IL&FS was a Lehman-like moment

When IL&FS collapsed in September 2018, there was talk of a “Lehman” moment. Many felt that the collapse would devastate the Indian financial system and the economy in much the same way that the fall of investment bank Lehman Brothers had impacted the US economy. 

The impact hasn’t been quite the same. We haven’t had banks failing. The Indian economy has not plunged into recession.  But the impact hasn’t been negligible either. The IL&FS debacle has shaken confidence in the non-banking financial company (NBFC) sector. It has undermined private consumption and investment. It has created more non-performing assets for banks. India’s GDP growth has fallen from seven per cent in the quarter ended September 2018 to five per cent in the quarter ended June 2019. IL&FS may not exactly have been a Lehman moment. But it was certainly Lehman-like in the blow it has dealt to the Indian economy. 

Whether Lehman Brothers should have been saved has been hotly debated. The three key persons involved in the Lehman decision — US Treasury Secretary Hank Paulson, Fed Chairman Ben Bernanke and New York Fed Chairman Tim Geithner— have contended that the Fed could not save Lehman because the bank did not have enough collateral against which the Fed could lend. Johns Hopkins University professor Larry Ball has argued in a book, The Fed and Lehman Brothers, that this is simply not true. Lehman had enough collateral to offer. 

The Fed had lent funds to Bear Stearns, an investment bank, before it refused similar help to Lehman. The decision to let Lehman fail was taken under intense political pressure to avoid a bailout. The authorities under-estimated the economic risks involved. Political considerations thus trumped considerations of financial stability. Just one and a half days after the Lehman failure, the Fed went all out to save AIG, an insurance company. The catastrophic implications of the Lehman failure had become all too evident and the lesson had gone home: You can’t let a major financial institution fail. 

Now that the consequences of the collapse of IL&FS are before us, the question worth asking is: Was the decision to let IL&FS fail a policy blunder as the Lehman decision was? To answer the question, we need to understand the sequence of events leading up to the collapse. These are narrated in an affidavit placed before the National Company Law Tribunal (NCLT) by former IL&FS vice-chairman Hari Sankaran. 

IL&FS’s liquidity position came under stress due to cost overruns on its infrastructure projects. To deal with the problem, in 2015 IL&FS attempted a merger with Piramal Financial Services Enterprises. The merger would have generated around Rs 8,500 crore of investible funds in the merged entity. Life Insurance Corporation (LIC), one of the principal shareholders of IL&FS, sat on the proposal for several months and ultimately did not agree to the valuation. The proposal was called off. IL&FS was subject to standstill requirements while the merger was under discussion. It could not raise debt or equity for nearly nine months. As a result, its liquidity position worsened. 

In November 2017, IL&FS attempted to raise  Rs 6,500 crore through the sale of one of its entities, IL&FS Transportation Networks Ltd (ITNL), to an American entity. This attempt too was unsuccessful. ITNL itself sought to raise $300 million through a bond issue. The issue failed. IL&FS then asked for lines of credit for a total of Rs 3,500 crore from two of its shareholders, State Bank of India and LIC. It also proposed to raise Rs 4,500 crore through a rights issue of equity shares. The lines of credit were to have been made available by August 2018 and the rights issue completed by September 2018. The funds from neither source materialised. The rest is history. 

As the liquidity position at IL&FS worsened over time, what steps did the shareholders take to address the problem? In August 2018, should shareholders, notably SBI and LIC, have provided the funding support sought by IL&FS?  If not, should the government have organised a rescue? The questions need answering, as we reckon with the still unravelling implications of the collapse. As news about IL&FS’s distressed position spread, its funding requirement rose considerably. Indeed, the capital requirement mentioned in the media at the time of its default was Rs 25,000 crore. 

High as this figure may seem, it pales in comparison with the significantly higher costs imposed on the economy by the collapse of IL&FS.  The collapse has had a cascading effect that took in its sweep NBFCs, the realty sector, banks, the commercial paper market and non-financial enterprises. The slowdown in the economy is leading to a huge shortfall in tax revenues. Coming on top of the banking crisis, the IL&FS failure is, perhaps, the single biggest factor underlying the deceleration in growth over the past year. 

The IL&FS collapse promptly led to cries of “scam” in the media. Allegations of malfeasance against the management flew thick and fast. In the face of such allegations, the government and public institutions tend to get paralysed. “Do nothing” becomes the motto. It becomes difficult to separate investigations into alleged wrongdoing from decisions required in the larger national interest.  As in the case of Lehman, political concerns about bailing out a private entity prevailed over the imperative to contain the damage to the economy. 
  
Last August, Reserve Bank of India Governor Shaktikanta Das declared that the RBI would not allow any big NBFC to fail. Alas, such determination was missing in the case of IL&FS.  The failure is costing the economy dearly.   
The writer is a professor at IIM Ahmedabad. ttr@iima.ac.in



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