Anti Money Laundering

By Preeti Anand, Nitish Kumar and Aditya Sharma (PGDRM Batch July’19-20 and Jan’20-21)

What is money laundering?

Money Laundering refers to the conversion of money which has been illegally obtained, in such a way that it appears to have originated from a legitimate source.

In India, money laundering is popularly known as Hawala. Hawala is an alternative or parallel remittance system. “Hawala” is an Arabic word meaning the transfer of money or information between two persons using third-person transactions.

Money laundering process

IL&FS case description 

• Infrastructure Leasing & Financial Services Limited (IL&FS) is a systemically important Core Investment Company with the Reserve Bank of India and is engaged in the business of giving loans and advances to its group companies (and holding an investment in such companies). IL&FS has a large number of group companies across various sectors such as Energy, Transportation, Financial Services.
•  IL&FS Group, which had approximately over Rs. 91,000 crores in debt, was facing a severe liquidity crisis. Between July 2018 and September 2018, two of the subsidiaries of IL&FS Group reported having trouble in paying back loans and inter-corporate deposits to banks/lenders.
• In July 2018, the road arm of IL&FS was facing difficulty in making repayments due on its bonds. Further, in early September 2018, one of the subsidiaries of IL&FS Group was unable to repay a short-term loan of Rs. 1,000 crore taken from Small Industries Development Bank of India (SIDBI). Also, certain group companies defaulted in repayments of various short and long-term deposits, inter-corporate deposits, and commercial papers.
• IL&FS failed continuously to service its debt and the imminent possibility of a contagion effect in the financial market led the Central Government to move an application under Sections 241 and 242 of the Companies Act, 2013 before the NCLT(National Company law Tribunal). Section 241 deals with the cases of mismanagement and oppression by company’s management.
• The NCLT suspended IL&FS board members and management and restrained the suspended members from alienating their personal assets.
• A forensic report looked into the alleged irregularities into the affairs of IL&FS Transportation Networks India Limited (ITNL) has found money laundering of over Rs 6,500 crore by the accused erstwhile management of its parent, Infrastructure Leasing & Financial Services (IL&FS).
• Identifying its former chairman Ravi Parthasarathy as the ‘prime mover’, the report also indicates that in at least 14 special purpose vehicles (SPVs) entered into by ITNL, there were deliberate cost overruns using a maze of shell and dummy companies to make them eventually untenable.

Stakeholder Mapping

Root Cause Analysis

• IL&FS hadn’t disclosed bad loans on its books for years despite a big part of its loan book having soured.
• As it was the shadow bank or NBFC company, “Unscrupulous, negligent and dormant management decisions were the main root cause of failure.
• Poor fund management and controls :- IL&FS lent funds to insolvent entities and troubled projects.
• “Deficient audit”  by the auditors (Deloitte Haskins & Sell) and KPMG’s audit partner BSR & Co. They failed to issue warnings.
• According to the ICAI, the auditors did not highlight the Reserve Bank of India’s (RBI’s) inspection report, which had labelled IFIN as over-leveraged, besides failing to report negative cash flows and adverse key financial ratios.
• RBI or any other entity did not strictly regulated NBFCs. The IL&FS crisis has raised concerns over the management of such entities.

Aftermath of IL&FS failure

Financial impact

• The IL&FS group operated over a hundred subsidiaries and is sitting on a debt of Rs 94,000 crore.
• The bankruptcy cases wiped out Rs.8.48 lakh crore of investor’s wealth.
• Commercial Paper worth Rs 300 Crores was sold at a discounted price, which belonged to DHFL.
• Share market got affected because anxious retail investors started selling shares of other NBFCs and redeemed from mutual funds.
• Default by IL&FS led to panic in the debt market and dried liquidity in the system of 1 lakh Crore.
• All other housing financing companies and infra companies stocks fallen up to 60% of its stock prices.
• IL&FS engineering(from Rs 45 to Rs 2.20) , IL&FS transportation(from Rs 166 to Rs 1.45)  and IL&FS investment(Rs 27 to Rs 2.40) share price crashed
• Widen of fiscal deficit which has adverse repercussion on inflation, exchange rate, growth etc.
• Sensex shed 2,000 points just in a week, sparking a bloodbath in the market.

Reputational Impact

• ICRA Ltd, CARE Ratings Ltd, India Ratings & Research Pvt. Ltd, Deloitte and BSR (Part of KPMG) reputation got  affected due to major lapses in audit of the IL&FS.
• IL&FS new infrastructure projects dried up, downgraded reputation across market.
• Loss of confidence of investors.
• Rating agency ICRA downgraded the ratings of its short-term and long-term borrowing programs from “AAA” to “D”.

Legal impact

• On April 2, 2019, former vice-chairman of IL&FS, Hari Sankaran, was arrested by Serious Fraud Investigation Office (SFIO) in Mumbai for granting loans to entities that were not creditworthy.
• The prosecution complaint was filed in a special court of the Prevention of Money Laundering Act, charging former senior management personnel of IL&FS — Ravi Parthasarathy, Ramesh Bawa, Hari Sankaran, Arun Saha, and Ramchand Karunakaran along with Aircel founder C Sivasankaran.
• The Enforcement Directorate (ED) conducted searches at multiple locations in connection with the IL&FS crisis, made provisional attachment of bank accounts and immovable property to the tune of Rs 570 crore held by these people.
• Sebi in December 2019 slapped a penalty of Rs 25 lakh each on ICRA Ltd, CARE Ratings Ltd and India Ratings & Research Pvt Ltd due to “lethargic indifference and needless procrastination and laxity” of the rating agencies.

Operational Impact

• Government discontinued old board as it was deemed to have failed to discharge its duties.
• In October 2018, the government constituted a new board as the. Kotak Mahindra Bank Executive Vice-Chairman and Managing Director Uday Kotak, Tech Mahindra Vice-Chairman, Managing Director and CEO Vineet Nayyar, former Sebi chief G N Bajpai, former ICICI Bank Chairman G C Chaturvedi, former IAS officers Malini Shankar and Nand Kishore were made members of the board.

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Read the full case study here: ILFS case study – AML

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