Madhuchanda DeyMoneycontrol Research
The default at IL&FS group was threatening to turn into a full-blown financial crisis because of its Rs 91,000 crore debt obligation. Bonds issued by the group, rated highly prior to the default, is widely owned in the financial system. The prompt takeover of the beleaguered company at the government’s instructions calmed financial markets and IL&FS exposure, therefore, remain a standard asset in the books of most banks.
Creditors of IL&FS were hoping that an emergency line of credit would put an end to the default. The longer term plan was to monetise assets of the IL&FS group.
Going by media reports, it appears that IL&FS hasn’t succeeded in raising money from its right issue and the board might seek a bail out from the government.
An overt bailout will open a Pandora ’s Box since a large section of the financial system is already grappling with huge problems.
The woes of public sector banks are well known. Eleven out of the country’s twenty one public sector banks are under RBI’s prompt and corrective action (PCA) and of the remaining, only a handful can survive unless they get adequate capital.
So far, there are no signs of any largesse from the government. As a last ditch attempt to keep IDBI Bank running, LIC has been nudged into hiking its stake in the bank. Bank of Baroda has been given a carrot of a well-run Vijaya Bank and a stick of a Dena Bank that is under PCA, in the first mega merger proposal post the NPA crisis.
The total gross NPA of the banking system has crossed Rs 10 lakh crore and there is more to come. Given that RBI guidelines make it near impossible to hide non- performing assets, the little over Rs 2 lakh crore capitalisation on offer from the government is grossly inadequate for PSU banks. Government being their owners, these entities are expecting that they will get a helping hand at some point.
IL&FS, on the other hand, was a private entity. Being a ‘professionally managed’ unlisted company, it had so far functioned like any other private sector financial institution with similar perks and privileges. Hence, it is not a government owned entity that got to be salvaged by the sovereign, in fact, should that happen, the risk of moral hazard is high.
Having said that, it is important to stop the contagion and restore confidence in the financial system. So it is a tough choice for the government.
Can it again ask the principal shareholder which is a government entity (LIC with 25.3% stake) to put that emergency funding? Or should it expeditiously clear the receivables (claims) of IL&FS in order to provide that liquidity? Reports suggest that around Rs 16,000 crore of group liquidity is stuck in claims and termination payments.
The indirect bail out should be limited to preventing a cascading effect of the IL&FS collapse, just as Lehman Brothers was allowed to collapse but the system was rescued through the troubled asset relief programme.
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