MUMBAI/NEW DELHI (Reuters) - India on Monday took control of Infrastructure Leasing and Financial Services (IL&FS), in a rare move that it said was needed to protect the country’s financial system and markets from potential collapse.

FILE PHOTO: A bird flies next to the logo of IL&FS (Infrastructure Leasing and Financial Services Ltd.) installed on the facade of a building at its headquarters in Mumbai, India, September 25, 2018. REUTERS/Francis Mascarenhas/File photo

IL&FS, a major infrastructure financing and construction company, defaulted on some of its debt obligations in recent weeks triggering wider concerns about risk in the rest of the country’s financial sector.

The government said it would replace the board of IL&FS with six selected nominees and ensure IL&FS has the liquidity needed to ensure no more defaults take place and the infrastructure projects are implemented smoothly.

“The government was compelled to take this extraordinary step ... to prevent further mismanagement in order to protect public interest,” the government said in a statement. It also said the government needed to ensure the solvency of IL&FS to maintain financial stability in the country.

IL&FS’s problems could threaten India’s economic growth as lenders cut exposure to what are known as non-banking finance companies (NBFCs) in India or shadow banks. More concerning, analysts say, is that potential defaults at so-called shadow banks could cripple many mutual funds that are heavily invested in their commercial paper.

These non-bank finance companies have played a major role in lending growth in India in the last two years, as Indian banks, saddled with roughly $150 billion of bad debt, slowed lending.

RARE MOVE

A string of defaults by IL&FS has led to a series of credit rating downgrades on the company and its subsidiaries that hold some of its 910 billion rupee ($12.48 billion) debt pile. Its fall from grace has spooked financial markets and sparked fears of contagion.

India has rarely stepped in to take control of a private company. The government’s attempt to take control of debt-laden realty firm Unitech Ltd in late 2017 was stalled by the Supreme Court.

Slideshow ( 2 images )

India did take control of Satyam Computer Services in 2009 after an accounting scandal.

The government applied to the National Company Law Tribunal (NCLT) on Monday to remove the board of IL&FS.

The NCLT approved the government’s interim application to replace IL&FS’s board with six nominees, including the managing director of Kotak Mahindra Bank Uday Kotak as IL&FS’ non-executive chairman.

“The current IL&FS crisis could have an adverse impact on the financial stability of the economy,” Sanjay Shorey a lawyer for the government told the NCLT, a quasi-judicial body for corporate grievances.

IL&FS has infrastructure and financial assets worth more than 1.15 trillion rupees ($15.77 billion) but its debts are the result of “mismanaged borrowings in the past,” the government said.

The government fears that IL&FS’s inability to finance and support the projects could damage the infrastructure sector.

“There is an emergent need to immediately stop further financial defaults and also take measures to resolve defaulted dues to the claimants,” the government statement said.

The government also said the Serious Fraud Investigation Office had been ordered to look into IL&FS and its subsidiaries.

RESTRUCTURING PLAN

The government’s intervention has cast doubt over IL&FS’ restructuring plan for which it has just secured shareholder support.

“The government decision to intervene ... could be disruptive at this stage,” Shriram Subramanian, managing director at proxy advisory firm InGovern, said.

IL&FS on Sunday said its shareholders had approved a plan to raise funds via debt and equity issuances. Earlier, the company had said its board would develop a “comprehensive” restructuring plan including asset sales and a rights issue.

India’s Life Insurance Corp Ltd, which is IL&FS’ biggest shareholder with a more than 25 percent stake, said last week it would participate in the rights issue.

IL&FS’s other large investors are Japan’s ORIX Corp with a 23.54 percent stake and Abu Dhabi Investment Authority (ADIA) with 12.56 percent.

India’s biggest lender by assets, State Bank of India (SBI), also owns a 6.42 percent stake in IL&FS.

LIC and Orix did not respond to requests for comment on the Indian government’s move to seize control of IL&FS on Monday.

SBI and ADIA declined to comment, while IL&FS said it would not comment.