Thanks to the cash crunch in IL&FS the rot in the company is now getting exposed
The Uday Kotak-led board of IL&FS has submitted a revival plan for the beleaguered company. But the board’s investigations on what led to the mess in the first place could well be a primer for business school students on how to run a business to the ground.
After a month of digging around, the new board seems to be still unsure of the magnitude of the mess. The report calls the efforts work-in-progress. But two things are clear.
One, the mess is the result of unbridled greed and mismanagement. Former board members and auditors of IL&FS entities have a lot to answer.
Two, information about the exposure of public financial institutions to the IL&FS group shows the gravity of the situation and explains why the government is keen on saving the company.
Out of IL&FS’s Rs 91,000 crore debt, Rs 57,000 crore is owed to public sector banks and institutions. The amount due to banks is over 10 percent of the net worth of all public sector banks in India. Considering the exposure of the entire banking sector to NBFCs is Rs 3.3 lakh crore, IL&FS’s share is slightly over 16 percent. This does not include corporate guarantees, debt service reserve arrangements or other similar financing arrangements. No wonder banks are jittery about lending to NBFCs.
While these numbers are no doubt important the greater takeaway is how the group managed to get away with this deception for so long using labyrinthine structures to shuffle money from one company to another to avoid detection
Indeed, one reason why the new board is moving slowly is the complex structure and the opaqueness in operations. IL&FS’s annual report said it has 24 direct subsidiaries, 135 indirect subsidiaries, six joint ventures, and four associate companies under the umbrella of the parent IL&FS. But the new board has found there are 347 companies, which was later confirmed by the auditors. The former board and auditors need to be questioned why this was not mentioned in the annual report.
The prime reason for using such complex, multi-layered structures would be to divert funds. The report goes on to say that large parts of the group operated as a single enterprise with no boundaries of legal entities and separate management.
Moreover, there were significant intragroup financial transactions. Consider IL&FS Financial Services (IFIN). The report said a preliminary analysis showed IFIN had outstanding loans and investments to companies in the IL&FS group of Rs 5,728 crore, Rs. 5,127 crore, and Rs. 5,490 crore in FY16, FY17 and FY18, respectively. These appear to be significantly in excess of permissible norms in all of the 3 years and result in significant negative capital adequacy for IFIN in these years.
In another instance, a Rs 1,500-crore loan to a group company had been routed through eight other group companies. Such transactions are usually used to hoodwink regulators. Clearly, the internal and external auditors have a lot to answer for the oversight.
Similarly, a certain asset was transferred from one group entity to another in June 2017 at Rs 30.8 crore, but a year later a committee of directors resolved to sell this to a third party at Rs 1 crore. The report said new boards found the reasons for this discount sale as “inadequately supported.” So much for having a well-qualified board.
It is not only the board that has to answer questions but some senior employees as well. About 55 IL&FS retired employees hired back as consultants costing the company Rs 16.5 crore annually. Wisely, the new board has cancelled the contracts of these consultants, subject to some exceptions.
As if this was not enough, the new board found that group companies leased properties owned by select employees (or their relatives) as guest houses for the group companies in what is a clear case of conflict of interest. While the investigation is still on, illustratively the report says in relation to six such properties the monthly lease rent aggregated to Rs 15.1 lakh per month and a deposit of Rs 2.26 crores. These have been terminated by the new team.
These examples clearly show IL&FS is a classic case of greed, mismanagement and lack of accountability. The crisis could not have run for this long without the knowledge of the top management and the recently expelled board members.This state of affairs would have continued had the company not run into a cash crunch. The government should now use IL&FS as an example for all companies who take their stakeholders for a ride and ask for greater accountability and oversight from the board of directors and auditors.