IL&FS Crisis | 'Initial Panic Has Subsided But Concerns Remain': Here's Where Things Stand On Remedial Action, Prevailing Sentiment And Lehman Comparisons

Written By Ankit Prasad | Mumbai | Published:


  • Professor Anant Narayan of SPJIMR has spoken to Republic TV about the recent IL&FS crisis
  • He has opined that the government and regulators have taken quick steps in the matter and the initial panic has subsided
  • Narayan has, however, cautioned that the true nature of IL&FS' travails are as-yet unknown and that things may get worse before they get better

A recent default by IL&FS has seen the infrastructure developer and financier's board being replaced following the government's intervention and a new one being installed in its place, but that was not before the entire matter sent jitters through the Indian market. Now, as the Uday Kotak and Vineet Nayyar-led new IL&FS board comes up with a roadmap, Republic TV has spoken to SPJIMR Professor Ananth Narayan for an informed opinion on the matter in a series of Q&As. 

Question 1: The reasons given for the IL&FS crisis appear to be specific to the company itself, i.e. board mismanagement, false financial representation, a complicated and ungainly corporate structure and others, rather than any kind of flaw or weakness in the infrastructure financing system per se. Should NBFCs in other domains, housing finance for instance, be worried about risks apart from what IL&FS may be causing? There's been a lot of parallels drawn with the 2008 Sub-prime crisis and the Recession, all of which is linked with Housing loans...

Professor Narayan:

Direct comparison with 2008 Lehman crisis is premature and probably hyperbole.

However, there is genuine concern with IL&FS issue that impact the broader ecosystem of financial services including NBFCs and housing finance corporations.

While a number of IL&FS' issues are idiosyncratic, there are themes that impinge upon others -- such as balance sheet risks. RBI itself highlighted that quality of balance sheet risks on housing finance and on NBFCs may not be the best -- may be relying a lot on short-term wholesale borrowing, more than is warranted. This creates concern in entire ecosystem. What is the real state of balance sheet risks? Is there a risk that there may be inadequate liabilities and funding available in the future?

We've still not discovered IL&FS' true nature of assets. Is what we see really reliable? Do assets need to be restated. Unfortunately, some of those whispers and suspicions go into other NBFCs and housing finance corporations as well, especially in builder lending and real estate lending. 

The last fear is IL&FS was essentially named lending -- given its pedigree, given its backers, there was always comfort that the worst couldn't happen till it did happen. Unfortunately, this extends to other NBFCs and HFCs as well where the comfort stems from the name rather than from the cash flow. All 3 issues -- balance sheet risks, asset quality and named lending rather than balance sheet lending are concerns that could hit the entire financial ecosystem.

Question 2: In IL&FS' case, a roadmap has to be submitted to the NCLT, which is incidentally currently undertaking a critical process of auctioning NPAs. What could the nature of the roadmap be? Could an ownership change be on the cards? Could the recommendation be to divide the company up? Could it be to demand a government bailout? And this is considering that the bailout suspect No. 1 -- LIC -- is the largest shareholder. Would that make it a convenient option?

Professor Narayan: It is important here to dimension the actual problem. It was a good start with the Kotak-headed board that will be respected. They'll make a clean breast of the actual risks in the IL&FS balance sheet. Hopefully, they'll tell us the funding gap, how much funding is required in the short-term. Hopefully, they'll address questions about asset quality. Do some need to be written down? Is there a knock that needs to be taken? And do we need to do more forensics? There are questions about management governance, board governance, credit rating agencies -- we may have to do a post-mortem to determine what went wrong where.

As far as the solutions go, it all depends on the true extent of the issues: Balance sheet risks, asset quality, governance and forensics. We don't know what we don't know, but once we get a grip, adequate measures can be taken. We may see some bad news before good news, things could get worse before they get better.

IL&FS is one entity. Solving the problem for one entity shouldn't be a problem.

Question 3: What could the government, RBI and other regulators do to remedy the situation and also avoid panic? And what should they not do?

Professor Narayan: It's been a good start. They've acted reasonably quickly. RBI has pumped in liquidity. Rates have come down, banks are flush with liquidity. Some of the related fears have gone away. NHB has extended the refinance limit which should give some relief to housing finance companies going forward -- the intent is definitely positive. Commercial banks have stepped in, perhaps egged on by the government, and said they'd like to buy portfolios from housing finance companies and NBFCs and this should reduce the balance sheet stress. Last, the government's swift action on IL&FS is very welcome as well. It's pre-emptive and hopefully will lead to a solution and localise the problem.

Good start, things have been done, the initial panic has subsided. There is pressure but it's been staved off.

If there's one criticism of regulators, it's important to be counter-cyclical while managing sentiment. Time to beat up the system is when things are good. When things aren't looking great you don't want to add to the panic by saying they aren't looking great.

There are ample buffers in the ecosystem to ensure that panic doesn't ensue. Unfortunately, some of the messaging from regulators, while accurate, could end up leading to additional panic. It's probably better to act than to talk. Also, going forward, they should be ready for more bad news just in case, supposing one more large financial institution starts to wobble. We have to remember that the ecosystem resides on a small debt market.

At some stage, RBI and SEBI need to be prepared to pump in liquidity directly into funds, NBFCs and HFCs, perhaps by nudging banks to lend.

Question 4: We saw an interesting argument put forth over NPAs recently -- that the RBI's move to identify them facilitated the crisis by causing NPAs in the system to balloon. Now, Housing finance companies' share prices fell after the RBI said it would look to address mismatches in assets and liabilities. Are they worried because they're aware their positions aren't healthy or is it just the market being worried?

Professor Narayan: The RBI is showing a mirror and has been doing so for the last few years. Through AQR and others. It's merely making a clean breast of what the actual situation is with respect to assets.

I don't think we should shoot the messenger even though the news isn't good. Hiding that there are issues on the asset side isn't the answer.

We have to recognise there's a problem and recognise that there are solutions, such as a good IBC and NCLT process for resolution. Maybe we need a one-time resolution process to ensure backlog is reduced. But the starting point has to be recognition, then resolving assets, recovering what can be recovered, recapitalising banks and financial ecosystem, and then finally reforming. 

Recognition has to be an essential pillar.

Question 5: There is a problem in the ecosystem, but there is also a solution. How do you see the state of the ecosystem as a whole?

Professor Narayan: Look at any financial ecosystem across the world. You never get a perfect system to start with. The good thing is that the way forward for resolution of certain issues is well known. Look at banks. Naik committee came out with a plan to reform the banking system over a period of time which contained some suggestions that were spot on, and could lead to a situation where public and private banks would be more robust and contribute towards the growth of the economy as a whole. Unfortunately, it's gathering dust, and I urge the powers-that-be to pick it up. There are other committee reports as well in other fields.

Solutions are available to us. As soon as we muster the execution skills to put them into practice, I think the future is bright. With 30% savings as a country, there's no reason why we shouldn't be able to put a good amount of it into financial assets and into productive investments.