The write-off of Lakshmi Vilas Bank's (LVB) debt is likely to hurt investor sentiment toward lower-rated and smaller Indian banks, which would push up their financing costs.

Sok Yin Yong, Fixed Income Analyst Asia, Julius Baer said: "We expect to see a growing divergence in funding access between the top-rated Indian banks and the riskier segment of the financial sector. Meanwhile, above-target inflation is likely to keep RBI on hold as it meets this week."

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The write-off of LVB's debt is likely to hurt investor sentiment toward lower-rated and smaller Indian banks, which would push up their financing costs, as wary investors reassess their investments in Tier-2 notes following this event and demand higher yields, Julius Baer said.

Last Thursday, the Reserve Bank of India (RBI) announced that Rs 3.18 billion ($43 million) of Lakshmi Vilas Bank's (LVB) Tier-2 bonds will be fully written down. This took markets by surprise, as it came on the heels of the RBI-driven acquisition of the LVB by Singapore's DBS Group Holdings (DBS) announced on Tuesday, with the RBI-appointed administrator earlier stating that DBS would take over all of LVB's obligations, including bonds.

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"This incident has once again highlighted the risks in India's credit market and could lead to higher funding costs for smaller Indian banks, as investors become increasingly wary and demand higher compensation. This would add pressure to their already-challenged access to funding, at a time when non-performing loans (NPL) are expected to climb amid the Covid-19 fallout and as banks still need to raise capital to strengthen their buffer," Sok said.

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The debt moratorium granted by the RBI will end at some point in time. At the same time, the bailout of LVB by a foreign lender for the first time demonstrates the RBI's willingness to explore various means in working towards the resolution of weak banks, given the limited availability of lenders with strong capitalization in India to support bailouts, the analyst said. (IANS)