MUMBAI (Reuters Breakingviews) - Sunlight can be a helpful disinfectant. India’s shadow banks have grown rapidly in recent years, extending loans for the purchase of everything from a house to a car or a laptop. Yet almost one year on from the default of a major alternative lender, Infrastructure Leasing & Financial Services, many others are still struggling to secure funds. The default on a payment by Altico Capital to a Dubai-based lender on Thursday highlights the stress. A central bank led-review could restore confidence in the quality of their assets and help reverse India’s sharp consumption-led slowdown.

Non-bank institutions depend on external funding, instead of deposits. For the first few months after IL&FS spooked the markets last September, the money dried up. Things have improved since. Bond issuance remains weak but traditional banks have picked up some of the slack, extending more loans. Unfortunately, both sources of funds have also become pickier.

Large banks can’t keep piling on exposure. Upstart lenders have already significantly contributed to what Ashish Gupta’s team at Credit Suisse calls a “second wave of stress”. They reckon, out of troubled debt worth 2.4 trillion rupees ($33 billion) across 16 companies now being settled between banks, about half relates to loans extended to shadow banks. One particular worry is residential real estate, where unsold inventory is piling up.

The pain is clear in both funding costs and share prices: a handful of shadow banks have lost between 40% and 90% of their market capitalisation over the past year, led downwards by Dewan Housing Finance. That, in turn, has led to a flight to quality. Stock in the star performer, $26 billion Bajaj Finance , has risen 20% over the same period. It is eyeing a large share placement to make the most of its dizzying valuation, hovering around 7 times forward book value.

For the rest, letting the frail collapse slowly is one option, but it will not help an economy cooling because Indians are barely spending. A faster fix would be for the central bank to review all troubled non-banks and let the market know where there is a big divergence in bad debt assessments. That’s what they did in recent years with traditional outfits. For those struggling to tap funds and with their equity value sharply eroded, there’s little to lose.

CONTEXT NEWS

- Bajaj Finance has picked banks including Nomura and Kotak Mahindra Bank to arrange a share issue of $1 billion, Bloomberg reported on Sept. 5, citing people familiar with the matter. The company plans to sell the shares by December, the report added.

- A filing on the same day said that the board of Bajaj Finance would meet on Sept. 17 to consider a proposal to raise funds via a so-called qualified institutional placement.

(Editing by Clara Ferreira Marques and Sharon Lam)

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