Moody's Investors Service's annual Banking System Outlook on India estimated the country's real gross domestic product (GDP) for the current financial year and next financial yea to grow at 7.2 per cent and 7.4 per cent, respectively.

In its banking system outlook published on Monday, the global rating agency stated that the growth will be driven by investment growth and strong consumption. It also stated that the operating environment will be stable, supported by robust economic growth.

It, however, asserted that liquidity constraints at non-bank finance institutions (NBFIs), increasingly important providers of credit for the economy, will be a drag on growth. "Also, rising interest rates are a risk," the report read.

Moody's added that asset quality will remain stable, but weak as cleanup of legacy problem loans nears completion and corporate health improves. "Banks have recognised the bulk of legacy problem loans and will start making recoveries from large resolved nonperforming loans (NPLs), which will help shore up asset quality, although the degree of success in resolution of large NPLs will determine the extent of asset quality improvements," the report mentioned.

It said that corporates' financial health will limit new NPL formation while adding that stress among NBFIs is a risk.

Moody's also noted that capitalisation at public sector banks will remain weak but government support will provide relief. "Public sector banks will continue to grapple with weak capitalisation and depend on government capital injections to meet minimum capital requirements," it added.

The report also mentioned about Net interest margins (NIMs) while stating that profitability will improve but remain weak due to high credit costs. "NIMs will widen marginally thanks to a reduction in NPLs and a strengthening of banks' pricing power amid woes surrounding debt capital markets, which make bank loans more attractive for corporate borrowers. However, credit costs at public sector banks will remain high despite a decline, and this will weigh on system-wide profitability."

Affirming that funding and liquidity will remain strong, the report added, "Banks are largely deposit funded and liquidity coverage ratios (LCR) of all banks are above 100 per cent. In particular, funding and liquidity profiles of public sector banks will remain resilient, notwithstanding their solvency challenges."

"Government support for public sector banks will remain strong. Capital infusions over the past few years for all public sector banks facing capital shortfalls and other government measures, provide strong support for our assumption of very strong government support for public sector banks," it added.