IL&FS owed Rs 91,000 crore — and its default nearly sank India's shadow banks

IL&FS — Infrastructure Leasing & Financial Services — was one of India's largest non-banking finance companies, a 'shadow bank' that funded long-term infrastructure projects. It did what many NBFCs do: it borrowed short-term, through commercial paper and short-dated debt, and lent long-term, into roads and projects that would pay back over many years. By 2018 the group's total debt stood at about Rs 91,000 crore, more than half of it from public-sector lenders.

The model broke in late August and early September 2018. IL&FS Financial Services first defaulted on commercial paper, then defaulted on a Rs 1,000 crore short-term loan to a state lender, triggering downgrades across almost all of its debt. Because mutual funds and other NBFCs held large amounts of this paper, the trouble did not stay contained.

Contagion spread fast. By mid-September it had reached mutual funds and the debt market; a fire-sale of another NBFC's paper sent the BSE Sensex crashing by about 1,500 points, and liquid funds saw huge outflows as investors fled shadow-bank debt. The government told the National Company Law Tribunal that the collapse of IL&FS could pull down many mutual-fund companies with it. On 1 October 2018 the NCLT allowed the government to take control and install a new board, chaired by Uday Kotak, which submitted a revival plan within the month.

IL&FS is the case that exposed the fragility at the heart of the shadow-banking model. Borrowing short to lend long works until one default makes every lender look at every other NBFC — and then the maturity mismatch stops being one company's problem and becomes the whole system's.