Desperate times call for desperate measures. Therefore, the Centre’s drastic decision to supersede IL&FS’ Board of Directors was perhaps essential to uncover the extent of financial rot at the beleaguered conglomerate. Despite marquee shareholders such as LIC, SBI, Central Bank, HDFC and Orix Corporation, the company seems to have witnessed glaring governance lapses. The conduct of operations through a labyrinth of over 130 subsidiaries, opaque financial reporting that effectively hid liabilities and over-the-top managerial pay and dividend payouts amid mounting losses, all smack of mismanagement that was clearly prejudicial to public interests. The newly anointed Board will have its task cut out in even diagnosing the extent of the financial rot at IL&FS, given NCLT’s stiff deadline, leave alone suggesting the surgery needed to correct it.
The initial steps that the Board may need to take post-haste, would be to commission a forensic audit on IL&FS’ books to arrive at the true liquidation value of its assets, seek moratoriums on its short-term dues and arrange for liquidity until a resolution mechanism can be thrashed out. More than rescuing IL&FS, the top priority should be to ensure that the firm’s assets are liquidated in an orderly manner, so that it doesn’t implode on the financial system. Here, it is the term loan exposures of over ₹55,000 crore to IL&FS that need immediate attention, given the already shaky depositor confidence in Indian banks. While much has been talked of mutual funds’ bond exposures to IL&FS, the NAV damage from this default is only a manifestation of the market risks that MF investors sign up for. The responsibility for damage control lies with the highly-paid fund managers who took this call. The Centre and the RBI should instead focus on containing the systemic fallout of IL&FS defaults on the bond markets, by opening a special liquidity window for NBFCs or mutual funds. The new Board however, must resist heeding the clamour from financial market participants for a bail-out of IL&FS. While IL&FS may be deemed ‘systemically important’ on paper, as an entity which is not listed (unlike Satyam) and doesn’t accept public deposits, it would be hard to justify using taxpayer money to bail out this shadow bank.
The role of rating agencies in this saga merits sharper regulatory scrutiny. Given that stress was evident from IL&FS’ financials for the last three years, it was inexcusable for rating agencies to assign it high investment grade ratings until confronted with defaults. Had they proactively pegged down IL&FS’ ratings, the jolt to bond markets and NBFCs would have been contained. This is not the first instance where they have been caught sleeping at the wheel. Hence, apart from examining their revenue model SEBI must consider stringent penal measures, such as fines or license revocation for rating agencies that repeatedly fail in their fiduciary duties to investors.