CAN a big financial firm’s credit rating fall from AAA one month—good enough for pension funds and life insurers—to junk the next without causing a crash? India’s government decided it did not want to find out. Last week it granted Infrastructure Leasing and Financial Services (IL&FS), one of India’s biggest shadow banks, a parachute. Plenty are worrying that it will not be enough.
As recently as early September, IL&FS raised few concerns. A couple of weeks later it had defaulted on several payments to creditors. By the end of the month it had said it would raise 45bn rupees ($630m) of fresh capital through a rights issue from its owners, including the Life Insurance Corporation of India, a state-owned insurer. On October 1st the government forced out the board and appointed a new one. It was, in effect, a shadow-bank bail-out.
IL&FS is a very Indian beast. It was founded in 1987, with the support of state-owned banks, to provide finance to local governments for infrastructure. It has grown into a vast conglomerate, with 169 group companies. It finances, builds and runs everything from toll roads to “smart cities”, not just in India but abroad. Though it is private, the projects it runs, and the roughly 40% of its equity that is owned by nationalised firms, make it what Indian analysts call “quasi-sovereign”. If it went bust, projects across the country would stall, leaving taxpayers on the hook.
As India’s state-owned banks have sought to repair their ropy balance-sheets, IL&FS, which lends but does not take deposits, grew to satisfy demand for infrastructure finance. Its own debt nearly doubled from 2014 to 2018, to 910bn rupees. It used to borrow mainly from banks. Recently it has turned to the corporate-bond market. More than a third of its debt falls due within 12 months, up from a fifth a year ago. The problem is that most of its assets are long-term, illiquid projects. This year interest due overtook operating profit; hence the cash crunch.
Few think that a liquidity crisis is the firm’s only problem. Even when its credit was good, its projects had a nasty habit of busting their budgets. Some, such as GIFT City, a pet project of Narendra Modi, the prime minister, in Gujarat, look like white elephants. More than half of IL&FS’s receivables are tied up in claims about delays, termination payments and the like. The government has accused the management of being “well aware of the precarious and critical financial position”, but continuing to present “a hunky-dory scenario which was just a mirage”. India’s Serious Fraud Investigations Office is investigating.
Bureaucrats in the Reserve Bank of India, the central bank, will be unsettled by the risks that lie outside the banking system, and not just within it. Bad debt in the regulated and largely publicly owned banking sector is rising (see chart). Last year the government had to recapitalise state-owned banks to the tune of 2.1trn rupees. Shadow banks offer a new festering mess. In recent years they have provided more credit to the commercial sector than banks have. Either India’s fast-growing mutual funds and insurers, which own much of IL&FS’s debt, have been judging risk inaccurately, or they know full well what they have been doing but expect the government to step in.
A cash infusion will win IL&FS and the government a few months. That will allow the revamped board to appoint new management, assess losses and start selling assets to pay down debt. The government may seek to clear obstacles in the way of those of its projects that could be made profitable. Meanwhile, markets are nervous. Shares in other non-bank lenders have collapsed. Which will be next to look for the government to cushion its fall?