Our own variety of Lehman fiasco

[dropcap]W[/dropcap]ith the country in the thick of massive frauds like the one involving Punjab National Bank and fugitive billionaire’s Kingfisher airlines, almost bringing down the banking system to its knees, India would have done well not to suffer a new crisis around leasing and infrastructure finance company IL&FS, now on the verge of collapse due to grossly irresponsible lending and payment defaults. It is ominous that the crisis has coincided with the 10th anniversary of the collapse of Lehman Brothers, a watershed in the history of contemporary world, which dealt a debilitating blow to the global financial system that it has still not recovered fully from. There is striking similarity between the two crises. Just as Lehman was brought down by the subprime mortgage crisis, IL&FS ills stem from the same type of toxic assets and unviable financial instruments.

It was purely a case of overleveraging and trying to bite more than one could chew. IL&FS borrowed funds left and right and was equally liberal with the disbursals, giving funds to infrastructure projects without caring for their viability and the ability to repay, just like our banks lent to companies based on project reports that sounded great but lacked substance. As a large number of projects failed to take off and the funds became sticky, IL&FS started failing to meet its obligations. With defaults in repayments, the company faced a serious liquidity crisis as lenders tightened the purse strings. The group is reported to be reeling under a debt burden of Rs 91,000 crore.

The result was a series of defaults by group companies on their term-deposits, inter-corporate deposits, commercial paper and non-convertible debentures, which could not but have an impact on financial markets. By the middle of last month, things went out of control as IL&FS started receiving notices against payment defaults and delays, leading to a downgrade of its financial instruments. The defaults jeopardised hundreds of investors, banks and mutual funds associated with the group as the markets, including stock, debt and money, were gripped by panic.

The government has moved the National Company Law Tribunal to supersede the IL&FS board and change the management ahead of a rescue plan to prevent the insolvency issue leading to a full-blown domestic credit crisis, which would be disastrous for banks and mutual funds. The Serious Fraud Investigation Office has kicked off a probe into the irregularities by questioning the top management, searching the group’s offices and gathering information from the computers. Also coming under the scanner are ousted directors and the company’s former chief Ravi Parthasarathy. A forensic audit of the role of auditors, directors and shareholders and their failure to fulfil fiduciary responsibilities will hopefully bring out what is at the root of the crisis.