S&P Global Ratings on Monday said quick resolution of Yes Bank's insolvency will keep India's banking sector contagion at bay, but as credit markets tighten there could be a possibility of wider economic pain in the country.
The Reserve Bank last week imposed a moratorium on the capital-starved Yes Bank, capping withdrawals at Rs 50,000 per account and superseding the board of the private sector lender with immediate effect.
Following this, country's largest lender State Bank of India (SBI) on Saturday said it will invest Rs 2,450 crore in the troubled private sector bank against 245 crore shares.
"The Indian government is working with the SBI to inject capital into Yes Bank, a troubled private-sector bank with 1.8 per cent of the country's bank deposits (as of March 31, 2019).
"Quick resolution of Yes Bank's insolvency will keep India bank-sector contagion at bay, though it poses pain for investors in bank hybrid securities. As credit markets tighten, we also see a possibility of wider economic pain in the country," S&P Global Ratings said.
It said the Indian government has consistently supported weak commercial banks by promoting the merger of distressed institutions with stronger lenders and has historically not allowed commercial banks to fail and has in the past swiftly stepped in to address trouble.
"The current weak economic and high-fear global investment environment, in our view, has prompted the government to support the recovery of Yes Bank. However, in better times, we believe the government would think twice about pushing such a package for relatively small banks," S&P said.
SBI will own a minimum of 26 per cent of Yes Bank for the next three years. SBI's ownership should give confidence to depositors and lenders about the bank's solvency, it added.
The Reserve Bank has put out a draft resolution plan for Yes Bank allowing SBI to acquire 49 per cent stake.
The ents follow Yes Bank's failure to raise capital to address loan losses, sparking a withdrawal of deposits.
India's central bank has highlighted serious governance issues at Yes Bank, lapses that have contributed to the institution's steady decline in recent years.
Any delay in, or uncertainty about, the implementation of the resolution plan may roil markets, S&P said.
"In our view, India's financial sector broadly needs to raise governance standards and restore trust. In the past few years, regulators have identified many governance shortcomings among Indian lenders, most recently at Punjab and Maharashtra Cooperative (PMC) Bank Ltd," S&P said.
It said if Yes Bank's resolution process is prolonged, there is a risk the broader banking environment may take a hit. This may raise investors' perception of credit risk in the system, tightening funding.
"Many mutual funds hold Yes Bank securities, including subordinated debt and AT-1s. A depreciation in the value of these instruments would hurt credit funds, potentially triggering capital outflows. This could widen spreads and drain the credit available to lower-rated entities," S&P said.
The speed of the government action will be critical to provide clarity, it noted.
In the past cases of bank failures--such as the collapse of Global Trust Bank Ltd., Nedungadi Bank Ltd., United Western Bank Ltd., Bank of Rajasthan Ltd. and Sangli Bank Ltd.--we have seen swift action that nipped contagion in the bud, S&P added.