India’s burgeoning shadow finance sector is likely to face a shake-up after defaults at one major lender battered the nation’s financial markets in the past week and reinforced worries about credit risk.

Industry officials and experts say they expect Indian regulators to cancel the licences of as many as 1,500 smaller non-banking finance companies because they don’t have adequate capital, and to also make it more difficult for new applicants to get approval.

The Reserve Bank of India (RBI), which has been tightening rules for non-banking financial companies (NBFCs), did not respond to requests for comment.

Infrastructure Financing and Leasing Services Ltd (IL&FS) , a major infrastructure financing and construction company, sent shockwaves through the NBFC sector when it defaulted on some of its debt obligations in recent weeks.

Then last Friday, a large fund manager sold short-term bonds issued by home loan provider Dewan Housing Finance at a sharp discount, raising fears of wider liquidity problems.

“The way things are unfolding, there is certainly cause for concern and the sector could see consolidation,” said Harun Rashid Khan, a former deputy governor at the RBI and now a non-executive Chairman at Bandhan Bank Ltd,.

The spotlight has now been turned on thousands of ‘high-risk’ small players dominating lending in villages and towns.

The shadow banking sector now comprises more than 11,400 firms with a combined balance-sheet worth ₹2,210 crore ($304 billion), and is less strictly regulated than banks. It has been attracting new investors, particularly as the nation’s banks have had to slow their lending as they seek to work through $150 billion of stressed assets.

The NBFC loan books have grown at nearly twice the pace of banks, and the cream of them, including IL&FS, had received top credit ratings.

Rising borrowing costs, exacerbated by the turmoil in markets in recent days, will lead to a credit crunch in the sector and make it difficult for firms that aren’t well capitalised to survive, according to top investors in the sector.

“Smaller NBFCs will face the problem of cost, their quantum of liquidity may not be the same as they are getting now. But medium and large-sized NBFCs should be able to achieve their volume as well as access to funds,” said Rajesh Sharma, owner of Capri Global Capital, an NBFC that had a loan book of ₹1,250 crore ($172 million) in the last fiscal year.

Nearly 11,000 of India’s NBFCs are small and medium-sized businesses with an asset base of less than ₹5 billion. But the top 400, many of which are backed by banks and finance companies, control about 90 percent of the assets under management.

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