Moody’s Investors Service downgraded the outlook for the Indian banking system to negative from stable; citing slowdown in domestic economic growth, demand stifled by high interest rate and weaker asset quality affecting profitability.

Moody’s vice-president Vineet Gupta quoted his pessimistic outlook as:

“With asset quality, given the tightening environment, we anticipate that it will deteriorate over the next 12-18 months, thereby causing an increase in provisioning needs for the banks in FY2012 and FY2013.”

Banks 

The rating agency also voiced its concerns regarding economic and debt crisis originating from the US and the Euro zone, putting breaks on Indian growth rate and questioning the sustainability of overseas demand for Indian goods and services.

Earlier, Moody’s had also downgraded the stand-alone rating of State Bank of India to D+ from C- on the back of its modest capital, weakening asset quality and lower baseline credit assessment of Baa3 level. The state-run banking major’s NPA stood at 3.52% of its assets as of June 2011.

Moreover, the prevailing high interest rate regime would slowdown incremental loan disbursals; even as chances of default rise for the existing loans with high loan EMI’s. Further, the recent deregulation of Savings deposit interest rates is likely to put strain on banks’ profitability, in their bid to lure low-cost CASA funds.

Lowering of credit outlook of Indian banking system would also raise its risk premium, leading to higher borrowing costs for these finance institutions while they set out to raise funds in the overseas market in future.

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