Moody's Investors Service has retained its negative outlook on the Indian banking system for the next 12-18 months, as slow economic growth, high inflation, high interest rates, and a weak local currency continue to pose challenges.
The rating agency has been negative on Indian banks November 2011.
"...We expect these factors to lead to a further deterioration in asset quality, an increase in provisioning costs, and a fall in profitability," Vineet Gupta, a vice president and senior analyst at Moody's, was quoted as saying in a press release.
Recently, the government informed Parliament that bad loans of public sector banks increased from March to September.
Minister of State for Finance Namo Narain Meena told the Rajya Sabha that the gross non-performing assets of public sector banks rose to Rs 1,43,765 crore as of end September from Rs 1,12,489 crore as of end March.
During July-September, banks' asset slippage remained high at 4 percent of loans, according to a research note by Credit Suisse.
The asset quality stress is visible at the banks, with total problem assets for many banks now 12-14 percent of loans, it had said.
Adding to the rising bad loans is the problem of the mismatch between the rise in loan demand and internal capital generation.
"...When we also consider the high level of loan growth which, at about 15% annually, is expected to continue outstripping internal capital generation, then most of the Moody's-rated Indian banks will be challenged to maintain capitalisation levels at current levels, and some
will even need to raise new capital externally," Gupta said.
According to Moody's, the loan classification, especially regarding the restructured loans, and provisioning practices in India as weak.
"Loan classification and provisioning requirements mask the extent of the banks' asset quality and capital challenges," the release said.
The positive side for the Indian banks is the their strong business franchises, which support their low-cost funding profiles. This helps them maintain sizable lending margins to sustain pre-provision earnings, Moody's said.
The government's high degree of involvement in the banking sector and related public accountability accords higher systemic support for the sector, it said.
The government already provides strong ongoing support in the form of annual equity infusions for the public sector banks, and all banks are mandated to meet loan quotas for certain sectors of the economy, Moody's said.
It expects the government to provide extraordinary support in the form of unsecured loans and/ or capital injections to both public and rated private banks if required.