 Hello and welcome to Newsclick. I am Paranjoy Guha Thakurtha and with me in the studio I have Hemindra Hazari. He's an independent analyst of India's banking sector. He's worked in banks himself. He takes a critical look at the working of the country's financial sector in particular private banks in this country. He writes for websites like Smart Karma which is based in Singapore, the wire and other outlets. In the first conversation that I had with him we discussed the entire episode concerning Mrs. Chanda Kocher, ICICI bag, Arun Jaitley's comments on the investigations of the Central Bureau of Investigation. We are now going to discuss the latest developments in the ILNFS story that is the meltdown of the infrastructure, leasing and financial services group of companies which has led to turmoil in India's financial markets. Mr. Hazari, if I can ask you to summarize what happened in the ILNFS which many people were deluded into believing it was a government supported, a government, even a public sector company but we all know now it was a privately owned non-banking financial company. How would you summarize the most important developments and its impact over the last few months? I think overall it tells me it's the failure of privatizing of infrastructure. I think infrastructure development in private sector hands is enormous risk and therefore I think an ILNFS's collapse is an outstanding example of what happens when you try to privatize infrastructure and the dangers to the system that it poses. In the case of ILNFS what has happened is that the kind of private funding they did for private sector infrastructure projects for a variety of reasons you know were a failure. In the sense that either the projects did not take off because of the promoters or founders incompetence or because of the economic slowdown they didn't want to take on the additional risk or for various other reasons of not getting environmental laws passed for the you know certain power purchase agreements or the procurement of raw material, a combination of all these factors led to these private sector infrastructure projects not taking off and therefore the financing of it also ultimately got into trouble. Right, so ILNFS has been engaged in infrastructure projects, a major infrastructure projects. India's longest tunnel, Chenani Nashri tunnel, April 2017 it was open. Now many many other major projects, the gift city, the Gujarat international fintech city, dozens of projects and very very important infrastructure projects. But how do you react to this company which was formed in 1987 by three financial institutions namely the central bank of India, HDFC, the housing development finance corporation and the unit trust of India. Okay, two public sector organizations, one private to provide finance and loans for major infrastructure projects and then other international players came in Mitsubishi through Orix Corporation Japan, Abu Dhabi investment authority and subsequently the life insurance corporation etc etc etc. Now its major shareholders today include the LIC, the life insurance corporation, Orix, Abu Dhabi investment authority and there are small bank shareholdings by banks, state bank included. How do you react to the way this group was structured? I mean it's truly amazing, it had 256 group companies as of 2018 include subsidiaries, joint venture companies, associated entities and on the surface it appeared it had only 23 direct subsidiaries, 141 indirect subsidiaries including what are called special purpose vehicles for different projects, six joint ventures, four associated companies and each of them are further subdivided into additional legal entities with cross holdings, cross ownership. Why did they choose such a complex pattern of ownership? See one was there, I think they were financing a lot of projects and they wanted to keep each in a separate vehicle but nevertheless as an analyst and even as a regulator the more and more subsidiaries you see associate company especially for a financial intermediary immediately it should raise warning signals because lot of these make the entire structure very complex and more importantly it makes it extremely opaque and anything that is opaque especially in the financial system should be immediately investigated because normally such opacity hides a lot of activities which may not make economic sense. Now what we saw is that from July to September two of ILNFS's major subsidiaries reported difficulties in repaying loans and inter-corporate deposits to banks other lenders and the Reserve Bank of India requested major shareholders to kind of rescue this operation and then the founder Mr. Ravi Parthasarthi would be leaving the firm for medical reasons, he had headed the firm for 30 years and then more and more of these reports started coming out. Money life India said in September 2018 that one of its subsidiaries had was unable to repay a thousand crore short-term loan taken from the small industries development bank of India Sid B and then more and more reports started coming out and this whole mess started playing out. Today we find all kinds of companies including the Z Group headed by Subhash Chandra seems to have got embroiled and there have been sort of collateral damage hit by the scandal in ILNFS. Can you explain what happened and how it happened? See essentially this problem could have been detected much earlier but for some strange reason nobody seemed to be bothering to do any basic financial analysis because if you just looked at the publicly available annual reports you could make out that this company five years ago when consolidated accounts was first introduced to be disclosed and if you calculated the equity plus reserves of this firm you would have noticed that would have been negative because this company has got huge intangibles which as per Reserve Bank of India norms has to be written off against your equity. Now someone had just done this very basic calculation you would have concluded that ILFS is an insolvent company it's got a negative net worth and therefore no one should have been lending any funds to this company but what we noticed is that from five years ago till now they kept coming to the market banks kept giving them monies and they were rolling over their loans and more importantly the credit rating agencies continued to give it a triple A rating until the first default happened which was reported in early September. So very basic financial analysis was not done by credit rating agencies was not done by banks and other financial intermediary even mutual funds who were lending funds to the ILFS group. So consequently we see that ripple effect once that first default happens it spreads across the system am I correct? No that's correct because once the first default becomes public no one will lend any more funds to that entity and that's when the whole you know house of cards collapses. And this becomes what is called a systemically important financial institution it's a the crisis within that institution leads to a the crisis spreading across the entire non-banking financial center. No very correct and that's why one would have thought that it's a basic financial analysis should have been done on such an important institution but there was a total gross failure by everybody here. Now one minute here the serious fraud investigation of affairs the securities and exchange board of India now a lot of investigations are going on into what I talked you know procedural lapses maybe illegal acts so you believe it's kind of too too late is it too little too late? Now it's too late because the whole is massive you see earlier once this problem came about the LIC chairman made a statement that you know LIC will step in but I think now seeing the enormity of the losses you know LIC you know is cautious about putting more funds into this company because you know we are looking at a huge liability here which I don't think any institution now can bail it out. And this is not going to disappear in a hurry this problem? No because it's got 100,000 crores of outstanding liabilities. One lakh crores? Exactly so that's the hit that everyone who's got exposure is going to take. If you were to apportion responsibility and blame who would you apportion the responsibility most to? The central bank the reserve bank of India under which is supposed to be the regulatory authority. If first and foremost the responsibilities of the board of directors they're directly accountable. What about the major shareholders or very marky names who not only were major shareholders but they had their normally directors on the company's board? What were they doing all these years? Could they not see that this company was insolvent? Could they not see that the company's consolidated position was you know the losses were mounting? Could they not see that the risk management committee which is an extremely important subcommittee of the board in a financial company had not met in the last three years? I mean these risk management committee of the board meets about three to four times a year normally. So this after the board of directors of important companies in the group its subsidiaries etc and associates who next you would say if you have to apportion blame and responsibility who would come after that? Would it be the reserve bank of India? Because the reserve bank of India in any financial highly leveraged entity it's the regulator who really protects the largest stakeholders because when the debt to equity is more than one is to one the debt holders have a greater stake in the company than the equity shareholders and by law it's the reserve bank of India which protects the interests. The reserve bank of India woke up extremely late. I see. Tell me you think the government of India did the right thing on the 1st of October 2018 when it took steps to prevent this you know what should I say to spread to try and check the collateral damage the fallout of the meltdown of IL and FS and what did it do? The old board was removed a new board was constituted as because the old board was supposed to have failed to discharge its fiduciary duties and the new board comprises the Kotak Mahindra Bank managing director Mr. Uday Kotak a former office of the Indian administrative service and the head of Tech Mahindra which took over bailed out Satyam group Vinit Nayar the former head of the securities and exchange board of India Mr. G. N. Bachpai the former head of the ICICI bank Mr. G. C. Chaturvedi besides other former civil servants and IAS officers like Ms. Malini Shankar Nand Kishore etc. Do you think this was the right thing to do? I think most definitely the board had to be superseded because they had very clearly failed there'd be you know complicity or ignorance whatever they were not fit to be directors either in ILFS or any other company so I think the government did the right thing however the constituents of the board I would have liked to I would have preferred to see more banking experts more infrastructure than retired civil servants exactly so this appears to be you know these retired civil servants seems to park themselves everywhere in our system you know now that you mention it if you look at a large number of these companies in the ILFS group its subsidiaries is associate companies etc there were also civil servants there were serving civil servants who were involved in projects in their state or retired civil servants this seemed to have been a very very conscious strategy on the company founded by Mr. Ravi Parthasarthi and his colleagues to closely link civil servants career bureaucrats in the working of the whole system because their logic is after all these are infrastructure projects where government bodies central government state government bodies are going to be executing or are executing that is correct when you're doing infrastructure projects in an emerging economy like India then naturally you'd be working very closely with the government but having said that I think it was done as a conscious strategy to make the entire company appear like a sovereign and that's how many people perceived it to be and therefore nobody bothered to do any financial analysis of ILFS because they all believe that it was sovereign risk okay now if I can just ask you to summarize and this is my last question to you since there are major infrastructure projects which are at different stages of inclusion by the ILFS and it's not just the the one I mentioned about the the largest tunnel uh the in in in Jammu and Kashmir but when you look at the major major projects there in areas like highways urban development electronic governance healthcare power projects ports water projects waste management urban projects education projects you name it tourism infrastructure etc etc what should the government do to ensure that the new board of directors of the ILFS group to ensure that these projects which are of great importance to the country that these projects and the execution take place in a relatively smooth and unhindered manner see the only way possible is for a huge bailout that means the government and the exchequer have to bail it out but I suspect that the hole is so big and too vast that they've not even come out about the exact size or what the accumulated losses are so this new board for all the names that you mentioned has really not been very successful since they've taken over because still today we don't know what the exact losses are this is the losses of FY 2018 where the accounts also now may be suspect and there's no way because now no one is going to fund any ILFS entity because no one is sure so it requires if you think that these projects are for national importance for India's economic development then the state has to come in but then there's going to be a huge bailout which will have an impact on your fiscal deficit and that's the whole you know that's where the original sin starts because so people were worrying about the fiscal deficit you decide to privatize infrastructure so the state doesn't have to invest and we've all seen this what's happened today all your private sector many of your private sector power projects are not taking off ILFS which was the private finance of a private sector infrastructure has been a colossal failure and all because you had this notion that you cannot increase fiscal deficit and the private sector is the best entity to do such projects so you think this there's been this fetish this kind of ideological rigidity which has brought us to these kinds of terrible situations well most definitely yes I think there is this prevailing ideology today that all your cures can be solved if you privatize nobody realizes today that your entire banks npm s is because of private sector assets going bad everyone blames public sector banks for lending money but no one blames the private sector entrepreneurs who took such high risk in setting up and where they could not execute those projects well thank you so much Hemendra for giving us your views in the first episode we discussed the ICICI bank and Mrs. Kocha and her husband that entire unseemly episode in this episode we've discussed the ILFS scandal and in the next episode let's have a look at the Kotak Mahindra Bank and the tussle it is having with the Reserve Bank of India and thereafter in subsequent episodes we could look at the yes bank and look at access bank so we'll take we'll conclude our discussion at this juncture you've just heard and watched independent analyst of India's banking sector Hemendra Hazari discussing the circumstances and the reasons and the factors responsible for the kind of financial crises and scandals that we've been happy happening in the next episode we're going to look at Kotak Mahindra Bank and its tussle with the Reserve Bank of India so keep watching news click and thank you very much for being with us on this program