India’s ‘perfect’ financial storm

Andy Mukherjee has been tracking IL&FS zealously and professionally. That the news of their financial distress broke out as the world was ‘celebrating’ the tenth anniversary of the collapse of Lehman Brothers is indeed a rather remarkably unfortunate coincidence.

Andy Mukherjee’s columns on their travails can be read here, here and here.

Andy’s piece on RBI’s five messages – including one message to itself – is an interesting piece. IL&FS’ distress again reflects poorly on RBI’s regulation because they are regulated by the central bank:

All of India’s finance industry ought now to feel the RBI’s regulatory heat, including Infrastructure Leasing & Financial Services Ltd. and its empire of 169 subsidiaries, associates and joint ventures. The IL&FS Group is systemically important, though it doesn’t take public deposits. Now that the infrastructure lender is defaulting on debt, it’s become painfully clear that the RBI hasn’t done enough to rein in that institution’s freewheeling ways. [Link]

However, his column was about the non-extension of the tenure of Rana Kapoor, YES Bank Chairman & Managing Director by RBI.

While many have applauded the RBI decision on YES Bank C&MD’s tenure being cut short, some have still questioned RBI’s terse communication on the matter, without explaining the decision. See Amol Agrawal’s blog post on that.

Back to IL&FS. Shankkar Aiyar wrote that fear has no bottom. Well, fear has. The worst that value can go to is zero. It is that exuberance has no ceiling! On Friday, 21st September, for a while, it did appear that fear had no bottom in Indian stocks. Intra-day drop was nearly 1500 points. Heavy buying by institutions stemmed the rot but that is no often good news. Indeed, the pressure is bottled up to be released later. On Monday, the Sensex Index shed 546 points (1.46%).

The shareholding of IL&FS should make us all worry about LIC. They have bailed out disinvestment from ONGC; IDBI Bank and they are now neck-deep at IL&FS. Who will shore up IL&FS Equity Capital? What is the true portfolio value at LIC?

ILFS shareholding

This is the source for the above chart. This story captures the importance of IL&FS to the Indian debt market.

Is the IL&FS situation a wake-up call for the Insurance Regulator? But, LIC is 100% government-owned. So, effectively, it is Government of India’s fiscal risk. To the extent that IMF re-calculates projected budget deficit for China to take into account the contingent liabilities of the Central Government in China, shouldn’t it be doing the same for the Indian government’s contingent fiscal liabilities? Of course, the topic of China, IMF and its Article IV report is the subject of a separate blog post. I am digressing.

Finally, I met Saurabh Mukherjea (ex-Ambit Capital) in August when we both were speakers at a conference in Coimbatore. We spoke that night by phone on the vulnerabilities of India’s shadow banks since they had become both aggressive lenders and borrowers in the wake of the torpor of public sector banks. He did warn me then India’s NBFC would be the next domino. He was prescient. Again, on September 8, he had written this post about India’s exposed financial system and it was published by moneycontrol on September 23.

5 thoughts on “India’s ‘perfect’ financial storm

  1. IL&FS is a big thing, really big thing. The whole system was quite lax and in fact complicit. The entire hierarchy was not bankable in the last 4 years that I tracked.

    I don’t think anyone really understands credit risk well enough in India. And FIs are even more difficult. I don’t think most Mutual Fund houses understand credit risk at all. All their schemes are stuffed with FI paper. And redemptions are on tap when they face an illiquid market. Information is so limited that it is very difficult to assess risks well enough.

    RBI was sleeping and let this build up. A CIC falls under its supervision. I don’t think they have fully understood the issues as yet. Resolution requires taking charge and calling the shareholders and the creditors.

    The Govt and it’s agencies should be really acting and spelling out the resolution plan quickly.


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