Infrastructure Leasing & Financial Services (IL&FS), the massive conglomerate of over 174 direct and indirect subsidiaries, is unravelling fast. Like the cops in Bollywood movies, the regulators and rating agencies have woken up to the implications of IL&FS’s imploding only after it began to default on its obligations.

The Reserve Bank of India (RBI), which classifies IL&FS as a systemically-important non-banking finance company, has ordered a special audit, only after it began to default. RBI, we are told, will investigate why the investment company did not inform it beforehand about its financial position. This belated action is laughable and is not going to resolve the looming crisis triggered by the huge debt overhang and severe liquidity crunch.

For years together, I have been highlighting the governance and accountability issues in a set of ‘professionally managed’ companies that quickly turned into protected fiefs headed by one or two people for decades. They, often, posture as quasi-government entities and have played a critical role in our economic or financial system. But these companies are not subjected to any government oversight such as by Central Vigilance Commission or Comptroller & Auditor General of India. They have managed to stay out of Right to Information Act too. IL&FS is one of them; the National Stock Exchange (NSE) is another.

NSE is under a cloud now after we published a whistleblower’s letter alleging price manipulation and unfair access in its co-location servers. At IL&FS, things started unravelling rapidly after Moneylife first reported its Rs1 000-crore default to SIDBI (Small Industries Development Bank of India) on 4th September.

This was followed by other defaults and a series of credit downgrades by rating agencies. The group debt is currently estimated at Rs1.2 lakh crore and what we have seen so far are tiny ineffectual steps by the board. It is nowhere up to the task of resolving a giant problem that is, once again, likely to need a bailout by the public through the exchequer.

Life Insurance Corporation (LIC) has reportedly stepped in but Hari Shankaran, the vice-chairman, and a close associate of the former chairman Ravi Parthasarathy (who stepped down in July for health reasons) has taken to occupying the chairman's room. Hemant Bhargava of LIC has been appointed as the chairman. Mr Parthasarathy has been fully in charge of this gargantuan infrastructure, education and consulting conglomerate for 30 years, without change or challenge.

In an election year, the government clearly does not want to admit that IL&FS’s precarious finances may be as big a problem as those of telecom, steel, coal and realty. But allowing the existing management to continue, while working at a surreptitious bailout by LIC, could boomerang both politically and financially.  

We now need the government or the finance ministry to step in and take some hard decisions ahead of the board meeting tomorrow (15th September). Before we go into what those would be, let’s look at where things stand and what has been done so far.

Writing for Bloomberg-Quint, Andy Mukherjee calls IL&FS a ‘shadow bank’ and compares the systemic shock of its unravelling to the collapse of Lehman Brothers, exactly a decade ago. He writes, “The IL&FS Group is too big to fail; isn’t regulated nearly as closely as it would have been as a deposit-taking institution; and has no ‘living will’—a plan to let it fail safely.”

He also says that ‘socializing losses’ by dumping the problem on to Indian taxpayers or, ultimately, the public (through the exchequer or a bailout by LIC) may be “the only way to avoid panic from spreading.” Mr Mukherjee, correctly, argues that ‘opacity’ has the ‘propensity to amplify panic’ and as “IL&FS goes radioactive, the money market doesn’t know who’s exposed to its toxicity, and to what extent.”

If this is, indeed, the inevitable way forward, then it is high time the government steps in more decisively. Clearly, IL&FS cannot remain in control of Ravi Parthasarathy’s crony club at this time – after all, they are fully complicit in having created the mess in the first place.

The role of the board, both shareholder directors and independent directors, also comes into question. If they were clueless about what was happening so far, are they capable of acting decisively in a panic? We have also heard nothing about the whistleblower’s letter, which, according to sources, has detailed corruption and pay-offs connected with the group’s finance companies.

Now that IL&FS is in trouble, we have been hearing many stories about the lavish lifestyles and big-spending ways of several senior employees in the group. This is yet another reason why the same management team should not be handling the crisis, especially if the group is headed for a bailout by LIC or the government.

In a letter to employees, the IL&FS management has said that the board meeting scheduled for tomorrow (15 September) will provide more clarity. It is unclear to me how a failed-board which was clueless about the mounting problems will, suddenly, be able to act decisively and steer a sinking ship to safe harbour. The board needs to be dismissed immediately and a core management committee put in charge that will report to the government and shareholders.

If the existing team remains at the helm, we will continue to see foolish media leaks that will do more harm than good. For instance, on 13th September, media reports said that IL&FS plans to sell its massive corporate building at the posh Bandra-Kurla Complex (in Mumbai) to raise money. The few hundred crores of rupees that this may fetch will not even be a drop in the ocean of debt.

IL&FS itself occupies only two floors of this extravagant building. The rest of the offices are on long-term lease arrangements with little scope for further value extraction. If shareholders, as reported by the media, want IL&FS to raise funds by selling non-core assets, it will need a genuine and concerted effort to find buyers for many group companies, in a distress situation.

The Ajay Piramal group was interested in buying IL&FS at one time, but even if the group is still in the market for some of its special purpose vehicles (SPVs), one can be sure that it will now want a sharp haircut.

In a letter to employees, IL&FS has said: “It is our case that if concession authorities released our monies, which is around Rs16,000 crore of IL&FS group’s liquidity and stuck in claims and termination payments, we would not be in the situation that we are in.”

But then, delayed payments by government agencies, litigation, stakeholder protests and other problems are an inevitable part of doing business in India. Surely, IL&FS has been dealing with these issues for over 25 years and should have factored this into its ambitious growth plans. Instead, it specialised in structuring lucrative public-private partnerships that escaped all the vigilance, audit, transparency and accountability forced on government organisations.

This gave us a bunch of gold-plated infrastructure SPVs, usually headed by ex-bureaucrats, whose connections helped push the ever-growing ambitions of Mr Parthasarathy’s private fiefdom and crony club. Such super-expensive infrastructure projects are scattered all over India—from Tamil Nadu to Gujarat, Rajasthan, Haryana, Maharashtra and elsewhere.

So far, there is no clear indication of how IL&FS plans to generate liquidity to meet multiple payment obligations that are due in the coming months. Bloomberg points out that Indian public sector banks are not only large shareholders in IL&FS, but have also lent to its distressed infrastructure projects, some of which are still being ‘carried as standard (debt) on the balance sheets of many banks’. Equity infusion by shareholders is unlikely to be enough to address the problem it faces.

The government needs to have a strong team in place to take charge of IL&FS and make an honest assessment of the situation. At stake are huge public investments by various debt mutual fund schemes, estimated at Rs3,500crore by Value Research, and instruments such as financial paper like the cumulative redeemable preference shares worth Rs8,500 crore with a AAA rating and dividend of 16%-16.5% that was mainly subscribed by high net-worth individuals (HNIs).