Moody's Investors Service on Thursday changed the outlook for Indian banking system to negative from stable, as it expects deterioration in banks' asset quality due to disruption in economic activity from the coronavirus outbreak.

It said Banks' asset quality will deteriorate across the corporate, small and medium enterprises and retail segments, leading to pressure on profitability and capital.

'We have changed the outlook for the Indian banking system to negative from stable. Disruptions to economic activity from the coronavirus outbreak will exacerbate a slowdown in India's economic growth,' Moody's said.

Stating that asset quality will deteriorate, Moody's said a sharp decline in economic activity and a rise in unemployment will lead to a deterioration of household and corporate finances, which in turn will result in increases in delinquencies.

'Growing solvency stress among non-bank financial institutions will increase risks to banks' asset quality because banks have large exposures to the sector,' it added.

It expects deteriorating profitability and loan growth to hurt capitalisation.

'Increases in loan loss charges and declines in revenue will hurt banks' profitability, which will lead to a deterioration of capitalization. If the government makes more capital infusions into PSBs, as it has in the past few years, it will mitigate capital pressure for them,' it added.

It said while funding and liquidity at public sector banks (PSBs) will be stable, growing risk aversion in the system following a default by a private sector bank (Yes Bank) will increase funding and liquidity pressure on small private sector lenders.

'Disruptions from the coronavirus outbreak will exacerbate India's economic slowdown. A deterioration of global economic conditions and a 21-day lockdown imposed by the Indian government in an effort to slow the spread of coronavirus will weigh on domestic demand and private investment,' Moody's added.

Moody's rates 16 commercial banks in India, which together account for around 75 per cent of deposits in the sys