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S&P Global Ratings said on Monday the recommendation by a committee of the Indian central bank to allow large industrial conglomerates to set up banks, as part of the proposed changes for the country's banking sector, is fraught with risks.

A working group at the Reserve Bank of India recommended a series of changes, details of which were made public last week, that include allowing industrial houses to act as so-called bank promoters, meaning they could take a major stake in a lender.

"The working group's concerns regarding conflict of interest, concentration of economic power, and financial stability in allowing corporates to own banks are potential risks," the note said.

Corporate ownership of banks raises the risk of inter-group lending, diversion of funds and reputational exposure, S&P said, adding that contagion risk from corporate defaults will also rise significantly if industrial houses are at the helm of a bank.

Last week, India placed a private lender under moratorium for a month due to a "serious deterioration" in its finances..

Non-performing assets (NPA) within the corporate sector remains elevated even though it has come down from 18% in March 2018 to 13% in March 2020, said S&P.

The panel's recommendations also includes allowing shadow banks to convert into lenders, which could improve financial stability, the ratings agency said.

The central bank has invited comments on the committee's report, which can be submitted until Jan. 15, 2021.

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