India’s $42 billion shadow-banking system has been creaking since one of the country’s biggest infrastructure lenders unexpectedly halted debt repayments in 2018. Investor nerves were rattled again in June when a major mortgage lender delayed bond interest payments, indicating credit markets remain under enormous strain. The situation presents a challenge to Narendra Modi as he begins his second term as prime minister. Can investor confidence be restored or is a full-blown financial crisis brewing?

1. What went wrong?

Shadow banking refers to all sorts of lending that takes place outside the regular financial system. The lenders are less tightly regulated than real banks and typically provide credit to riskier businesses and individuals. The crisis in India started a year ago when Infrastructure Leasing & Financial Services Ltd. missed debt payments after its short-term financing costs jumped. Until then, investors had viewed the group’s debt as rock solid. The sudden default sent shock waves across India’s credit markets, pushing up funding costs and making it harder for peers to access debt markets. Investors are demanding the highest premium in six years to hold short-term debt of non-bank lenders over government bonds.

2. How did this happen?

Loans from the shadow-banking sector expanded rapidly in the period up to IL&FS’s default, a time during which conventional banks were preoccupied with battling a $190 billion bad-loan crisis. In the race to grab market share, shadow financiers borrowed short-term funds and lent it out for longer periods, setting up a classic mismatch. The binge was funded by bond sales, credit from Indian mutual funds and bank loans.

3. How big a deal is this?

Non-bank financing companies have accounted for nearly a third of all new credit over the past three years, as India’s conventional banks struggled to come to grips with one of the world’s worst bad debt problems. Shadow lenders fund everyone from poor entrepreneurs seeking startup funds to property tycoons looking to roll over debt, and hence lending by them is crucial to the Indian economy.

4. Is the crisis spreading?

Mortgage lender Dewan Housing Finance Corp Ltd. missed debt payments in June and Care Ratings Ltd. slashed its AAA credit rating to D this year. A news site alleged in January that the company diverted funds to shell companies, a claim Dewan Housing has denied. Other companies including Reliance Capital Ltd. and Piramal Capital & Housing Finance Ltd. have also had their credit ratings cut on liquidity concerns. Access to funding has gotten tougher for many non-bank financing lenders in credit markets, and they have a record 1.1 trillion rupees ($15.9 billion) of debt due in the third quarter of 2019.

5. Where is this heading?

The worst is probably still to come. Observers warn the credit crunch may hit the property sector next. It is heavily dependent on funds from shadow banks, and concerns are already being reflected in some realtor bonds. The nation’s conventional banks may also see more pain, as about 7% of their loans are extended to non-bank financing companies.

6. How are shadow lenders coping?

As access to funds in onshore debt markets has dwindled, shadow lenders are tapping overseas markets where they have to pay 25 to 50 basis points more than onshore rates to get cash.

7. What’s the economic impact?

India’s consumption engine is sputtering because the shadow-banking sector plays a key role in the nation’s financial system, particularly in delivering credit at the grassroots. A prolonged slowdown in lending from the sector poses a significant challenge to the Indian economy, where consumer spending growth has cooled on everything from toothpaste to air tickets. It expanded just 5.8% in the quarter ended March -- the slowest pace in five years and lagging behind China.

8. What are policymakers doing?

To avoid contagion from the IL&FS fallout, the government last year seized control of the debt-laden company, ousted the management and installed a new six-member board. The Reserve Bank of India has cut interest rates three times in 2019. It has said it’s prepared to come to the help of the troubled shadow-banking sector if needed, while also signaling it will tighten liquidity requirements to bring shadow lenders into line. Despite the steps taken by regulators, market participants often complain that authorities aren’t doing enough. They want them to announce specific measures and find solutions at the level of individual companies.

To contact the reporter on this story: Divya Patil in Mumbai at

To contact the editors responsible for this story: Andrew Monahan at, Finbarr Flynn, Andy Reinhardt

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