India's private banks suffer after RBI tightens monetary policy India's private sector banks have proved to be among the country's most resilient companies during its recent economic downturn - but perhaps not for much longer. Tuesday's moves by the Reserve Bank of India to bolster the rupee by tightening liquidity levels in the overall economy, in part by increasing bank borrowing costs, caught the sector by surprise, sending shares sharply down. The Bombay Stock Exchange's Bankex index of leading financial stocks fell a further 2 per cent on Wednesday, adding to the 5 per cent it lost the day before in the aftermath of the RBI's announcements. Banks that are especially reliant on wholesale funding have been hit particularly severely, notably Yes Bank, part of India's newest generation of private banks founded in the mid-1990s, whose shares dropped 6 per cent on Wednesday. This added to a 10 per cent decline the previous day, a fall that provided only the most dramatic focus for a broader sell-off that has dented other smaller wholesale-funding dependent private institutions, including Kotak Mahindra Bank. Rana Kapoor, Yes Bank's managing director, backed the RBI's policy moves, but said markets had overreacted to the changes, arguing that his own institution enjoyed a stable, diverse funding base and was not dependent on wholesale finance. This is how markets are sometimes, when something looks like bad news. But I think it will correct very soon," he told the Financial Times. India's banking sector is dominated by state-backed institutions, but its private operators, which control about a fifth of banking assets, have long found favour with international investors. Yet newly-heightened jitters over the sector's future appeared to be underlined when HDFC Bank, often seen as the country's best managed private institution, produced first-quarter results broadly in line with market expectations, only to suffer a share price fall of about 3 per cent. The immediate cause were HDFC's non-performing asset levels, which ticked up in absolute terms compared with the previous quarter, raising concerns that even high performing private institutions may no longer be immune to the bad loan issues that have dogged the country's state-back institutions over the past year. However, Tuesday's policy changes are now likely to make private banks less attractive to investors in general, as indicated by Morgan Stanley's decision to downgrade its outlook on the entire Indian financial services sector in the aftermath of the RBI's announcement. "The trouble is that the private banks were one of the few sectors investors still liked during the downturn," says Nick Paulson-Ellis, the head of broker Espirito Santo's Indian office. But it now looks as if they are going to have to think again about the wholesale-dependent new-generation banks, leaving HDFC Bank as the best option. Much now depends on how India's central bank decides to manage its new, tighter liquidity controls. Yes Bank's Mr Kapoor forecasts the measures will be held in place for just 90 days, before being reversed once India's currency has settled. But if they are kept in place for longer, as some analysts fear, their effects may begin to be felt more broadly by India's private and state-backed banks alike. "It all depends on how long these measures last," says Anish Tawakley, banking analyst at Barclays in Mumbai. If it is a short-term thing, those affected will recover. But if it lasts for a long time, then eventually it will hurt growth and that will impact the entire sector.