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IL&FS Fallout: Is it a Business Failure or Corporate Governance

Failure?

Chapter · January 2020

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Case

The Failure of Corporate Governance South Asian Journal of

Business and Management Cases
at Infrastructure Leasing and 1–14
© 2021 Birla Institute of Management Technology
Financial Services Limited: Reprints and permissions:
[Link]/journals-permissions-india
Lessons Learnt DOI: 10.1177/2277977921991897
[Link]/home/bmc

Gagan Kukreja1, Sanjay Gupta2 and

Meena Bhatia3

Abstract
This case study investigates multiple issues related to corporate governance, regulations, auditing and
financial reporting of Infrastructure Leasing and Financial Services Limited (IL&FS). Combinations of
these issues resulted in default in payment obligations by IL&FS in August 2018 originated from the
agency problem. It posed a substantial systematic risk to the whole financial system of India. This case
study highlights the severe drawback of concentration of decision-making and unprofessional work
ethics at the senior management level. Further, the case study also provides the opportunity to discuss
the inappropriate regulations and governance practices which cause a severe problem in long-standing
and prominent organizations like IL&FS.
Research Questions: (a) Discuss the vital role of corporate governance in major corporations and
the reasons behind governance failures. (b) How did asset–liability mismatch create liquidity problems
in a company which deals with long-term projects? (c) How does lack of a proper and unified regulatory
framework for Non-Banking Financial Corporation (NBFC) harm investors’ interest?
Link to Theory: This case study provides an opportunity to learn the role of corporate governance
in NBFC. This case demonstrates the problems arisen because of agency problem and conflict of inter-
est among real-world stakeholders. The case study also highlights the importance of assets–liabilities
management in a strategically important organization like IL&FS.
Phenomenon Studied: This case study attempts to understand the potential problems that occurred
in IL&FS from the failure of good governance, lack of unified regulations for NBFCs and non-adherence
of professional responsibilities by the external auditors.

Disclaimer: This case is a revised and enlarged version of the original case titled ‘IL&FS Fallout: Is it business model failure or
corporate governance failure?’, presented at International Conference of Management Cases 2019, organized by Birla Institute of
Management Technology, Greater Noida, India, 5 and 6 December 2019.

1
Ahlia University, Manama, Bahrain.
2
Reserve Risk Control, Central Bank of Bahrain, Manama, Bahrain.
3
BIMTECH, Greater Noida, Uttar Pradesh, India.

Corresponding author:
Gagan Kukreja, Ahlia University, PO Box 10878, Manama, Kingdom of Bahrain.
E-mail: gkukreja@[Link]
2 South Asian Journal of Business and Management Cases

Case Context: The case study explores the vital role of the infrastructure development and financing
companies in developing economies like India and how it may affect other vital entities of the financial
system. Further, it demonstrates how unethical practices at senior management and lack of unified
regulations can harm the organization.
Findings: The research study found senior management’s potential involvement in unethical practices
while managing the company. The financial statements did not reflect the true and fair picture of the
entity, which misled investors and other stakeholders. It created chaos in the stock market, resulting
in a loss to shareholders. The government set up a new board to restore the confidence of the stock
market. Further, the government started to address the problems that arose.
Discussions: The case of IL&FS by default, at first glance, looks like a case of asset–liability mismatch
due to the lack of supervisory roles of the board and senior management’s massive regulatory failure.
It is shocking how under the nose of regulators like Reserve Bank of India (RBI), Securities and Exchange
Board of India (SEBI) and Ministry of Corporate Affairs (MCA) a default of this scale could take place.
How could IL&FS group grow unchecked into a massive 348 entity. It appeared that regulators, mar-
quee shareholders (banks and institutions), and the board of directors failed in their fiduciary obligation
to regulate and supervise IL&FS.

Keywords
Agency problem, corporate governance, asset–liability mismatch, the board of directors

Introduction
The trouble in Infrastructure Leasing & Financial Services Limited (IL&FS) started when IL&FS, a
group company, defaulted payment obligations of bank loans (including interest), long-term and short-
term deposits and the commercial paper due on 14 September 2018. On 15 September, the company
reported that it had received notices for delays and defaults in servicing some of the inter-corporate
deposits (Table 1). Consequent to defaults, rating agencies such as Investment Information and Credit
Rating Agency (ICRA) and other agencies downgraded the ratings of its short-term and long-term
borrowing instruments to BB from AA+. The defaults jeopardized hundreds of investors, banks, pension
funds and mutual funds associated with IL&FS, along with other non-banking financial companies
(NBFCs) for their investment safety and collectability. It resulted in a massive sell-off in shares of
NBFCs and their prices nosedived, resulting in redemption (repayment) pressure in mutual funds holding
such financial instruments and adversely impacted sentiments in the stock, money and debt markets. It
also created a considerable systematic risk, leading to good-quality debt papers being sold at steep
discounts to meet redemption demand.
The failure of corporate governance at IL&FS was the leading cause of the problem as per the
published available resources discussed in the following sections.
In response to such a crisis, the Government of India suspended the then board and reconstituted a
new board with eminent professionals to restore confidence among the market players. The government
asked various government departments to release funds to IL&FS to ease the liquidity problem of
IL&FS. Further, the government told National Company Law Tribunal (NCLT) that the collapse
of IL&FS may lead to a collapse of many mutual fund companies and pension funds and might adversely
impact the market players, stock market and economy.
Kukreja et al. 3

Table 1. IL&FS Timeline: When and What Happened from June 2018 till December 2019

Date News Item

June 2018 IL&FS group’s transport subsidiary IL&FS Transportation Networks (ITNL) delayed
repayment of USD 64 million of inter-corporate deposits from Small Industries
Development Bank of India (SIDBI). Rating companies ICRA and CARE rating agencies
downgraded ITNL’s debt papers/credit facilities citing weak financials. There was lots
of criticism of rating agencies being reactive, rather than proactive in the media and
investors community (Parmar, 2018).
21 July 2018 Group’s Founder and Chairman Ravi Parthasarathy steps down, citing health reasons.
Hemant Bhargava, LIC MD and nominee, takes charge as Non-Executive Chairman of
IL&FS group. (Parmar, 2018).
28 August 2018 Group’s financial arm IL&FS Financial Services defaults on repaying a few hundred billion
of rupees to its commercial-paper investors but pays the same two days later.
(Parmar, 2018).
Early September The group defaults on a USD 143 million term loan and its subsidiary defaults on dues
2018 worth USD 71 million owed to SIDBI. (Parmar, 2018).
August-end and ICRA, CARE and Brickwork Ratings downgraded the conglomerate’s various long- and
early-September short-term borrowing programmes worth over USD 1.7 billion to ‘default’ or ‘junk’
2018 grades. ICRA downgraded the group twice in a fortnight and removes all group entities
from its rating watch. Meanwhile, the RBI initiates a special audit. (Parmar, 2018).
12 September to 26 Several short-term loan defaults take place, totaling USD 63 million (bank loans: USD
September 2018 41 million, term deposits: USD 15 million and short-term deposit of USD 7 million).
(Parmar, 2018).
12 September 2018 In a letter to employees, IL&FS says USD 2.3 billion is stuck in claims and termination
payments with concession authorities and it had been planning on raising USD 6.4
billion through the issue of shares and USD 500 million as long-term debt from
shareholders. (Parmar, 2018).
15 September 2018 Former LIC Chairman SB Mathur takes over as IL&FS group Chairman. The company
started planning to monetize assets to pare its debt by up to USD 4.3 billion over the
next 18 months and identifies 25 projects for the same. (Parmar, 2018).
18 September 2018 Market regulator, Securities and Exchange Board of India (SEBI) started looking into the
IL&FS matter with regards to rating agencies and the impact on mutual funds. (Parmar, 2018).
21 September 2018 Fears of a debt market crisis, due to an IL&FS default prompts DSP Mutual fund to
sell commercial papers of Dewan Housing Finance (DHFL) which leads to a contagion
effect in equity markets, which crashed nearly 1,500 points. Ramesh C Bawa, MD and
CEO of IL&FS Financial Services resigns. (Parmar, 2018).
24 September 2018 IL&FS defaulted again and loses access to fund raising through commercial paper
market for up to six months from the date of repayment of this obligation. IL&FS
board seeks relief from NCLT to work out an arrangement with shareholders, creditors
and board of directors. SIDBI threatens to file a case at the NCLT for non-repayment.
(Parmar, 2018).
28 September 2018 Top shareholders meet RBI and raised concern on the crisis. (Parmar, 2018).
29 September 2018 At its Annual General Meeting (AGM), IL&FS decides to raise USD 643 million through
a rights issue and raises borrowing limit to USD 5 billion from USD 3.6 billion.
The company appoints Alvarez and Marsal as specialist agency to execute the debt
restructuring plan. (Parmar, 2018).
1 October 2018 NCLT judgement allowed government to assume control on the company and institute
a new board under the chairmanship of Uday Kotak and five other board members.
(Parmar, 2018).
(Table 1 continued)
4 South Asian Journal of Business and Management Cases

(Table 1 continued)
Date News Item
15 October 2018 NCLT passed an interim order granting a moratorium on all creditor actions against
IL&FS as well as all its group companies (Goel, 2018a).
22 October 2018 IL&FS new board appointed advisors for developing and executing a resolution plan
(Goel, 2018b).
21 February 2019 Enforcement Directorate (ED) registered a case of money laundering against the former
CMD of IL&FS Ravi Parthasarthy, former director Hari Sankaran, IL&FS Rail and IL&FS
Transportation Networks India Limited (ITNL) (Rajput, 2019).
4 March 2019 Audit firm Grant Thornton submitted its interim report on the special audit of IL&FS
flagging dealings aggregating to USD 1.9 billion as suspect (Business Standard, 2019a).
5 March 2019 New IL&FS board sent a show cause notice to the former Board of IL&FS Financial
Services Limited (IFIN) asking why the criminal action should not be initiated against
them (Rajput & Sinha, 2019).
23 April 2019 IL&FS agreed to sell its 874 megawatts (MW) operational wind energy portfolio to
state-run gas utility GAIL (India) Ltd for `4,800 crore, this ensures that debt of
`3700 crore on wind power Special Purpose Vehicles (SPVs) will be fully paid back.
23 April 2019 IL&FS agreed to sell its 874 megawatts (MW) operational wind energy portfolio to
state-run gas utility GAIL (India) Ltd for `4,800 crore, this ensures that debt of
`3700 crore on wind power SPVs will be fully paid back.
15 May 2019 Independent directors of various IL&FS companies are under the scanner of Ministry of
Corporate Affairs (MCA) for alleged lapses in carrying out their duties.
22 May 2019 The ED carries out raids is residences and offices of four directors of IL&FS, this was in
connection with money laundering probe.
30 May 2019 The Ministry of Corporate Affairs (MCA) and the new board at IL&FS are investigating
why questions raised by a junior analyst at a rating agency about financial irregularities
at the infrastructure financier were ignored by the top management at the
creditworthiness evaluator. The junior executive has allegedly told probe officials that
when he brought his concerns to the notice of the senior management at the rating
agency, the decision makers refused to act upon his findings, claiming the books of IL&FS
and related companies were good.
4 June 2019 The Supreme Court of India allowed reopening of IL&FS accounts for the last five
years. The move by the top court comes as a setback for Hari Sankaran, the former
IL&FS managing director, who had challenged an order by the National Company Law
Appellate Tribunal (NCLAT) to reopen the past books of the embattled infrastructure
lending company.
8 June 2019 It was reported that the Auditor, Deloitte and Haskins and Sells (DHS) was aware of
the company’s modus operandi of funding the defaulting borrowers for payment of
interest and principal in a fraudulent manner by IL&FS management time and again to
window dress the asset book of the company for several years. The auditor was thereby
complicit in nature with the management.
10 July 2019 Il&FS group starts monetizing its assets, put its 2,880 acres of non-contiguous land banks
spread across seven villages in the Kutch region of Gujarat for sale.
21 July 2019 Grant Thornton reported that the credit rating agencies gave top ratings to IL&FS group
entities despite being aware of the weak financials of the group, SEBI hence expanded its
probe into the role of credit rating agencies CRAs.
16 August 2019 Blatant mis-governance reported by RBI report. The RBI report said that some of
the key committees in IL&FS did not convene any meetings in last few years, the Risk
Management Committee (RMC) and the Investment Review Committee did not meet
for around three years.
Kukreja et al. 5

Date News Item

17 August 2019 The ED filed charge-sheet and attached assets worth Rs 570 crores under the
provisions of Prevention of Money Laundering Act (PMLA)
6 September 2019 India’s first fully privately financed Rapid Metro system, built by IL&FS is facing closure
due to the financial crisis.
21 November 2019 Gujarat Narmada Valley Fertilizers and Chemicals Limited (GNFC), in its annual report
mentioned that it might lose Rs 10.25 crores as it is holding secured and unsecured
debt securities of IL&FS.
5 December 2019 IL&FS reported a loss of Rs 22,527 crore for the year ended March 2019 as against
a profit of Rs 333.4 crore in March 2018. The company has incurred a loss (including
other comprehensive income) of Rs 22,527.25 crore for the year ended March 31, 2019,
and has net liabilities of Rs 16,935.1 crore, the company’s auditor SRBC & Co said.
13 December 2019 Audit quality review of Deloitte, Haskins and Sells by National Financial Reporting
Authority (NFRA) reported, ‘The AQR has disclosed that DHS (Deloitte) has failed
to comply with the requirement of the SAs (standards of auditing). The instances of
failure noticed are of such significance that it appears to NFRA that DHS did not have
adequate justification for issuing the audit report asserting that the audit was conducted
in accordance with the SAs’.
Source: The authors.

Overview of Infrastructure Leasing & Financial Services

Limited and Its Capital Structure
IL&FS is one of India’s leading infrastructure development and finance companies. Its central mandate
was to catalyse the development of innovative world-class infrastructure in the country. It is a Systemically
Important Non-Deposit Accepting Core Investment Company registered with Reserve Bank of India
(RBI) (Banking Regulator of India). IL&FS was initially promoted by India’s institutional investors such
as the Central Bank of India, Housing Development Finance Corporation Limited and Unit Trust of
India. Over the last 30 years, IL&FS has broadened its shareholding and inducted other institutional
investors such as the State Bank of India, Life Insurance Corporation of India, ORIX Corporation Japan
and Abu Dhabi Investment Authority (Table 2).
The sheer size of IL&FS can be gauged from the fact that it has 186 subsidiaries, 146 jointly controlled
entities, including 111 jointly controlled operations outside India and 20 associate entities as per its
annual report of 2017–2018. Its international presence includes offices in Singapore, Spain, London and
Dubai, and robust network partners in the USA, Tokyo, Philippines and Abu Dhabi. As per the audited
financials of the company as on 31 March 2018, the size of the total assets and borrowings was US$16.5
billion and US$13.6 billion, respectively.
The IL&FS group has two NBFCs, namely IL&FS and IL&FS Financial Services (IFIN); these two
firms held over 35% of the group debt. The business model is distinctive; it was both a financier and
developer and the group transactions are also intricate. IL&FS, the holding company, had equity investments
in its subsidiaries, and its financial arm IFIN lent money, apart from having an equity stake in these
subsidiaries. IL&FS depended heavily on external borrowings to fund its projects resulting in a high debt–
equity ratio (Table 3), and it became increasingly difficult for IL&FS to service its borrowing obligations.
Apart from high debt–equity ratio, the company had duration mismatch, and the duration gap was widening.
IL&FS carried a debt which was always at the higher end of the range of debt–equity ratio carried by other
companies in the same industry. However, in the year 2017–2018, IL&FS debt–equity ratio suddenly
6 South Asian Journal of Business and Management Cases

Table 2. IL&FS Ltd. Equity Shareholding Pattern as on 31 March 2017

S. No. Name of Shareholder Number Percentage

1 Life Insurance Corporation of India 32,541,123 25.34
2 ORIX Corporation, Japan 30,227,509 23.54
3 IL&FS Employee Welfare Trust 15,406,092 12.00
4 Abu Dhabi Investment Authority 16,129,252 12.56
5 Housing Development Finance Corporation Ltd 11,587,194 9.02
6 Central Bank of India 9,843,386 7.67
7 State Bank of India 8,237,967 6.42
8 UTI- Unit Linked Insurance Plan- UTI Asset 1,051,111 0.82
Management Co Ltd
9 India Discovery Fund 1,104,211 0.86
10 Others 2,275,431 1.77
Total 128,403,276 100.00
Source: IL&FS 2016–2017 Annual Report.

Table 3. Debt Equity Ratio of IL&FS and Its Competitors

Debt–equity ratio
Company 2017–2018 2016–2017 2015–2016 2014–2015 2013–2014
IL&FS 11.4 7.8 7.1 7.1 6.3
L&T Infrastructure Development 4.1 6.2 8.2 5.7 8.4
Projects Ltd.
Reliance Infrastructure Limited 2.8 2.8 1.6 1.6 1.5
IRB Infrastructure Developers 6.0 5.9 7.6 7.9 3.4
Limited
GMR Infrastructure Limited 5.7 4.2 7.8 5.9 5.0
Jaiprakash Associates Limited 7.6 10.2 4.6 4.6 6.0
Source: The authors.

spiked, demonstrating severe stress on the financial position of the company. High debt–equity ratio placed
severe pressure on IL&FS to generate that many revenues to continue to service its debt (Figure 1).
It can be noticed from Figure 2 that short-term borrowings in proportion to long-term borrowings
have been showing a rising trend, particularly over the last 3 years. Over the last 5 years, both kinds of
borrowing have been rising steadily. The fundamental nature of the financial services business is about
managing asset–liability mismatch. An asset–liability mismatch is inherent, but it needs to be monitored
and controlled by the top management.

Corporate Governance Practices

The Organisation for Economic Cooperation and Development (OECD) published its Principles of
Corporate Governance in the year 1999, which defined corporate governance, as follows:

A set of relationships between a company’s management, its board, its shareholders and other stakeholders.
Corporate governance also provides the structure through which the objectives of the company are set, and the
Kukreja et al. 7

Figure 1. Consolidated Borrowings, Assets, Revenues and Income of IL&FS.

Source: Annual Reports of IL&FS from 2013–2014 to 2017–2018.

Figure 2. Short-Term and Long-Term Borrowings of IL&FS.

Source: Annual Reports of IL&FS from 2013–2014 to 2017–2018.

means of attaining those objectives and monitoring performance are determined. Good corporate governance
should provide proper incentives for the board and management to pursue objectives that are in the interests
of the company and shareholders, and should facilitate effective monitoring, thereby encouraging firms to use
recourses more efficiently.

The theoretical foundations for corporate governance come from Berle and Means (1932) classic work,
which described the agency problem arising from the separation of ownership and control. Companies
8 South Asian Journal of Business and Management Cases

incur high agency costs as agents (managers) are driven by self-interest (Jensen & Meckling, 1976); the
governance discussions stress that managers must act in the interests of external stakeholders (Fama,
1980). Effective corporate governance mechanism is considered as a powerful approach in reducing
agency costs (Vishnani & Bhatia, 2019)

Top Management at Infrastructure Leasing & Financial Services Limited

IL&FS was led by one man, Ravi Parthasarathy, and his chosen cabal, for 30 years. The Serious Fraud
Investigation Office (SFIO) has charged the erstwhile top management members of the group’s financial
services subsidiary IFIN of forming a ‘coterie’ with its auditors and independent directors. SFIO has
gathered enough evidence to show gross failure in corporate governance, several conflicts of interest,
and even undue personal enrichment of some key personnel who were running IL&FS (Business
Standard, 2019b). The charges against some of the former directors include masking the actual state of
the group’s financial stress, suppression, misrepresentation of critical facts, siphoning off funds via
excessive executive package and gross financial mismanagement.
The new board appointed by the Government of India ordered an extensive special audit of crisis-hit
IL&FS group which was conducted by Grant Thornton (GT). The audit identified numerous financial
irregularities in deals with financial implications of over US$1.9 billion. The audit firm noted
10 anomalies, including conflict of interest, inadequate risk assessment, deviations from banking norms
and loans sanctioned at a negative spread. More than 50% of these transactions studied by the audit firm
relate to IFIN, a 100% subsidiary of IL&FS. The audit report has identified at least 29 instances where
loans disbursed to borrowers appeared to have been used by their group companies to repay the existing
debt obligations with IFIN. IL&FS, and its direct subsidiaries—IL&FS Financial Services and IL&FS
Transport Networks—borrowed short-term funds from the market and banks, based on window-dressed
financials and high credit ratings. They lent the money for the long term at high interest rates to its
project subsidiaries and group companies, which in turn used these funds to pay interest on loans taken
in the past from the same set of lenders. That made the parent, and its key subsidiaries, look financially
healthy to borrow more. The cycle continued till it became impossible to sustain, ending in multiple
defaults and spooking the credit market (Business Standard, 2019a).
Further, Grant Thornton’s IL&FS audit found that former IFIN directors have been accused of sanctioning
loans worth thousands of crores (1 crore = 10 million) to certain entities by ‘overlooking negative assessment
by the credit risk assessment group’ and without recording any cogent justification, despite having full
knowledge that the assets of the borrower entities were stressed. A scrutiny of the loan books has revealed
that around US$171 million loans are without any security, and another US$286 million are without
adequate security. Advances of close to US$429 million have been made without proper risk assessment,
and another US$429 million have been routed to other entities that were not eligible to borrow. The auditors
have also discovered that US$357 million was used for ever-greening earlier loans.
Besides, loans given to several entities were written off. Former directors of IFIN have been accused
of being ‘prima facie responsible for causing financial stress and losses to the company by acting in a
mala-fide manner’. According to an estimate of IFIN’s outstanding loan book of over US$2.1 billion as
of March 2018, nearly US$1.0 billion of advances, availed of by 50 entities, have turned non-performing.
Bad loans surged after borrowers stopped repaying, taking advantage of distress in the group (Business
Standard, 2019a).
The GT report pinpoints responsibility on the Committee of Directors of four persons, including
its founder Chairman Ravi Parthasarthy. The Enforcement Directorate (ED) has charged the former
Kukreja et al. 9

top officials, including its chairman Ravi Parthasarathy, Ramesh C. Bawa, Hari Sankaran and K.
Ramchandaran, under the Prevention of Money Laundering Act (PMLA), and conducted searches across
several of its offices. A first information report (FIR) was filed by the Economic Offences Wing of the
Delhi Police in December 2018. Later after the investigation by ED, it has been revealed that the IL&FS
siphoned out roughly US$43 million over several years through fake work orders issued as part of the
construction of the Gurgaon Rapid Metro. Further, FIR revealed that the IL&FS’ subsidiary, IL&FS Rail
Infra issued work orders to a string of companies for non-existent work, namely Silverpoint Infratech,
Suryamukhi Projects, NKG Infrastructure, Divyanshi Infra Project and Ethical Construction, among
others. ‘The task assigned to these bogus companies was to generate cash and hand over the same to the
persons accepting those bogus invoices as genuine’, as stated in FIR. The Income Tax Department had
noticed the discrepancy first time in May 2018 and had issued a demand notice to IL&FS Rail, seeking
clarity on unexplained expenditure (Business Today, 2019).

Independent Directors in Infrastructure Leasing & Financial Services Limited Board

Independent directors of the erstwhile board were all well-known personalities, namely R. C. Bhargava,
Chairman Maruti, Michael Pinto, former Secretary for shipping, Sunil B Mathur, Former LIC Chairman,
Jaithirth Rao, Banker Citibank and Rina Kamath, a legal practitioner. The board is effective only if it has
independent directors who have expertise in the industry in which the company operates. The independent
directors of IL&FS lacked experience in managing complex NBFC. The then board did not recognize the
importance of risk management function. That is why the risk management committee, comprising
mostly of independent directors, never met after July 2015, even as the company’s finances kept
tumbling. Also, the nominees of IL&FS shareholders on the board and the bankers never questioned the
Chairman and Managing Director (CMD).

External Auditors
An initial investigation by GT suggested that auditors did not fulfil their professional duties. The Institute
of Chartered Accountants of India (ICAI) is self-regulating professional bodies to take disciplinary actions
against its members in India (Business Standard, 2019a). The National Financial Reporting Authority
(NFRA) indicted Deloitte Haskins and Sells LLP for its significant failure in conducting audit of IFIN and
in its Audit Quality Review (AQR) report of the statutory audit for the year 2017–2018, has concluded that
‘the failure to comply with the Standards on Auditing are of such significance that Deloitte did not have
adequate justification for issuing the audit report’. ‘NFRA has concluded that the quality control system
and processes of Deloitte Haskins and Sells are severely inadequate and ineffective...,’ NFRA is examining
whether disciplinary proceedings against the auditor need to be initiated (Money Life, 2019).
The Institute of Chartered Accountants of India has held certain statutory auditors of the beleaguered
IL&FS group, including its parent IL&FS Ltd. and two of its subsidiaries ITNL and IFIN, ‘prima facie
guilty’ of professional misconduct (Saxena, 2018). ICAI interim report alleged that the auditors failed to
report:

• That IL&FS did not meet RBI’s regulatory framework for core investment companies.
• Whether the required approvals were being taken to provide high managerial remuneration.
• Direct and indirect investments made by the parent IL&FS in its group subsidiaries.
• The ‘serious mismatch’ between assets and liabilities which indicated liquidity concern.
10 South Asian Journal of Business and Management Cases

• Key balance sheet indicators of the beleaguered financier, such as its over-reliance on short-
terms borrowings for financing its long-term assets, adverse key financial ratios and deterioration
in the value of the assets used to generate cash flows. ‘In fact, the SA (statutory auditors)
have mentioned that in view of its (IL&FS) positive net worth, positive cash flows, credit
ratings and boards proposals, there is no doubt on the ability of the entity to continue as a going
concern.’
• The report also found irregularities in the books of IL&FS Financial Services. Even though RBI
pointed out that the net owned funds of the non-banking lender had turned negative and its balance
sheet was over-leveraged, in its 2014–2015 annual inspection report, and made similar observations
later, the auditors failed to state the material facts in their report.
• Auditors understated the lender’s bad loans and did not point out the inadequate provisioning
made against such loans, violating RBI’s circular on ‘Disclosure in the Notes to Accounts
to the Financial Statements – Divergence in Asset Classification and Provisioning’. No reasons
were given for increasing liabilities/loans and increasing borrowing costs of the financial
services arm, leading to non-disclosure of the consequential impact of insufficient provisioning
for debts.
• Auditors failed to show the diversion of the lender’s funds through its subsidiaries, due to fraud or
error. They failed to report that the lender indulged in non-viable financial transactions with its
own subsidiaries and did not indicate the risk involved in such transactions.

In the special audit conducted by Grant Thornton following the following points were reported (Business
Standard, 2019a):

• The credit rating rationale which is supposed to be drafted by the rating agencies was materially
modified, or significant suggestions from the former key employees of IL&FS were incorporated,
to provide and support good ratings given by the Credit Rating Agencies (CRAs);
• If the then key employees of IL&FS became aware that ratings are not going to be favourable,
they then either delayed the process of rating surveillance or delayed the publication.
• Intentionally incorrect or incomplete information was being provided to CRAs to avoid rating
downgrade.
• If the then key employees of IL&FS did not receive the desired rating from the CRA, they used to
potentially pressurize rating agencies to either withdraw the credit ratings or credit rating request
or approach other rating agencies that would provide the desired ratings.
• If the ratings were not favourable, the then key employees of IL&FS tended to keep the ratings in
the private domain.
• After meeting with the then key employees of IL&FS, CRA would not downgrade the ratings that
it initially decided.

Regulatory Framework
IL&FS is an NBFC regulated by RBI. However, RBI does not have all the information needed to
understand other financial firms’ risks arising from its debt. Notably, pension funds, provident funds,
mutual funds and insurance companies hold the debt of IL&FS subsidiaries. However, RBI does not
regulate these and hence will not have the full picture.
Kukreja et al. 11

IL&FS’s case is a loud wake-up call to the lawmakers and regulators to take cognizance of such
systemically important institutions. There is an urgent need to develop a risk-sensitive oversight regime
for financial conglomerates (FC) like IL&FS where the intrusiveness of oversight of FCs is proportionate
to a combination of the entity’s size, and the likelihood of an adverse event, so that remedial measures
are taken in a timelier manner.
Post financial crisis of 2008, one of the supervisory tools applied by the central banks is banks’ stress
testing. All systemically important financial institutions should be covered by the stress testing exercise
at periodic intervals.

Discussion
IL&FS is an organization needed for a developing country like India. These institutions need to be governed
and monitored by a team of professionals with high repute. There were many red flags ignored by the
external auditors as per ICAI and GT report. Over-relying on very key senior management raises the failure
of good governance. The lack of effective governance was noted as RBI, Ministry of Finance, Ministry of
Corporate Affairs and Securities and Exchanges Board of India were partly sharing monitoring responsibility.
There was no single regularity body to regularize it. ICAI and NFRA observed lack of professionalism by
the external auditors, and there is a need to reform the audit profession in India.
RBI must credibly step up its supervisory abilities, or even be willing to hand this over to a new
agency created for this purpose. Appointment of auditors is another critical area that needs the attention
of regulators. Mandatory rotation of audit firms and joint auditors’ appointment can mitigate the risk of
audit negligence significantly. It is time to establish an inspection mechanism for such systemically
important companies similar to RBI’s inspection of banking institutions.
The government may consider forming an emergency fund wherein a certain percentage of profits
from NBFC’s is transferred to tide over any systemic crisis like IL&FS. It is similar in line with reserve
requirements for banks.

Remedial Measures Taken So Far

The Government of India has taken over the Board of IL&FS and appointed a six-member team which
includes Uday Kotak of the Kotak Mahindra Bank, retired IAS officer Vineet Nayyar, former Securities
& Exchange Board of India (SEBI) chairperson G. N Bajpai, ICICI’s non-executive chairperson G. C.
Chaturvedi, IAS officer Malini Shankar and senior bureaucrat from C. A. G. Nand Kishore. NCLT had
asked the new board to submit a report on its findings and a roadmap before the NCLT bench. The new
board ordered an extensive special audit of crisis-hit IL&FS group which was conducted by Grant
Thornton (Vyas, 2018).
The Reserve Bank of India is in a dialogue with market regulator SEBI to flesh out new regulations
that would impact the way credit rating agencies function (The Siasat Daily, 2019).
The Institute of Chartered Accountants of India is investigating the role of statutory auditors in
multiple IL&FS group entities (Srivats, 2018). Banks’ request to RBI, seeking relaxation in classification
NPA norms in respect of dues from IL&FS, has been turned down by RBI. However, NCLT has passed
an order stating that the debt of all IL&FS group firms should not be declared as NPAs (The Economic
Times, 2019).
12 South Asian Journal of Business and Management Cases

Under the Financial Stability and Development Council (FSDC), an Inter Regulatory Forum
for monitoring Financial Conglomerates (IRF-FC) is carrying out the oversight of Financial
Conglomerates (FCs).
In its half-yearly Financial Stability Report, RBI acknowledged that while the present system is
exhaustive, it is backward looking and may not adequately capture emerging risks and vulnerabilities. A
risk-sensitive FC oversight regime where the intrusiveness of oversight of FCs is proportionate to a
combination of the size of the entity, and the likelihood of an adverse event may help make remedial
measures in a timelier manner (The Economic Times, 2018).
Days after Grant Thornton (GT) India LLP submitted its interim report detailing out irregularities
in IL&FS, the new government-appointed board of IL&FS has sent show-cause notices to the
erstwhile Board of IL&FS Financial Service Ltd (IFIN) asking why criminal action should not be
initiated against them.
The new Board of IL&Fs is taking a series of measures to improve the liquidity position of the group,
which includes taking workforce cost optimization measures and selling stakes in subsidiaries.

Conclusion and Recommendations

IL&FS is a serious case of corporate mismanagement and massive regulatory failure. It is shocking how
under the nose of regulators such as RBI, SEBI and Ministry of Corporate Affairs, Ravi Parthasarathy
and his chosen cabal IL&FS could grow unchecked into a massive 348-entity empire masquerading as
the favourite partner of state and central governments. It is apparent that regulators, marquee shareholders
(banks and institutions) and the board of directors failed in their fiduciary obligation to regulate and
supervise the actions of Ravi Parthasarathy and his chosen coterie.
IL&FS’s case is a loud wake-up call to the lawmakers and regulators to take cognizance of such
systemically important institutions. There is an urgent need to develop a risk-sensitive oversight regime
for FCs like IL&FS where the intrusiveness of oversight of FCs is proportionate to a combination of the
entity’s size and the likelihood of an adverse event so that remedial measures are taken in a timelier
manner. RBI has acknowledged the need for such a risk-sensitive oversight mechanism in its half-yearly
Financial Stability Report (The Economic Times, 2018). BI must credibly step up its supervisory abilities,
or even be willing to hand this over to a new agency created for this purpose.
Post financial crisis of 2008, one of the supervisory tools applied by the central banks is banks’ stress
testing (Bernanke, 2013). All systemically important financial institutions should be covered by the
stress testing exercise at periodic intervals.
Appointment of auditors is another critical area that needs the attention of regulators. Mandatory rotation
of audit firms and joint auditors’ appointment can mitigate the risk of audit negligence significantly.
It is time to establish an inspection mechanism for such systemically important companies similar to
RBI’s inspection of banking institutions.
The government may consider forming an emergency fund wherein a certain percentage of profits
from NBFC’s is transferred to tide over any systemic crisis like IL&FS. It is similar in line with reserve
requirements for banks.

Limitations of the Study

This case study is solely based on publicly available information. None of the authors has access to
confidential primary information on IL&FS and other parties and entities under investigation. Authors
Kukreja et al. 13

have not interviewed IL&FS management, people involved in the audit of IL&FS, or any party or the
investigator charged with fraud. The evolution and unfolding of the IL&FS story are covered only until
December 2019. Any significant developments after December 2019 must be considered for case
discussion.

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of
this article.

Funding
The authors received no financial support for the research, authorship and/or publication of this article.

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