Cash woes at India shadow lenders may lead to more bad debt at banks

Moody’s Investors Service said funding challenges at India’s non-bank financing companies are increasing the risk of asset quality deterioration at banks, which are already saddled with the world’s worst bad-debt pile.

Risks of loan losses at shadow financiers will weaken their financials, prompting banks to further reduce lending to them and worsening their funding stress, the ratings company said in a report dated Friday. “The consequences will ultimately lead to more nonperforming loans for banks.”

Moody’s statement follow warnings from S&P Global Ratings, which sees risks of contagion rising in the Indian financial sector, and any failure of a large shadow lender could lead to a “solvency shock” to banks. Resolving the cash crunch at non-bank firms is important because they fund everyone from street merchants to business titans in Asia’s third-largest economy, whose growth rate has already slowed to a six-year low.

Banks and non-bank firms are in a feedback loop, especially through exposures to the real estate sector, which is under “significant stress,” Moody’s said. Tighter funding will exacerbate the stress and lead to more soured debt at banks because they have large exposure to non-banks that have actively lent to builders.

“This will hinder improvements in banks’ asset quality, profitability and capital,” Moody’s said. “This is credit negative.”