IL&FS fiasco: RBI, FM’s failure

After considerable market instability and fall in investor confidence, the government has decided to take over Infrastructure Leasing and Financial Services (IL&FS) and replaced its old board with a new one comprising prominent individuals. It is to be hoped that a new look IL&FS will be able to get down without much delay to its primary business of funding and overseeing infrastructure development. Without an adequate and improving infrastructure, rapid economic growth cannot be sustained. For this, it is necessary to learn the right lessons from the fiasco. First, the basic malady that has afflicted IL&FS is not unique to itself but also lies at the root of the high level of bad loans in public sector banks. The malady is that the nation is unable to get the hang of successfully lending to infrastructure projects. This is because of the serious deficit in the ease of doing business in the country for such projects, leading to delays and erosion of promoters’ capital. They are thereafter left to their political devices to remain in control of their companies without much of their skin remaining in the game. The only way to ensure increasing ease of doing business is for the promoters, lenders and regulatory authorities to remain in constant dialogue so as to be able to change rules to remove glitches. This is not possible unless lenders have faith in the basic integrity of promoters, and the public has faith in the personal integrity of regulatory officials.

Second, there is a basic mismatch in India when it comes to infrastructure financing. There is no market for borrowing for more than 10 years whereas infrastructure projects can take much longer to be fully operational. The result is that to lend to infrastructure you have to borrow short-term and lend long-term. The only way to overcome this asset-liability mismatch is for India to develop a market for 20-30 year paper. As an economy matures and businesses start thinking increasingly long-term, this can happen.

Third, and perhaps most importantly, exiting independent directors of IL&FS have asserted that it was clear for two to three years that it was getting into trouble but the powers-that-be did nothing. Right now, LIC, the largest shareholder, is being accused of not responding to plans to get IL&FS out of its resource crunch and LIC, in turn, is accusing the former IL&FS board of not seriously pursuing asset sale to generate cash. The question is, what were the Reserve Bank of India, which oversees non-banking finance companies like IL&FS, and the union finance ministry, which oversees major shareholders like LIC, SBI and Central Bank of India, doing? IL&FS was, after all, a systemically important company!