Asset Liability Mismatch

IL&FS is a private sector entity, but around 40% of its shares are held by public sector undertakings. Hence, the government had to ensure solvency in order to maintain financial stability in the country. In an attempt to salvage the sinking ship of IL&FS, the government petitioned to change the managerial board of the company, which was ratified by the National Company Law Tribunal (NCLT). The existing management had lost its credibility due to the continued payment of dividends and managerial pay-outs in spite of an impending liquidity crunch. In 2018, a new board was constituted as the old one failed to discharge its duties. The government also appointed transaction advisors - Arpwood Capital & JM Financial, and Alvarez & Marsal (“WHAT IS IL&FS CRISIS”) to maintain strict liquidity control, manage stakeholders as well as develop a resolution plan. Even though these measures were being taken, IL&FS was far from being rescued.

Malpractices within subsidiaries of IL&FS Ltd. propelled the collapse. IL&FS Financial Service (IFIN) is one such example where the company and its auditors colluded to deceit and dishonesty. IFIN is the lending arm of IL&FS ltd., and it extended loans to companies without adequate securities, negative net worth, and for the purpose of evergreening of loans. The auditors of IFIN were Deloitte (2008-2018) and BSR Associates, a unit of KPMG, for FY17-18. This abusive lending wasn’t enquired by the auditors. The government sought a 5-year ban on these auditing companies. The Serious Fraud Investigation Office was involved to investigate 30 entities related to IL&FS group, and a new auditor, Grant Thorton was appointed to audit the books.

The shadow banker operated over hundreds of subsidiaries and as of 2019, it was sitting over a debt of Rs. 94000 crore of this, almost Rs 60,000 crore of debt is at the project level, including water, road and power projects (Rangan and Kalesh, 2018) and the prime reason for the majority of these debts is an asset-liability mismatch.

Asset Liability Mismatch

In the case of IL&FS it continued to borrow short-term loans to finance long-term projects, but the long-term projects could not generate revenues to repay the loan in time (Chanda, 2019).

The debt-to-equity ratio indicates the proportion in which financing is provided in the company. It is crucial in determining whether or not banks will lend to the companies. The preferred debt-to-equity ratio is generally 2.0 or less, which portrays a healthy balance of finances in the company. As is indicated in the graph below, this was not the case with IL&FS:

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Fig- Increase in debt-to-equity ratio in the case of IL&FS (from 2015-2018) Source: (Rakheja, 2019)

This graph indicates that the debt-to-equity ratio increased from 9.47 to 16.78 in the years 2015-2018. Inflation in short-term loans from 22.9% to 28.3% in this period worsened the asset-liability mismatch - increasing short-term loans for long-term projects.

Rubbing salt to the wounds was the alarming “current ratio” - which is defined by Will Kenton as,

“the ratio that measures a company’s ability to pay short-term obligations or those due within one year. ” In other words, it is the ratio of the current assets of the company to the current liabilities of the company. In the case of IL&FS, this current ratio was less than 1, which was a clear indication that the capital in hand with IL&FS was insufficient to meet its short-term obligations if they were all due at the same time, but still, they opted for it.

The 3 credit rating agencies of IL&FS were ICRA (Investment Information and Credit Rating Agency), CARE (Credit Analysis & Research Ltd), and India Ratings and Research Pvt Ltd. They gave ratings to the NCDs (Non- convertible debentures), CPs (Commercial paper), and ICDs (Inter-corporate deposits); in which the NCD was given the highest ratings. This continued till August 2018. But from August 17 to September 17, the rating got downgraded which brought a serious financial loss to investors.

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