Banks on the brink
The unprecedented crisis in the Indian banking sector, which has brought banks’ lending operations to a virtual standstill, means that they can do little to help the economy, which is buffeted on multiple fronts.
THE FILING FOR BANKRUPTCY BY LEHMAN Brothers on September 15, 2008, resulted in a stunning collapse of the global economy from which it is yet to recover. Ten years later, the Indian financial system, which supposedly escaped the crash’s effect, faces its own Lehman moment. With public sector banks (PSBS) already tottering under the massive burden of bad loans, this was the last thing the financial system wanted.
On September 21, the Sensex at the Bombay Stock Exchange (BSE) gyrated between its lowest and highest points, swinging 1,495 points. Although conclusive evidence is never available to explain why markets move this way or that, market pundits attributed the spectacular pirouette to the dire straits in which Infrastructure Leasing & Financial Services Ltd (IL&FS), a premier lender to many of the infrastructure projects undertaken in the public private partnership (PPP) mode, finds itself. Share prices collapsed across the board, even in sectors completely unconnected to the IL&FS crisis, but the most dramatic collapse was reserved for the NBFCS (nonbanking finance companies) sector and those focussed on housing finance.
Although the stock market did recover by the close of play, the sheer breadth and depth of the spike revealed several disturbing facets of the Indian financial system. The most important one was the rude revelation of the utter opacity of IL&FS’ operations. Indeed the day’s frenzy was driven by the fact that no one knew which company or institution would be dragged down by the unwinding of the IL&FS. The contagion was also perhaps triggered by fears that other NBFCS could have similar dud assets in their portfolios.
IL&FS is an unlisted entity. That in itself is a staggering factoid. Given the sheer size of loans it owes—more than Rs.1 lakh crore—being unlisted, it would have to reveal little to investors and regulators. IL&FS is not a bank since it does not take deposits. Instead, it borrows from banks, financial institutions and BY V. SRIDHAR mutual funds. According to Nomura Research, almost two-thirds of its borrowings are from banks, mostly public sector financial institutions, including the beleaguered PSBS.
Shockingly, for such an opaque operation, IL&FS is merely the parent company. It has 24 subsidiaries, 135 indirect subsidiaries, four associate companies and six joint ventures. One subsidiary, IL&FS Financial Services Ltd, an NBFC, has already defaulted on payment of a short-term loan of Rs.1,000 crore to the Small Industries Development Bank of India (SIDBI). Some others are also reported to have defaulted in repayment of loans aggregating about Rs.500 crore. To cap it all, since NBFCS are not covered by the provisions of the Insolvency and Bankruptcy Code (IBC), there is no immediate recourse to initiating legal measures to recover whatever it can from companies that have borrowed recklessly to gamble on road projects, power plants, water treatment plants, all in the name of enhancing infrastructure capacities (see Table 1). Reports indicate that IL&FS Financial Services Ltd has loan repayments worth $500 million (Rs.3,600 crore) due in the second half of the current financial year, while it has cash to the tune of only $27 million (about Rs.194 crore). Not surprisingly, the credit rating agencies ICRA and CARE (Credit Analysis and Research) have downgraded its creditworthiness.
Andy Mukherjee, the well-regarded Bloomberg columnist, pointed out that the opacity of IL&FS’ operations meant that there was very little information on the true extent of the mess. This is what happened on September 21 when there was mayhem in the stock markets. Since mutual funds and other lenders feared defaults by the IL&FS Group, they may have rushed to exit from company stocks, which precipitated the market collapse. Moreover, there was no information about how much IL&FS
As the RAGHURAM RAJAN.RBI Governor, he was responsible for egging on the banks to resolve the NPA mess.