Global rating agency Standard and Poor’s on Wednesday warned that there is a rising risk of contagion in the Indian financial sector. “Markets reflect this fragility. Many finance companies have lost more than half of their equity value in the past year, and credit markets are charging huge premiums on debt issued by the riskier finance companies,” it said in a report titled 'Indian Financial Sector Braces For Fat Contagion Tail Risk'.

Pointing to the recent analysis by the Reserve Bank of India (RBI), which suggests that the failure of any top-five housing finance company (HFC) or non-banking financial company (NBFC) could result in the default of up to two banks, S&P said that this could have dramatically negative effects on credit growth and the economy.

“India's finance companies are among the country's largest borrowers. A substantial part of this funding comes from banks. The failure of any large non-banking financial company (NBFC) or housing finance company (HFC) may deliver a solvency shock to lenders," said S&P Global Ratings credit analyst Geeta Chugh.

Swift and orderly resolution

In its base case, S&P said that it expects that the resolution of weak finance companies will be swift and orderly, and contagion will be managed. It pointed out that even the default by Dewan Housing Finance Ltd (DHFL) has not generated the kind of panic that was seen after the default of Infrastructure Leasing and Financial Services Ltd (IL&FS) in mid-2018.

It said that it also expects the government to support systemically important institutions that get into trouble, although the support is more likely to be available to banks, rather than any finance company.

Capital shortfall

Earlier on Tuesday, rating agency Fitch had said that banks would face a capital shortfall of about $50 billion or about Rs 3.5 lakh crore in the event of a systemic crisis in the non-banking financial sector.

"The credit profiles of the state-owned banks would come under significant pressure, and the weakest -- including those with Viability Ratings in the ''B'' range -- would face heightened solvency risks without capital injections from the government," a stress test conducted by Fitch Ratings had found.