Global rating agency Moody’s has downgraded the long-term local and foreign currency deposit ratings of four public sector banks--Bank of Baroda, Bank of India, Canara Bank and Union Bank of India--from “Baa3” to “Ba1”.

It also downgraded Baseline Credit Assessments (BCAs) from “Ba3” to “b1” for these four PSBs as economic shock from Covid-19 may weaken borrower credit profiles and hurt banks' asset quality. The outlook on the ratings of all four banks is negative.

At the same time, Moody's has affirmed Punjab National Bank's long-term local and foreign currency deposit ratings at "Ba1" and its BCA at "b1". PNB's ratings outlook has changed to negative from stable, Moody’s said in a statement. The rating actions concludes the review for downgrade initiated on June 2, 2020.

Prolonged financial stress among households, weak job creation and a credit crunch among non-bank financial companies will lead to a rise in non-performing loans. This may delay the ongoing clean-up of banks' balance sheets.

The BCA downgrades take into consideration rising risks to the banks' asset quality as a result of the severe economic contraction, which will result in an increase in credit costs. The increase in credit costs will hurt profitability and strain the banks' modest capitalisation, reversing recent improvements. Funding and liquidity continue to be key credit strengths given their status as public sector banks, which results in good deposit franchises.

Moody's assumes of a very high probability of support from the Government of India (Baa3 negative) in times of need. It also factors in the banks' deposit market shares as well as their linkages with the government, including by way of ownership.

Referring to affirmation of rating for PNB, Moody's said that deteriorating asset quality and profitability will weigh on its capitalisation. However, PNB's financial metrics had been improving prior to the economic slowdown, which combined with the bank's good funding and liquidity mitigates the negative impact on its credit profile of deteriorating asset quality and profitability.