Shadow bank woes may continue to haunt stock market after disrupting rally

India’s shadow banking crisis has sucked in more financial firms this week, eroding a stock market rally that’s been driven by a surprise $20 billion tax cut package.

The S&P BSE Sensex Index posted its third day of losses on Tuesday, ending a surge since the Sept. 20 announcement of the tax cuts. Financial stocks, which account for 45 per cent of the benchmark index, contributed the most to the declines since late last week, according to data compiled by Bloomberg.

Debt concerns at lenders including Indiabulls Housing Finance Ltd. and a co-operative bank, and worries a cleanup in corporate debt could be prolonged, have spooked the financial markets. The sight of depositors lining up to pull their money from Punjab & Maharashtra Co-operative Bank Ltd., after the central bank put limits on lending, has also been unsettling.

The Reserve Bank of India on Friday tweeted the “banking system is safe and stable and there is no need to panic.” The nation’s stock markets will reopen Thursday after a one-day holiday.

Banking Troubles

• Punjab & Maharashtra Co-operative Bank concealed large exposures from RBI since 2008, a former managing director said
• Central bank put restrictions on Lakshmi Vilas Bank Ltd., which Indiabulls Housing plans to acquire
• Yes Bank Ltd.’s shares plunged almost 34 per cent in two days on concerns a cleanup in corporate debt could drag on

Here is what the analysts are saying:

Stay Selective

Negative news flow around lenders has “overshadowed the recent tax cut tailwind, bringing focus back on sector issues: liquidity issues and contagion risks,” Jefferies Financial Group Inc. analysts including Bhaskar Basu wrote in a note on Tuesday.

Basu said he likes non-bank lenders with a strong liability base, low asset quality risks and good earnings visibility. He prefers stocks including Bajaj Finance Ltd. and Mahindra & Mahindra Financial Services Ltd.

Negative Impulse

Credit Suisse Group AG on Tuesday warned that “banks are not likely to grow their loans” as companies are likely to retain almost 90 per cent of the savings spurred by the tax cuts. Materials, energy and industrial companies are not planning any new capital expenditure, Neelkanth Mishra, the broker’s India strategist, wrote in a note on Oct. 1.

Renewed Concerns

There have been “renewed concerns” around India’s banking system’s stability in the last week but the corporate tax cuts will help economic growth, UBS Group AG strategist Gautam Chhaochharia said in a television interview with Juliette Saly and Rishaad Salamat.

Chhaochharia’s June 2020 target for the NSE Nifty 50 index is 12,300 and he remains overweight on financial, property and oil & gas stocks.