India’s shadow banking sector has been thrust into the spotlight over the past few weeks, triggered by news that the Infrastructure Leasing & Financial Services (IL&FS) Group is likely to miss several debt repayments this year. Fears over contagion in the sector have caused funding costs to jump and there has been a sharp drop in non-bank financial (NBFC) stocks. As it happens, we think that the risk of a systemic crisis in the shadow banking sector is manageable. NBFC balance sheets in are healthier shape than those of their bank counterparts. In addition, much of the shadow banking sector is state-owned, which raises the possibility of government intervention if there were signs that contagion was spreading. Nevertheless, problems in the shadow banking sector could weigh on economic activity over the coming quarters. NBFCs have contributed a large share to new credit growth. The implication is that higher funding costs for NBFCs could now weigh on new lending, which in turn would have a negative impact on both household consumption and investment.
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