An analysis by Moody's Investor Service revealed that the stable outlook forecast for the Indian banks over the next 12-18 months is based on "favorable operating conditions, solid capital levels, a strong retail deposit funding base and sound liquidity."

However, these positive factors are balanced by the need to manage the accelerating pace of loan growth and recent asset quality challenges, particularly consumer lending, said Moody's.

The report said though the banks are likely to witness high credit growth with GDP expected to expand to its pre-financial crisis level of nearly nine percent annually, "potential downside risks, emanating from still-high levels of inflation" remain.

Moody's also warned of the risks "of an overheating economy, including the probable formation of asset bubbles, given our expectation of continued strong economic and credit growth, while real estate prices in metropolitan areas and equity markets have already recaptured their pre-crisis peaks."

"Regulatory limits on Indian banks' exposure to sensitive sectors, including capital markets, somewhat tamper our concerns, as does our view that the asset quality pressures faced by Indian banks over the past two years will moderate," said the report, referring to the asset quality which is expected to improve next year as industrial companies return to utilizing their full capacity.

"We expect loans that were restructured during the past two years to perform relatively well, as their track record so far suggests minimal slippages into problematic status," it added, pointing towards the moderate deterioration in asset quality despite reduced demand for Indian exports and higher delinquencies on unsecured personal loans.

India's banking system remains resilient and it has the buffers to absorb the envisaged losses," said Moody's.

However, it cautioned that Indian banks do have high loan concentrations relative to their equity base and this "systemic vulnerability is unlikely to change significantly".

"Even while the banking system is generally well capitalized, the Indian government is likely to continue infusing fresh equity into public sector banks as part of its recapitalization plan," said the report.

Private sector banks have sufficient capital to grow at above system average rates over the next one to two years, it added.

"One of the Indian banking system's strengths is its favorable funding profile, driven mainly by retail customer deposits and a minimal reliance on wholesale funding which provides stability to the banks," said the report.

Indian banks generally have sizeable state securities portfolios which are available to obtain immediate liquidity from the RBI through repurchase transactions. These holdings, the report said, provide the capacity to handle occasional and transient tight local currency liquidity conditions arising out of material corporate payments.

Moody's expects Indian banks to grow at a compounded annual rate of 20 per cent for the next three years.

"Overall banking profitability will grow in the coming quarters," said Moody's. "Recurring earnings, especially for public sector banks, are likely to remain highly dependent on net-interest income in view of the traditional banking model followed in India."