IL&FS crisis: Here is why all is not lost

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26 Aug, 2025 12:21

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After a brutal Friday in the equity market and a near-no-trade Friday in the debt market, there was more bad news over the weekend. IL&FS, the company whose sudden downgrade has led the debt market into fear and illiquidity, announced that it has defaulted on an LC (letter of credit) payment to IDBI.

Further, its financial services subsidiary announced the resignation of its MD, a director and 3 independent directors. The illiquidity in the debt market led the equity markets to hammer shares of two housing finance companies in particular and NBFCs in general.

The week to come will be a tense one. But let us take note of a few positives: First, IL&FS itself has only Rs 35 billion-odd of Commercial paper in a 16 trillion rupees fixed income mutual fund AUM(assets under management).

Second, while there has been general celebration that India’s mutual fund kitty has risen to Rs 25 trillion from Rs 10 trillion in 2014, this year itself debt funds saw a fall of one trillion rupees. So debt markets and NBFCs aren’t so unprepared for the illiquidity. Many saw it coming and have a decent amount of liquidity or cash equivalents.

Third, with Sept 30 drawing near and an expected rate hike in the Oct 6 monetary policy many debt funds had already gone into cash..

Fourth, over the weekend, a source at one of the shareholders of IL&FS confirmed that RBI has called a meeting of the IL&FS shareholders . This will be a source of  comfort that the lender of the last resort is taking control.

Fifth, and most important RBI released a statement on Sunday that it is closely monitoring recent developments in financial markets and is ready to take appropriate action. The SBI chairman too has put out a statement that banks won’t be averse to lending to NBFCs.

While all these will help, the equity and debt markets will want to see the money on the table. Firstly, will LIC, Orix of Japan, ADIA(Abu Dhabi Investment Authority), HDFC and SBI be willing to put money? The planned rights issue of 3,500 cr will hardly suffice. It may have to be doubled or trebled or new investors roped in. That takes time.

Secondly, with the string of defaults by IL&FS, the chances of existing loans becoming NPA is very high. So fresh loans for IL&FS look tough. SBI Caps has been retained for monetizing some assets of subsidiary ITNL, but that’s for the longer term. Immediately, a resolution plan is needed between the shareholders, board, management and creditors of IL&FS to restructure loans, lengthen maturities and settle shorter term paper at a haircut.

The sooner the announcement of a final resolution plan is announced, the better though the track record of bankers agreeing to haircuts has been discouraging so far.

Thirdly, for the near term, it may be tough to see mutual funds agreeing to refinance some of the NBFCs. So while most of these NBFCs may have enough liquidity to redeem their maturing CPs, they may not get new money or get it only at higher rates.

So the growth of these NBFCs will likely be marked down and hence price-to-book value  will be marked down from the3 times to 5 times book to a drastic 1 time before investors start bottom fishing. But that is a problem of lower share prices, not a disaster.

A financial stability problem may arise if all corporate investors rush to their debt funds and seek redemptions. One should know that by the first half of Monday.If that were to happen, debt fund CIOs need to aggressively write down the price of their securities. One hears that some funds have already written down their IL&FS paper by 50% or more. But not all have. Much less is known about valuation of other corporate debt securities.

If there is a rush of redemptions, the lender of the last resort can always provide a line of credit. SEBI’s mutual funds ED is the experienced Mr Mahalingam, who has seen the Lehman crisis from the RBI end in 2008. The line of credit provided by RBI at that time was never used, but its very announcement cooled the debt market.

IL&FS has been called India’s Lehman, but it may be more India’s Fannie Mae what with its public sector shareholders. The fact is IL&FS has always behaved like a private company in terms of recruitment , pay scales and decision making but as a public sector when it comes to rating of its bonds. Most pension funds in the country would be holding IL&FS bonds, though not shares of  Reliance and TCS. The pain of haircuts is therefore going to be borne by a broad mass of investors and savers.

If the NPAs at PSU banks have been blamed on politicians, the losses at IL&FS have to be pinned on the professionals who ran the company. RBI, as the NBFC regulator, needs to order a forensic audit of the company and all its subsidiaries to check for malfeasance and/or conflict.

If yet again depositors at public sector banks and policy holders at LIC and pensioners in various companies have to provide the cash  and take the haircuts, the professionals who ran IL&FS should also be cross examined and  penalized if found guilty.