The downfall of IL&FS happened because of a failure of good governance, because the warning signs were not recognized, and there was a cover up instead of remedy. But the larger danger is that it is threatening to have other repercussions, especially to investor confidence in the Indian financial markets
There is a popular saying, ‘Prevention is better than cure’. This is true not only for our physical health, but for all walks of life. Prevention against the ills of the country comes from good governance provided by the government. Similarly, corporate governance of a high standard prevents sickness in companies. Healthy and expanding companies are not only good for their shareholders but they also constitute an integral part of the rising national economy and thus of the financial well-being of the country.
Some recent happenings related to corporate misgovernance have been seen as the cause for the fall of Infrastructure Leasing and Financial Services (IL&FS), which has been one of our biggest shadow banks. Shadow banks or non-banking finance companies (NBFCs) are strong complements of our banking system. They advance loans to most of our infrastructure ventures, both inside and outside the country, as loans for infrastructure sector are for longer duration which banks do not finance. The borrowings from banks from depositors are for short duration and hence they advance with short durations in mind.
Corporate governance of our public sector banks came under question when non-performing- assets (NPA) rose to mammoth proportions, which stand at Rs.11 lakh crore today. Our biggest private sector bank ICICI has come under the investigative lens for the alleged conflict of interest of its top executive leading to her resignation. The IL&FS happenings have been a major cause for the current meltdown in the stock exchange, besides the other reasons of the falling rupee and rising oil price. The fall of IL&FS has rung the alarm bells for mutual funds too, as it has been closely connected with many mutual funds. The government has initiated steps to see that the fall of IL&FS does not ruin our economic health.
IL&FS was founded in 1987. Initially, it was promoted by the Central Bank of India (CBI), Housing Development Finance Corporation(HDFC) and Unit Trust of India (UTI). Over the years, it broad based its shareholders by inducting Life Insurance Corporation (LIC), State Bank of India (SBI), Orix Corporation of Japan and Abu Dhabi Investment Authority (ADIA). As on today, LIC is the single largest shareholder in the company. The central mandate of IL&FS has been catalyzing the development of innovative world class infrastructure in the country, while also undertaking world class civil contracts outside the country. This company has been widely acknowledged as the pioneer of Public-Private Partnership (PPP). The company developed marquee roads, townships and water treatment projects.
The company has a very complex structure with 348 entities with more than 200 subsidiaries. The company was, till recently, rated as a blue chip company with a ‘AAA’ rating until August 2018. Its internal sickness was suddenly discovered in September 2018, when it became apparent that the company was failing in its debt-servicing. The company was seen to be under a debt pile of Rs.91,000 crores which was too heavy to pay-even the interest thereon.
The top executives and directors of the company started resigning for personal reasons when these top people had been receiving sizeable emoluments compared to the market rate. The directors and auditors always portrayed a rosy picture about the company to cheat shareholders, public and the government. Dividends were being paid out of borrowings, as there was no profit to pay dividends. There was a liquidity crisis in the company.
The government took an immediate step by approaching the National Company Law Tribunal(NCLT), taking its approval to suspend the board of directors and appointing a new board composed of government selected members headed by leading banker Uday Kotak. This sudden action was taken when the suspended board was in the midst of restructuring its asset and liability profile. The government considered it as a sham exercise to further dupe the share holdersand the people by disguising the affairs of the company.
It is believed that the government contended in its application before the NCLT that IL&FS is a ‘Titanic ship’ and that the board of the company was responsible for the negligence, incompetence and for putting a veil on the actual state of the company with the intent to mislead the people. The management not only failed, but was involved in operation cover-up as has been alleged in the stand of the government before the NCLT. Public money was managed in an unscrupulous manner. The Serious Fraud Investigation Office (SFIO) too has been asked to probe the transactions of the company. Senior executives, including those who resigned are under the scanner and investigation. Normally, the government does not do what it has initiated against IL&FS, and the last it did so was in 2009 when the board of Satyam Computer Services was superseded on the allegation of total collapse of corporate governance and fraud perpetrated by the directors and auditors.
"The IL&FS happenings have been a major cause for the current meltdown in the stock exchange, besides the other reasons of the falling rupee and rising oil price. The fall of IL&FS has rung the alarm bells for mutual funds too, as it has been closely connected with many mutual funds"
The problem with IL&FS has come at the most inopportune time when our rupee is continuously falling and oil price is constantly rising. It may seriously affect the credibility of our NBFCs and our debt market. Already, it is seen that DSP Mutual Fund as sold the non-convertible debentures of Dewan Housing Finance Company Ltd at a discount. As on today the loan book of NBFCs is at Rs.22 lakh crore and if the problem of IL&FS is left uncontrolled then it will have a catastrophic effect on this sector.
Respected foreign institutional investors have a stake in this ailing company and if they lose their money because of wilful corporate failure then t will have an adverse impact on future foreign investment in our financial schemes. On the top of all these issues is the fund of common citizens who have invested in mutual funds for more security and less volatility, and mutual fund money has gone into IL&FS and similar other NBFCs. These serious issues have forced the government to push the panic button by suspending the board and having a board of some distinguished professionals. The government fears that continued problems may trigger a debt market sell-off and mutual funds may start selling government securities. The arising liquidity crunch can further add to more fall in the stock market.
What needs to be done to abate the problem? The government, and more particularly the RBI, have to come out with strict regulatory measures for the safety of NBFCs. There should be constant monitoring of the functioning of these companies. Auditors should be taken to task by the newly constituted National Financial Regulatory Authority (NAFRA). The first task of the new board of IL&FS will be to seek timely payment to its creditors and doing its debt-servicing effectively. The assets of the company have to be sold quickly in a transparent manner, but at the best possible price so as to generate funds to pay off the loan. There will be no fund infusion by the government or even by the owners as announced at the moment. While saving the company, the new board has also to endeavor to see that its projects for infrastructure development of the country are not impaired. Recently, a life line project for Ladakh region for constructing a tunnel at Zoji La had been undertaken by IL&FS which may be the longest two-way tunnel in Asia, and the same should be completed while fighting for the financial health of the company.
IL&FS presents the latest example of the lack of corporate governance or mis-governance. Corporate governance comprises the mechanism, process and relations by which corporations are controlled and directed. Good corporate governance nurtures the health of the company and takes steps for the growth of the company while serving the interest of all the stake holders and also of the public and society at large, with corporate social responsibility
"Well managed companies work because of the passion of the management, and not due to any fear of regulatory authority or pecuniary interest"
On the contrary, corporate mis-governance stifles the growth of the company. Corporate misgovernance can happen due to many reasons such as greed and personal interest of the management, negligence and lazy approach, non-experience, lack of passion, etc. The reasons can be any, but it is the company which becomes the victim along with the shareholders, people and ultimately the country. The probe will find out the circumstances behind the mis-governance of IL&FS. Satyam Computers was hurt by the greed and fraud of the management and lack of interest of the auditors in doing proper audit. Public sector banks suffered due to the twin reasons of corruption and due diligence by the concerned executives while giving loan. Conflict of interest also plays a major role with top management while not looking for the interest of the companies they manage. Sometimes, even a good management falls in the vicious trap of mis-management when the company is not run ethically. If a company wants to rise by giving bribes, then the automatic side-effect is fudging the accounts to generate cash for bribe. The fudged book account of a company is one major symptom of corporate mis-governance in which auditors become team members with the top management. Rosy pictures are created in the fudged accounts when the real situation is otherwise.
Multi-national Enron is a classic case of a company getting bankrupt due to fraudulent activities and giving bribes to secure international contracts. Along with Enron, even their auditor firm Arthur Anderson which was a leading audit company died its natural death for being complicit with the management of that company. In our country too, the leading audit firm Price Waterhouse Coopers suffered due to being a silent partner with the management of Satyam Computers.
Corporate governance will prosper if the top management takes pride in nurturing the companies headed by them. To illustrate this point I cite the example of late Sri Sumant Moolgaokar who headed Telco (now Tata Motors). He used to say that while entering the Telco factory in Pune, he stood still at the factory gate for some time as he used to feel proud seeing the factory he had given birth to. For late Sumant Moolgaokar his creation was like his child. This is the satisfaction the management should have, and not what money they get from the company. It is a natural by-product that the salary of the management will grow with the growing company. The scenario should not be otherwise.
Well managed companies work because of the passion of the management, and not due to any fear of regulatory authority or pecuniary interest.
by S K Jha
