Chennai, Oct 29 (IANS): Credit rating agency Moody's Investors Services (MIS) Wednesday gave a negative outlook for Indian banking system on the grounds that high leverage in the corporate sector could prevent meaningful recovery in asset quality.

In a statement issued in Singapore, MIS, citing its research report, said its outlook on Indian banking system is negative reflecting its view that high leverage in the corporate sector could prevent any meaningful recovery in asset quality over the next 12-18 months.

"The negative outlook on the Indian banking system pertains mainly to the public sector banks, which represent more than 70 percent of total banking system assets," Gene Fang, vice president and senior credit officer, was quoted as saying in the statement.

"These banks have experienced higher growth rates in non-performing and restructured loans, as well as greater weakening in profits, than private sector banks, and these trends are unlikely to improve for public sector banks," he added.

"Going forward, India's corporate sector will remain highly levered, representing an obstacle to a cyclical recovery in asset quality."

The MIS' report looks at India's banking system in terms of five factors: operating environment (which is classified as "stable"); asset quality and capital ("deteriorating"); funding and liquidity ("stable"); profitability and efficiency ("deteriorating"); and systemic support ("stable").

While MIS expects economic growth will pick up moderately, growth remains constrained by the high interest rates needed to contain inflation.

According to the report, the best case forecast is for gross domestic product (GDP) growth of five percent for the fiscal ending March 2015 and 5.6 percent for 2016, compared with 4.7 percent in 2014.

According to MIS report, India's broad corporate sector is highly levered, with a debt-to-equity ratio of more than 3.0x.

In particular, corporates engaged in infrastructure projects face both structural and cyclical challenges.

Without a stronger economic recovery, significant deleveraging will only occur beyond the horizon of this outlook, the report added.

And although the new government of Prime Minister Narendra Modi may formulate some policies within the 12-18 month horizon of this outlook, it will take longer to see an impact on the real economy, it noted.

Profitability will also remain under pressure as banks continue to provide for problem loans. This is particularly problematic for public-sector banks, which have lower pre-provision margins and greater asset quality problems.

However, funding and liquidity will remain stable, given high domestic savings rates and a low reliance on market funding.

The MIS expects that a high degree of support from the Indian government for bank creditors will remain in place over the outlook horizon.

If senior creditors of an ailing public-sector bank were required to absorb losses, this could easily risk contagion of financial distress to other public-sector banks, given their similar business models and credit characteristics.

The MIS rates four private sector and 11 public sector banks in India that collectively account for 67 percent of system assets.