"This environment is characterized by slow economic growth, high inflation, high interest rates, and a weak local currency, and 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, vice president and senior analyst at Moody's said.
Moody's report comes a day after investment bank Morgan Stanly asked investors to stay away from several public sector banks citing asset quality problem.
According to the Reserve Bank, Indian banks need about Rs 5 lakh crore of additional capital to meet the Basel-III norms. Basel-III, which comes into effect from January 1, 2013, requires banks to maintain a minimum overall capital adequacy of 11.5 per cent (against the current nine per cent) by March 31, 2018.
The government has estimated capital requirement of Rs 15,000 crore for banks this year, while an infusion of Rs 90,000 crore has been estimated during the next five years to meet Basel-III norms.
Most of the Moody's-rated Indian banks will be challenged to maintain capitalization levels at current levels, and some will even need to raise new capital externally.
Moody's views the loan classification - more particularly with regards to restructured loans - and provisioning practices in India as weak.
The Bank Nifty on the NSE traded flat on Tuesday, in line with the broader markets, which were flat tracking global stocks.
On the positive side, Moody's said the strong business franchises of Indian banks support low-cost funding and help maintain sizable lending margins.
Moody's said the government provides strong support to public sector banks in the form of annual equity infusions, and all banks are mandated to meet loan quotas for certain sectors of the economy. This implies a high degree of involvement by the government in the banking sector and related public accountability.
Moody's believes that the government would provide extraordinary support in the form of unsecured loans and/or capital injections to both the public and the rated private banks.