collapse. The board is expected to submit a resolution plan by October 31.
What lies ahead
The biggest challenge for the IL&FS board is to raise funds in quick time so that fresh defaults can be avoided. One way to get money is to sell assets. A more permanent way of getting funds is to raise equity capital. Capital can be raised through a rights issue. The proposal for a rights issue was mooted by the previous board too, but they were unable to convince the large shareholders. The Life Insurance Corporation of India is the largest shareholder in IL&FS with a 25.34% stake, followed by Orix Corporation of Japan with 23.54%. Another option is to sell stakes to a new promoter. Again, that was also mooted by the previous board, but some existing shareholders could not agree on valuations. So the new board has its task cut out. As Uday Kotak, the newly appointed chairman of IL&FS, indicated, the crisis is much bigger and more complex than it was initially thought. For example, the new board found that there are 348 entities in the group, significantly larger than the 169 entities it was aware of. “And this underscores the task at hand,” Mr. Kotak said.
It is also to be seen if the new board, which the government has thrown its weight behind, could convince the shareholders for more fund infusion. Economic Affairs Secretary Subhash Garg has said the challenges facing the firm will be “substantially resolved” in six to nine months. That suggests a long haul ahead.
