Lessons from the IL&FS Debacle

Author : Riya Abraham – 5th year Law Student, Alliance School of Law

The economic crisis in America in 2008 shook the economy of many countries. It had a catastrophic effect on the investment of many countries due to the tripling down effect. Indian financial markets  exactly a decade after the Lehman Brothers is under the same pressure due to the default of the shadow bank Infrastructure Leasing and Financial Company (“IL&FS“). The three-decade-old infrastructure lending giant, IL&FS, is a ‘shadow bank’ or a non-banking financial company that provides services similar to traditional commercial banks. IL&FS is a major infrastructure finance and construction company running since three decades. The company faced a cash crunch when it defaulted on a short-term loan from SIDBI in 2018. The defaults didn’t stop there, there were a series of defaults that led to a major dip in its credit ratings. The IL&FS funds long-term projects, of over 10 years, but its borrowings are of a lesser duration, which widens the asset liability  gap.

IL & FS was incorporated in 1987 and initially promoted by the Central Bank of India, Housing Development Finance Corporation Limited (“HDFC“) and Unit Trust of India (“UTI“), it has a complex structure with 169 subsidiaries. The major shareholders of IL&FS include state-backed Life Insurance Corp of India holding, 25.3 per cent stake, Housing Development Finance Corporation with 9.02 per cent, Central Bank of India with 7.67 per cent and State Bank of India with 6.42 percent. [1]Over the years, its shareholding has crossed borders and it inducted institutional shareholders, including the SBI, the LIC, ORIX Corporation of Japan, and Abu Dhabi Investment Authority. Currently, the group is reeling under a huge outstanding debt of Rs 91,000 crore and planning to sell assets to raise funds.

The IL&FS default rattled investors of non-banking finance companies, particularly housing finance companies. Banks and mutual funds are main sources of funding for housing finance companies and other non-banking finance companies. While banks contribute 40% of the funding, mutual funds contribute 30%. Market estimates suggest mutual funds have around ₹2,000 crore exposure to IL&FS. The investors have lost confidence due to this debacle. Though the government has decided to chip in and help IL&FS recover, this would affect the already increasing fiscal deficit which has adverse repercussion on the Indian economy.

Legal aspect of the issue

The IL & FS default has exposed the huge gap in the bankruptcy law in our country. The Insolvency and Bankruptcy Code (“IBC“) is one of the routes for debt recovery. The IBC was engaged with the bankruptcy laws relating to companies, partnerships as well as individuals but it excludes financial service providers like banks, insurance companies, stock exchanges, and non-banking financial companies[2]. The Central Government under section 227 of the IBC has the power to formulate rules and notify a financial service provider, on an ad-hoc basis , to be referred for resolution of insolvency under the IBC, this has not happened so far. However, the subsidiaries of IL&FS which are not financial service providers can avail of the mechanism provided under the IBC on an individual basis. IL&FS has several  subsidiaries and therefore  it wasn’t easy to adopt the IBC route because of the conglomerate group companies.

Special purpose vehicles (“SPVs“) of IL&FS were generally sheltered from the credit risks of the sponsor or the ultimate parent company, they are supposed to be independent from their parent company but now they have been exposed to unfamiliar default risks.[3] CRISIL downgraded the bonds issued by one of IL&FS’ SPVs, Jharkhand Road Projects Implementation Company[4] (“JRPICL“) to junk status, as it defaulted on its payment due. The actions of IL&FS’ SPV raises concerns on the sanctity of the reserved SPVs and the payment waterfall structure. This default can affect the long-term financing of the infrastructure sector  as financing good operational assets would become extremely challenging. In a court of law, the SPV model should hold and its fortune should be separate from holding company, if this is not the case, it raises question on the SPV model itself.

 Remedial action

Like they say, there is a silver lining to every crisis, the IL& FS fiasco has taught us much about the vulnerability of our financial laws and regulations. Lessons learnt from the Satyam, PNB scam or even the Sahara scam did not go unnoticed, it led to stricter laws to stall a re-occurrence. Similar lessons can be learnt from the IL&FS crisis as well. The immediate response to such a crisis would be to introduce stringent governance norms and their effective implementation, however there is more to do this time to regulate  financial governance in our country. Firstly, the government along with the resolution committee should work towards simplifying the complex structure of IL&FS. Secondly, the government should make stringent laws to deal with lack of transparency in both companies structure and finances as well as credit rating agencies. There is a need to review the role of credit rating agencies as they continued to rate IL&FS at a top notch investment grade even a day before it defaulted on its payment obligation, IL &FS was rated a AAA before coming down eight notches in a day. [5]The SEBI has in fact started proceedings against the credit rating agencies that failed to warn investors in time about the deteriorating credit profile of IL&FS. Rating agencies need to have better market intelligence and surveillance rather than depending upon historical data and some structure based on past estimates.[6] They need to consider changes on the ground like change of leadership, cash flow management and market environment.[7] One of the suggestions given by a local rating company is that the regulators should consider mandatory rotation of the rating agency of an issuer just like the rotation of auditors this will break the concern that a very long association between  the issuer and the rating agency may allow scope for complacency. [8] In light of the recent circumstances, SEBI has instructed all the credit rating agencies to publish details about the historical average rating transition rates across various rating categories. This guideline would enable investors to make more informed decisions by comparing different ratings.

Thirdly, the Board of directors and more importantly the independent directors should be held  accountable for such major defaults and should be brought under regular audit mechanism. The Board of directors are generally not held liable for not working efficiently. In the instant case, the government in light of the default sacked all the 14 directors of IL&FS and appointed a new Board under the chairmanship of Mr. Uday Kotak.

Fourthly, the important task of auditing should be done by an independent third party auditor appointed by the government in consultation with RBI and major shareholders. This would bring about transparency in the  auditing of financial records. Fifthly, NBFCs have to be regulated efficiently. The IL&FS crisis points to the evident gap in the regulation of NBFC as well as lack of data and interaction. India has 10,000 active NBFCs that are regulated by the Reserve Bank of India (“RBI“), of which some 275 are systemically important (“SI“).[9]  The RBI in its February 2019 policy has announced measures in order to ensure flexible credit facility to well-rated NBFC. According to this policy a bank gets to decide on loan to NBFCs depending upon their ratings.


According to a research by Nomura , shadow banks in India have amassed large balance sheets, pumping out 30 per cent of all the new credit in the economy over the past three years.[10] Housing-finance and NBFCs entered the financial market when state-run banks recoiled from lending money for infrastructure  project due to the increasing nonperforming assets. But unlike banks, shadow lenders didn’t have access to household deposits. So they became increasingly dependent on wholesale funding. The funding however depends entirely on the creditworthiness of the shadow banks. So if the RBI were to step in and lend to mutual funds against their holdings of CP and NCDs, it would essentially be accepting credit ratings as collateral.[11] The credit rating agencies in light of the IL&FS default cannot be trusted, for their rating can fall from AAA to a D in a short period of time.

Thus IL&FS default presents before us a classic case of financial irregularities. Credit rating agencies had the duty to ensure that they overlook over the financial health of the rating company. They were destined to enable the shareholders make wise choices regarding their investments. In the instant case, the credit rating agencies weren’t vigil and efficient in giving the warning signals of the increasing debt. Therefore, we need to adopt the remedial measures and have an effective system in place to prevent another financial debacle like the IL&FS.

[1] ETOnline, ‘ IL&FS: The crisis that has India in panic mode’( The Economic Times, 3 October 2018) <

[2] Section 2 of the Insolvency and Bankruptcy Code, 2016

[3] Prashant Mahesh, ‘ Two mutual funds mark down IL&FS SPV debt’( Economic Times, 23 January 2019) < https://economictimes.indiatimes.com/mf/mf-news/two-mutual-funds-mark-down-ilfs-spv-debt/articleshow/67651382.cms>

[4] Jharkhand Road Projects Implementation Company (JRPICL), the IL & FS promoted road project is the special purpose vehicle.

[5] Jayashree Upadhay, ‘Sebi moves against 3 rating agencies over IL&FS crisis’( LiveMint, 13 December 2018)< https://www.livemint.com/Money/2COset9mxPdob9zsreS1mO/Sebi-moves-against-3-rating-agencies-over-ILFS-crisis.html>

[6] Anurag Joshi, ‘ How credit ratig agencies work ‘ ( LiveMint, 28 September 2018) <https://www.livemint.com/Companies/kDBrz7DB4Ti4Pz2TdxG85N/How-credit-rating-agencies-missed-the-ILFS-crisis.html >

[7] Ibid.

[8] Ibid.

[9] Narayanan Ramachandran, ‘The case for a unified supervision regime for NBFCs’( LiveMint, 3 February 2019) < https://www.livemint.com/opinion/columns/opinion-the-case-for-a-unified-supervision-regime-for-nbfcs-1549212321254.html>

[10] Andy Mukerjee, ‘India’s shadow-bank bust has a Lehman echo’ ( Economic Times, 3 September 2018) <


[11] Andy Mukerjee, ‘Lesson from IL&FS crisis: Indian finance firms need to hold assets that can be collateral’(The Print, 8 December 2019) <https://theprint.in/opinion/lesson-from-ilfs-crisis-indian-finance-firms-need-to-hold-assets-that-can-be-collateral/129293/ > accessed on 19 April 2019

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