"Contagion Runs The Risk Of Spreading" In India's Financial Sector, Rating Agency

India, one of the largest emerging markets in the world, is at serious risk of widespread contagion ripping through its banking sector as many large financial companies have already seen their equity value halved over the last 12 months, S&P Global Ratings said in a report on Wednesday, also reported by Bloomberg

India's shadow lenders, also called non-banking finance companies, have been under severe pressure since the collapse of Infrastructure Leasing and Financial Services (IL&FS) last Sept., which was on the 10th anniversary of the bankruptcy of Lehman Brothers.

"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 or housing finance company may deliver a solvency shock to lenders," said S&P Global Ratings credit analyst Geeta Chugh. 

According to the report, the next big banking failure in India could run the risk of disrupting local credit markets, interbank markets, payments, and even damage economic growth. 

"This contagion runs the risk of spreading to real estate companies too. Finance companies are the largest lenders to this segment and any failure among such institutions could jeopardize credit flows to developers," Chugh said. 

"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," Chugh added. "A governance deficit could also quickly turn to a trust deficit, hurting the stability of a bank."

It's likely that if one Indian bank fell, "the contagion could spread to other banks perceived to be struggling with the same problems as the failing bank," S&P warned.

S&P's report comes several weeks after Punjab Maharashtra Co-operative Bank (PMC) collapsed, while contagion at the moment is unknown, thousands of depositors have been locked out of their accounts, likely to never see their savings again. 

S&P says if the banking crisis widens in India, the Indian government will act "swift and orderly" to limit the contagion -- but with a synchronized global slowdown, and emerging markets getting slammed the hardest -- it's likely that a large banking crisis is brewing in India.