IL&FS Crisis

The IL&FS Crisis refers to the severe financial distress and subsequent default of Infrastructure Leasing & Financial Services Limited (IL&FS) in 2018, which triggered widespread disruption across India’s financial system. The crisis exposed structural weaknesses in non-banking financial companies (NBFCs), raised concerns about corporate governance, and had far-reaching implications for banking stability, financial markets, and the Indian economy.

Background and Profile of IL&FS

Infrastructure Leasing & Financial Services was established in 1987 as a core infrastructure development and finance company. Over the years, IL&FS grew into a large and complex conglomerate with hundreds of subsidiaries, associates, and special purpose vehicles operating across sectors such as roads, power, ports, and urban infrastructure.
IL&FS was widely perceived as a systemically important institution due to its size, interconnectedness, and prominent shareholders, which included public sector entities and financial institutions. This perception contributed to strong market confidence prior to the crisis.

Nature and Emergence of the Crisis

The crisis came to light in mid-2018 when IL&FS and several of its subsidiaries began defaulting on debt obligations, including short-term commercial paper and bank loans. These defaults revealed acute liquidity stress and deeper solvency issues within the group.
Key factors behind the crisis included:

• Aggressive leverage and reliance on short-term borrowing.
• Long gestation infrastructure projects with delayed cash flows.
• Complex group structure obscuring true financial health.
• Weak corporate governance and inadequate risk management.

As defaults mounted, confidence in IL&FS eroded rapidly, leading to a reassessment of credit risk across the NBFC sector.

Impact on the Banking System

Banks were significantly exposed to IL&FS through loans, guarantees, and investments in debt instruments. The defaults led to asset quality deterioration and provisioning pressures for banks, particularly public sector banks.
Beyond direct exposure, the crisis heightened risk aversion within the banking system. Banks became more cautious in lending to NBFCs and infrastructure projects, tightening credit conditions and slowing the flow of funds to the real economy.

Contagion in the NBFC Sector

The IL&FS crisis triggered a broader liquidity crunch in the NBFC sector. Mutual funds and other investors reduced exposure to NBFC debt, leading to sharp increases in borrowing costs and refinancing difficulties for many institutions.
Even fundamentally sound NBFCs faced funding constraints as market confidence weakened. This contagion highlighted the sector’s dependence on short-term market funding and its vulnerability to sudden shifts in investor sentiment.

Role of Financial Markets

Financial markets reacted sharply to the crisis. Bond yields of NBFCs spiked, equity prices declined, and mutual funds faced redemption pressures. The reassessment of risk led to reduced market liquidity, particularly for lower-rated issuers.
The crisis underscored the interconnectedness of banks, NBFCs, mutual funds, and capital markets, demonstrating how stress in one segment can quickly spread across the financial system.

Regulatory and Government Response

The crisis prompted swift intervention by regulators and the government. The Reserve Bank of India implemented measures to ease liquidity conditions, including open market operations and regulatory forbearance to support credit flow.
The Government of India superseded the IL&FS board and appointed a new management to oversee resolution and asset monetisation. This intervention aimed to contain systemic risk and ensure orderly resolution rather than abrupt liquidation.

Resolution and Restructuring Process

A comprehensive resolution framework was put in place to address IL&FS’s liabilities. Assets were categorised based on viability, and a phased approach was adopted involving asset sales, restructuring, and selective repayments.
While the resolution process was complex and prolonged due to the group’s size and structure, it marked a shift towards more transparent and systematic handling of large financial distress cases outside the traditional banking system.

Implications for Financial Regulation

The IL&FS crisis led to a re-evaluation of regulatory oversight of NBFCs. It highlighted gaps in supervision, especially for large and systemically important non-bank institutions.
Regulatory reforms focused on:

• Strengthening asset-liability management norms.
• Enhancing disclosure and governance standards.
• Closer monitoring of systemically important NBFCs.

These measures aimed to align NBFC regulation more closely with that of banks, without undermining their role in credit intermediation.

Impact on the Indian Economy

At the macroeconomic level, the IL&FS crisis contributed to a slowdown in investment and credit growth, particularly in infrastructure, real estate, and small business segments reliant on NBFC financing.
Reduced availability of credit affected consumption, employment, and overall economic momentum in the short term. However, the crisis also catalysed structural reforms aimed at strengthening financial stability and risk management.

Lessons for Banking and Finance

The IL&FS crisis offered critical lessons for India’s financial system. It underscored the importance of robust corporate governance, transparent group structures, and prudent leverage management.
For banks and regulators, the crisis highlighted the need for holistic supervision across the financial sector, recognising interlinkages between banks, NBFCs, and capital markets.