Why India’s Troubled Shadow Banks Spook the Market

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?

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.