India has a problem with its banking sector and it’s beating down equities

India is suffering from contagion in its banking system, with a mounting pile of non-performing loans, poor accounting standards and growing evidence of major banking fraud, unearthed over the last few weeks by government agencies.

India’s ratio of bad loans (as a percentage of total loans) is among the worst in the G20, just behind Russia and ahead of Brazil, Turkey and Indonesia, according to the IMF, though back in 2009 it was among the best in the world in this regard.

Standard & Poors Global Ratings said the recently detected fraud at Punjab National Bank underscores and urgent need for reforms in public sector institutions, with further losses for these banks being expected. Banking stocks were among the biggest fallers on the NIFTY50 last week, on top of significant monthly losses.

It’s an issue that the Narendra Modi’s Union government is taking steps to address. In October last year, the government unveiled a massive bailout plan to inject Rs2.11 lakh crore (equivalent to around $32.43 billion) into banks over the next 2 years to improve their capital positions. Stress tests conducted by the IMF last year on India’s 15 largest banks showed Indian lenders fell behind their emerging market peers including Indonesia, China and Russia in this regard. However it wasn’t all bad news – the IMF described 64 percent of the assets of the top 15 banks as ‘resilient’.

There are reasons to suspect that many more bad loans have not yet been accounted for. The latest corporate results from India’s largest lender (State Bank of India) showed the bank posted surprise losses of higher-than-anticipated bad loans, though officials from the bank claimed the worst is over.

The problems in banking have crept into the stock market too, unnerving foreign investors. If India wants to realise its true potential as an economy then the authorities will need to take a firm stance on the matter.

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