With already weak capital buffers, public sector banks in India will need external capital injection of Rs 1.9-2.1 trillion over next two years to restore loss absorption capacity, according to Moody’s.

The most likely source of capital to plug these capital shortfalls is the government, despite its completion of a large recapitalisation just a few months ago.

Alka Anbarasu, Vice President and Senior Credit Officer, Moody’s, said PSBs dominate India's banking system, meaning any failure could jeopardise financial stability.

The sharp slowdown in India's economic growth, exacerbated by the coronavirus outbreak, will hurt public sector banks' (PSBs) asset quality and drive up credit costs. The Non-Performing Loans (NPLs) ratio will rise to 14.5 per cent by March 2022 from 11 per cent as of March 2020.

Moody's expects retail and micro, small and medium-sized enterprises (MSMEs) will lead a rise in NPLs, delaying the ongoing clean-up of legacy corporate NPLs.

The banks will require approximately Rs one trillion to build loan-loss provisions to about 70 per cent of NPLs, and a similar amount to grow loans 8-10 per cent annually – faster than the four per cent recorded in fiscal 2020 and supporting economic expansion.

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Moody's base case assumes a sharp contraction in the Indian economy in fiscal 2021, before returning to modest growth in fiscal 2021. Even before the coronavirus outbreak, the economy had already been growing at its slowest pace in six years, it added.