Moody's Investor Service on Wednesday downgraded its outlook for India's banking system to "negative" from "stable", as it warned of slowing growth at home and overseas hitting asset quality, capitalization and profitability.

A curbing of economic growth and increased borrowing by the government will drain funds from the private credit market, the ratings agency said in a statement, pressuring lenders in Asia's third-largest economy.

"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," Vineet Gupta, Moody's vice-president and senior analyst, was quoted as saying in the statement.

Moody's defines a "negative" outlook as one characterized by volatility and uncertain conditions.

The BSE banking index fell on the news of the downgrade to 11,307.99 at 9:37 a.m., down 0.1 percent, against a 0.2 percent rise in the benchmark index.

The ratings agency said monetary tightening and a slowdown in the economy would cut bank loan growth, while a recent liberalization of savings deposit rates by the central bank would pressurize lenders' profitability.

In October, shares in State Bank of India, the country's largest lender, had fallen to their lowest level in 2 years after Moody's cut its standalone rating to D+ from C-.

On Wednesday, State Bank shares erased early gains and were trading down 0.2 percent at 1,993 rupees ahead of the bank's quarterly earnings.

"For those banks with weaker capital ratios on average and higher asset quality pressures relative to their individual rating levels, their standalone ratings are likely to come under pressure," the Moody's statement added. 

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Moody: India Banking