S&P warns of increased contagion risk in India’s financial sector

S&P said if an Indian bank got into trouble, the contagion could spread to other banks “perceived to be struggling” with the same problems as failing banks.

Representational image of Indian currency | Photo: Brent Lewin | Bloomberg

Mumbai: The risks of contagion are rising in the Indian financial sector and any failure of a large shadow lender could lead to a “solvency shock” to banks, S&P Global Ratings said Wednesday.

India’s shadow lenders get a substantial part of their funding from banks, and the weaker ones have seen a sharp rise in their borrowing costs and a big drop in their equity values, the ratings firm said in a report.

That could have knock on effects on India’s banks, especially if they are perceived to have governance issues.

“The credit profile of a bank could deteriorate sharply due to outsized exposure to weak entities, huge market or operational losses, or significant deposit withdrawals if the depositors lost confidence in the bank,” the S&P analysts led by Geeta Chugh wrote. “A governance deficit could also quickly turn to a trust deficit, hurting the stability of a bank.”

India’s shadow banking crisis erupted last year when Infrastructure Leasing & Financial Services Ltd. defaulted on a series of debt obligations. Since then, banks and mutual funds have turned cautious on lending to the troubled sector, leaving several other shadow lenders struggling to stay afloat.

If an Indian bank got into trouble, “the contagion could spread to other banks perceived to be struggling with the same problems as the failing bank,” S&P said. However, it said the government would likely intervene to support systemically important institutions that get into difficulties.

S&P’s report follow similar warnings from Fitch Ratings, which estimated Tuesday that about 30% of banks’ exposure to shadow lenders could become non performing, putting pressure on capital and reversing the process of bad debt recovery.

The risk of a small to mid-sized bank failing is limited, S&P said. However, the contagion impact of any such failure would be much higher than for a finance company.

“Typically, we expect the government will only intervene for large and mid-sized banks,” S&P said. “But when paranoia is high and the contagion risks are pronounced, they may extend support to smaller banks too.” – Bloomberg