Moody's alters Indian banking system outlook to 'stable'

International ratings agency Moody's on Monday upgraded India's banking system to 'stable' from 'negative' due to an improvement in operating environment for banks.

"The stable outlook on India's banking system over the next 12-18 months reflects our expectation that the banks' gradually improving operating environment will result in a slower pace of additions to problem loans, leading to more stable impaired loan ratios," said Vice President and Senior Credit Officer Srikanth Vadlamani.

"But the pace of improvement is likely to be slow and steady as the recovery in asset quality is expected to be U-shaped rather than V-shaped, due to highly leveraged balance sheets," he added.

The agency's stable outlook is based on Moody's assessment of five drivers that includes Operating Environment (improving); Asset Risk and Capital (stable); Funding and Liquidity (stable); Profitability and Efficiency (stable); and Government Support (stable).

Moody's expects India to record a GDP growth of around 7.5 percent in 2015 and 2016. Growth has been supported by low inflation and the gradual implementation of structural reforms.

While the government's plan to inject Rs 70,000 crore is a credit positive, the ratings agency points out that it is still short of the banks' overall capital requirements. "Ability to access equity capital markets remains key if the PSU banks have to address their capital shortfall," states the report adding that by contrast, high capital levels are a credit strength of the private-sector banks that Moody's rates.

Moody's rated 15 banks, including four private-sector banks and 11 PSU banks in India, which together account for around 70 percent of system assets.