Global credit rating agency Moody's Investors Service has revised its outlook for India's banking system to negative from stable.
It also warned that bank ratings may come under downward pressure.
This change in outlook is due to concerns that an increasingly challenging operating environment will adversely affect asset quality, capitalisation, and profitability of Indian banks.
“India's economic momentum is slowing because of high inflation, monetary tightening, and rapidly rising interest rates,” said Mr Vineet Gupta, Vice-President and Senior Analyst, Moody's.
At the same time, Mr Gupta said, concerns have emerged over the sustainability of the recovery in the US and Europe, and the rise in the borrowing programme of the Indian Government, which could drain funds away from the private credit market.
According to Mr Pratip Chaudhuri, Chairman, State Bank of India, the agency's earlier experience in overseas markets may have prompted it to believe the worst.
Emphasising that the Indian banking system was stable, Mr Chaudhuri averred that unlike their counterparts in the West, Indian banks did not have any hidden assets, did not deal in exotic products and were conservatively leveraged.
Mr Hemant Contractor, Managing Director, SBI, said the change in outlook by Moody's will not come in the way of his bank raising funds at competitive interest rates from overseas markets.
Given the tightening environment, Moody's is anticipating that banks' asset quality will deteriorate over the next 12-18 months, thereby causing an increase in provisioning needs in 2012 and 2013.
The rating agency expects loan growth to be a strain on the banks' capital over the next 12-18 months. As monetary conditions tighten and economic activities slow, it sees bank loan growth falling to 16-18 per cent in 2012 and 2013, from 21 per cent in 2011.
Asset quality to deteriorate
When it comes to profitability, Moody's expects it to come under pressure due to lower interest margins as deposit rates re-price and get a further push from the latest liberalisation on savings deposit rates.
For those banks with weaker capital ratios and higher asset quality pressures, their standalone ratings are likely to come under pressure as underscored by Moody's downgrade of SBI's banking financial strength rating on October 4.
Positive side
But, on the positive side, Moody's recognised Indian banks' stable customer deposit base and high level of government securities holdings, which provide them with a resilient funding and liquidity profile that buffer them against destabilising shocks.
Moody's also expects the Government to remain committed towards providing support to both public and ‘private' banks. Such potential support translates to an average one-notch uplift to the banks' debt and deposit ratings to ‘Baa2', compared with their standalone base line credit assessment of ‘Baa3'.