In today’s Finshots, we see how Reliance Capital ended up in bankruptcy court and who gets hurt by all this.

The Story

In 2010, Anil Ambani, chairman of the Reliance Group said this — “It has always been our ambition to create a world-class bank.”

Cut to November 2021, and India’s banking regulator RBI has taken over the Board of Reliance Capital, the group’s non-banking finance company, and sent it to the dark corridors of bankruptcy courts.

Forget running a bank, even the non-banking arm didn’t survive. But, how did Reliance Capital end up in such dire straits?

Well, the story begins in 2005 when the Ambani brothers split the family business. Anil Ambani took over the telecom business along with financial services. He was betting on what he believed could be the “future” of India. But having a foot in the business isn’t enough, you still need to run it well. And let’s just say that the execution wasn’t exactly spot on. Anil Ambani kept taking bigger and bolder (maybe riskier?) bets in entertainment, infrastructure and power.

“His decisions did not come out of a carefully crafted strategy; they were driven by ambition”, charges a stock market analyst who did not wish to be named.

“It was fashionable to bid for huge projects, which were financed by public sector banks (PSBs) at the behest of politicians,” says another observer.

Debt! Debt! Debt!

Companies in the Reliance Group took on enormous amounts of debt in a bid to grow at all costs. And when one entity fell i.e. Reliance Communications in 2017 — Anil Ambani’s business empire came crashing down like a pack of dominos.

And the final piece to tumble? Reliance Capital. A financial services company that had its hands in many pies including asset management, life insurance, wealth management, commercial finance, and home finance.

At first, the diverse set of businesses did seem to hold a lot of potential. But, problems began to emerge soon enough.

Let’s take Reliance Home Finance for instance. Now, you’d think that a home finance company primarily lends money to regular folks intending to buy their dream homes. But Reliance Home Finance made over 50% of its lending to other companies. Companies in real estate development and infrastructure. As you can imagine, cash flow issues plague these sectors especially and are when the economic cycles turn. But matters get even worse when you lend to struggling companies in your own group. Think of Reliance Home Finance lending to Reliance Infra and Reliance Power. Now if those companies are mismanaged and go bust, you get dragged down with them as well.

So if the Home Finance subsidiary was in this “inter-corporate lending” mess, you can imagine the state of affairs in the Commercial Finance subsidiary (whose job is to lend to corporates). They were sailing in the same boat and lending even more money to Reliance Group companies.

And finally, when the likes of Reliance Communications and Reliance Power started to fail and default on their loans, it led to a chain reaction. Reliance Capital couldn’t even pay its own creditors. In March 2019, it only had Rs 11 crores in cash. By June, its auditor PwC had resigned. The auditor said that it wasn’t satisfied by Reliance Capital’s response to financial issues it had flagged. And by September 2019, Care Ratings had downgraded Reliance Capital’s debt to default status.

Do you see the problem with this sort of incestuous lending relationship?

Sure, we could say that a part of it was also due to the business environment. Think back to the NBFC crisis when Infrastructure lender IL&FS had gone belly up in 2018. Suddenly, no one wanted to lend money to NBFCs like Reliance Capital anymore. So their funding dried up. And to keep itself afloat, Reliance Capital began selling its stake in companies that actually were doing quite well. Like its mutual fund company which was at one point the fifth largest in the country. Even today, Reliance Capital has $9 billion in assets to meet its $2.9 billion liability.

But with all the corporate governance issues, the RBI finally had enough and decided to take matters into its own hands. What will come out of Reliance Capital’s bankruptcy proceedings now? Let’s look at what happened to another NBFC–DHFL, which went through something similar. When Piramal Group took over the company after a bidding process, they set a precedent of sorts for other bankruptcy proceedings. Lenders including banks managed to recover 30–40% of the value of loans. But, shareholders were wiped out. DHFL’s shares stopped trading on the stock exchanges on 11 June 2021. 3.8 lakh shares were held by small shareholders hoping to eke out some value during the delisting process. But instead, they were left with nothing.

And we can expect a similar outcome for Reliance Capital too. While Anil Ambani has cut his stake from 52% in December 2018 to 2% by March 2020, retail investors have been lapping up the shares hoping to make a quick buck whenever some good news emerges. They now own 57% of the company. If a DHFL-like situation does manifest itself, these shareholders could lose all their money.

And the folks including banks who lent money to Reliance Capital are expecting 30 cents back for every dollar they lent.

So is there any silver lining here? Well, as Andy Mukherjee of Bloomberg pointed out, there’s a segment of people who didn’t get hurt. Potential “depositors”. Imagine if the RBI had indeed allowed corporate houses to set up banks. Reliance Capital would have jumped at that prospect in 2010. And the ones holding the short-end of the stick now may have been the everyday fixed deposit holders. Not the stock market fellows.

So yeah, maybe that’s one positive to come out of this debacle. But overall, it’s quite a tragic sequence of events.

Until next time…

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