Moody's, on Monday, downgraded three top private sector banks — ICICI Bank, HDFC Bank and Axis Bank — on growing concerns over the country's sovereign debt ratings and low level of cross-border diversification of their operations.

Moody's also downgraded Life Insurance Corporation of India (LIC) following its recent investments in the oil and gas giant Oil and Natural Gas Corporation (ONGC). The LIC lost its higher rating as Moody's downgraded it from Baa2 to Baa3, although it kept the outlook stable.

“LIC's increased investment in ONGC and increasing investment in public sector banks are credit-negative,” Moody's Investors Service analyst and Assistant Vice-President for financial institutions group Stella Ng said, adding that its overexposure to state-run banks was also a concern.

Ng, however, added that the agency “sees no change to LIC's rating after sovereign rating action and therefore retain our stable outlook for the company.”

Moody's believes that the credit quality of financial institutions, with high levels of domestic sovereign debt holdings, and low geographically diversified revenue and earnings sources, is closely linked to the sovereign's credit strength, said Moody's in a statement on Monday.

Moody's lowered the standalone ratings of the three private sector banks to the sovereign ratings level of D (+) from the earlier C (-). At the same time, the rating agency has downgraded the hybrid ratings of Axis Bank and ICICI Bank to Ba3 (hyb) from Ba2 (hyb).

“Our review indicated that there are little, if any, reasons to believe that these banks would be insulated from a government debt crisis…..these three banks are primarily domestic institutions with similar macroeconomic exposures as the sovereign government”, said Moody's in a statement.

Another rating agency, Standard and Poor's cut India's credit rating outlook last month (April 25) to negative from stable, citing large fiscal and current account deficits and political paralysis affecting reforms to bring in economic changes in the country.

LIC has rapidly increasing direct or indirect exposures to the government through its holdings of government securities and its equity investments in government-related entities, including banks and corporations.

More appropriate

Moody's views the lower rating, which is now positioned at the rating of the Indian government, as more appropriate to capture the credit profile of LIC.

It also said that LIC's credit strength was very much closely linked to the Indian's sovereign, which justifies the insurer's current rating.

“We don't believe this would have any material impact on the financial strength of these banks. We maintain our bias towards private sector banks,” said Kotak Securities.

This downgrade has to do more with the lower sovereign ratings of India. The standalone credit assessment ratings of these banks were above India's sovereign debt rating, it added.