Home / Opinion / Views /  Opinion | Only more sunshine will stop the rot

The Infrastructure Leasing and Financial Services (IL&FS) contagion is spreading. After mutual funds and non-banking financial companies (NBFCs), it is the turn of the exempt pension funds to be worried about their investment in bonds from the beleaguered institution. The story is: as non-performing asset-laden banks dried up lending to firms, these companies turned to other sources of money as a firm needs working capital to keep the wheels of business turning. Money comes from two sources—extra funds that other firms have and household savings. Institutions such as banks, mutual funds, insurance firms, pension funds, and NBFCs act as intermediaries between households, who are the lenders, and firms who are borrowers. In the IL&FS case, there are bonds that have not kept to the interest payment schedule and were, thus, classified as below investment-grade by credit rating firms. Once that happened, the exposure to such bonds held by mutual funds came to light. Next came the exposure of NBFCs to these bonds.

A new report finds these bonds in portfolios of the exempt pension funds. Organized sector employees are either a part of the government-run Employees’ Provident Fund Organisation or subscribe to what are called “exempted trusts" set up by both public and private sector firms. These pension funds give an assured return each year by managing the money of provident fund subscribers. Some public sector exempt trusts have exposure to unsecured IL&FS bonds, meaning they stand at the end of the line in the resolution process through the Insolvency and Bankruptcy Code. This has alarmed both fund managers and subscribers because of a possible drop in their return. Of course, the question why low-risk appetite fund managers were punting on bonds with credit risk remains to be answered. The IL&FS story is getting repeated across smaller bond issuers. The problem is deeper than just IL&FS and its current cash crunch. The problem is of an underdeveloped bond market struggling to find ways to raise short-term funds to keep the furnaces burning. The problem is also of opacity in disclosures in various parts of the financial sector. The reason mutual fund investments in IL&FS were in the news first and the holdings of others are now coming to light is because of the differing disclosure norms financial firms face. Mutual funds have a far better public disclosure and reporting structure than an insurance firm, an NBFC, a pension fund, or an exempt trust. We should worry about what is held in the opaque pools of traditional insurance funds and what else is held by fund managers of the exempt trusts.

India had a chance to solve a part of this problem with the Financial Resolution and Deposit Insurance (FRDI) Bill. The December 2017 bill was aimed at putting in place rules of the game so that financial firms can fail in an orderly manner. A resolution corporation (RC) would put in place a system to monitor financial firms, such as banks and insurance companies, as well as stock exchanges and payment systems, so that the ill health of such a firm can be detected early, rather than allowing it to come to the brink and fail, causing the risk of contagion. This would mean better disclosure of firms whose bonds and stocks these market intermediaries buy. A problem such as that of IL&FS would have been spotted far earlier if the RC was up and running. Politics and bank unions killed the FRDI Bill. We will continue to pay the price of opacity.

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