The credit outlook for the Indian banking system remains negative because of poor asset qualities and rising problem loans, according to global rating agency Moody’s.

“The fundamental credit outlook for the Indian banking system remains negative, having changed from stable in January 2009,” said Moody’s Investors Service division in its new Banking System Outlook on India report released Monday.

According to it, this reflected “the challenging economic conditions and rising levels of problem loans and the resulting adverse implications for asset quality”.

“Our main concern about the Indian banking system is the deteriorating asset quality and the volume of restructured loans,” said Moody’s vice president and senior analyst Nondas Nicolaides.

Last fiscal, Nicolaides said, the absolute level of gross non-performing loans (NPLs) for Indian commercial banks increased 22.5 percent compared to about 12 percent the year before.

“Although the NPL expansion must be seen in the context of the problems faced by banks globally over the past couple of years, the rapid expansion of retail lending in recent years, combined with the slowdown of the Indian economy, has led to increased delinquency rates, especially for unsecured retail loans.”

Moody’s, however, said the profitability of commercial banks has improved in recent years with core income benefiting from the high lending environment and net interest income rising.

At the same time, it said, banks’ profits could be affected in the short term by the central bank’s recent requirement that they increase their NPL provision cover ratio to at least 70 percent by September 2010.

“In particular, more diversified earnings profiles will act as positive drivers for bank financial strength ratings,” Nicolaides added.

More In: Economy | Business