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.

FrontLine - - COVER STORY -

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.

OPAQUE STRUC­TURES

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.

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