In a series of Q&As with Republic TV, former SEBI Executive Director JN Gupta has highlighted a number of knowns and unknowns from the recent travails of IL&FS, in particular, that until the newly installed Uday Kotak-led board of the infrastructure financier sheds light on what's actually gone wrong, the various hypotheses being put forth are guesswork, and also, that India needs to rebuild modes for long-term lending in order to ease asset-liability management at NBFCs and Housing Finance Companies.
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...
JN Gupta: The first thing is don't compare with 2008 financial crisis because 2008 crisis was a global crisis which was all over the world, be it developed countries, developing countries, super-developed countries, super-poor countries, and was something to do with the system.
However, in the present case -- IL&FS -- the counter question is that, do we really know what is wrong? So the answer is, we really do not know what is wrong, we all are making our guesses. So is it internal to IL&FS or to external? I would say it is a mix of the two.
It's important to examine the background. Originally in India there were term-lending institutions ICICI, IDBI, IFCI -- they were lending for long terms. Over a period of time these institutions have disappeared. On the other hand, the requirement for long-term finance has increased. 20 years back we'd not heard of a road project or airport or railway line project on Build-own-operate-transfer (BOT) basis. Now many of these have come. These projects have a concession period of 30-50 years and maybe more. Without term-lending all these institutions are borrowing on a short-term basis and putting money into long-term projects, causing a problem of liquidity, as you borrow for 7 years and lend for 30 years. As long as these companies were able to borrow more and repay old borrowing there was no problem. But this problem is there. And people are aware of this problem. It needs one crisis for people to sit and look into the reasons.
On IL&FS particularly, as we've seen, if it's a crisis which is limited only to the liquidity it is universal, but in IL&FS' case, one thing is very important which is that you cannot manage a family which has got 350 members. The big size is a problem. Now here it was big size not only in terms of volume of assets or number of projects but also the number of subsidiaries or companies. We only knew it was around 160 but the new board has said that it 350 subsidiaries. Managing this is a Herculean task.
Second issue -- government has dismissed the board. Issue is why does a person become a board member? If I'm not qualified or don't have time, I shouldn't become a board member. When we study it we find that it's hard for a person to do a good job besides their full-time work a directorship in more than 2-3 companies. When you have a board where directors have directorship in more than 7-8 companies, obviously their time is limited and they won't be able to pay attention.
Other fundamental issue is while evaluating companies, you go by a glossy thing like the big order and size of company, but nobody gets into the cash flow. Problem for EPC companies is getting retention money is sometimes difficult. You complete Rs 10000 crore project, Rs 500 crore project is retention money -- for that you struggle for a long time. When you've constructed 50 projects over 10 years, retention money of every project gets accumulated into a big asset, which itself is a problem. That is one of the issues in IL&FS.
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?
JN Gupta: Like I said, we don't know the nature of this animal. Once we know, any of these solutions is possible. Also, the credit rating agencies have been analysing this. It's impossible that they wouldn't know this nature. Second, RBI has a duty to supervise, regulate and keep an eye on all these things. And given IL&FS' importance, RBI should have been more focused, as should have been bankers, board, credit agencies and investors.
In terms of roadmap, we'll know only when we know what's the problem.
There could be three possible issues: First, it's a simple liquidity issue (long-term funding but short-term raising). That's easily solved by restructuring debt. Second, is if assets on their books are overvalued as compared to current market price. That would entail a loss. If the loss is less than equity, it's not a worry as only the shareholders would lose, the banks and lending institutions won't. But if the loss is more than that, it becomes an NCLT case. Third, would be if there's been a fraud or any siphoning, which only forensics will reveal.
Coming to solutions, if the need is to put more money, question is who will put -- existing or new investors? Equity will only be brought in a manner to not negatively influence the health of the person who is bringing it in. It won't be charity from anybody, and it'll be everybody's endeavour to ensure that the sentiments don't turn negative, in case it's irretrievable.
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?
JN Gupta: RBI has to come out with a policy on what the parameters are on the basis of which they're regulating, as today, it's a black box. And RBI should say who failed in supervision. Transparency has to be brought in and going forward, government will have to think about how to finance long-term infrastructure, as its need is going to rise. This finance has to come from long-term sources.
Pension funds, provident funds should be brought into the infra financing. New long-term financing instruments should be introduced. Couple of years back tax-free bonds were issued by NHAI and other institutions, perhaps that could be a way forward. Government has to do some balancing act and introduce new instruments.
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?
JN Gupta: The argument is like -- 'I have a disease, but I don't go to doctor or hospital so nobody gives me a prescription, so I won't die'. I don't buy that argument. Discipline is coming into the market. Earlier, one NPA would be replaced by a new loan. We've put a full stop to the window dressing where NPAs weren't reported and the balloon which could have burst has been contained and there won't be a big balloon bursting in the future.
Today, future creation of NPAs is becoming very difficult because of the discipline that has been brought by RBI and NCLT. But those with books-mismatch on liquidity are worried.
And market sentiment becomes negative because lenders become cautious as they don't know what is the future -- hence, cash becomes king. In order not to have contraction, we'll have to stem it, and sentiments have to be turned positive, and regulators will have to come out with a statement as to what the problem is. It's time for RBI to introspect and come out with a white paper as to what it is.