Drawing Parallels- The NBFC Turmoil

An Institution deemed “systematically important” by the RBI, one that is too big to fail defaulted on bank loan payments, short term deposits and commercial papers redemption. Exactly a decade ago, the fourth largest investment bank in the United States filed for bankruptcy. As Lehman fell like a house of cards, it invited a financial crisis. And true to script, India happens to be marking the 10th anniversary of the global financial crisis with its own Lehman momentdue to defaults by the NBFC- Infrastructure Leasing and Financial Services.

The first default of Inter corporate deposits worth₹450 croreshappened in June. This was followed by a ₹1000 crores default on a short term loan from SIDBI, on September 4th,and yet another default on the 14th. IL&FS a long term darling of the Indian debt markets soon became a pariah. And true to script, belatedly, after subsequent defaults CARE and ICRA were impelled to downgrade its ratings on September the 17th.

The company has overall debts of around $500 million coming due for repayment in the second half of the fiscal year and only $27 million available (most of its assets being infrastructure projects that are not liquid) . It is highly leveraged (13:1, Lehman 31:1) and has asset- liability mismatches due to funding projects with longer payback periods. The point of this case being a cause of worry is that the linkages between IL&FS and financial sector entities such as banks, mutual fund companies and infrastructure players is too strong.

In July, Ravi Parthasarathy, founder of IL&FS (Indian equivalent of Richard Fuld at Lehman) stepped down citing health reasons. Opacity causes panic and the money market at this point in time is unable to determine the exact extent to which it has exposure. What happened with the Lehman Brothers is that it was allowed to collapse like a house of cards but New Delhi has made a solid move by appointing a committee lead by UdayKotak to replace the current board and has moved to the NCLT. There are also reassuring assumptions that the LIC, a majority shareholder (now saving another sinking bank) will rope in majorly to save this entity. But, given all the uncertainty, an implosion in the coming months cannot be ruled out.

The Benchmark index shedding points and a series of defaults have caused waves of panic amongst retail investors. These investors are jittery of ₹2800 crores worth of mutual fund investments in the company. The crisis singed the NAVs of multiple mutual funds across categories, all giving negative returns. If the series of defaults continues and the Government’s appointed panel is unable to derive a solution, the effects would have adverse effects on the values of unit-linked insurance plans, endowment plans, the National Pension Scheme, etc.

The case in point should not be viewed in isolation, coupled with infrastructure companies in stress, record levels of NPAs, the rupee’s freefall against the dollar, rising petrol prices (subsequently burgeoning current account deficit) and soaring unemployment rates, this might just be an omen of the worse yet to come. This scenario(although much smaller in size) conjures up images of the Lehman Brothers.

What needs to be probed is how a company “systematically important” has managed to fly in a radar of “mis-governance”. The debt pile-up due to over-leveraging did not happen overnight. How did the RBI, as the regulator, miss the goings-on? Are the shareholders, which are well-known institutions, guilty of misplaced faith in the management, or were they negligent? Meanwhile all the lay(eh)man can do is hope that India has averted its Lehman moment and the worst lies behind us.

Shireen Wagh and Sehaj Alagh