Global ratings agency Standard & Poor's (S&P) called for a multi-pronged strategy to help banks tide over asset quality issues, saying stronger economic growth and improvement in fiscal situation alone cannot resolve the crisis, said the media report.
The agency noted that while improvements in policy making have raised prospects for a stronger economic and fiscal performance, there is need for action on other fronts to improve the weakness in asset quality, which it termed as a "risk".
"Economic risks could increase in the absence of such steps and lead to a continuous increase in stressed assets for the banking sector," S&P said.
It added that for the next 12 months, it expects risks from economic imbalances to be low as credit growth remains moderate and inflation-adjusted property prices are likely to decline.
However, the report said the economic risks trend, which affects the banking sector, is "negative".
Gross non-performing assets (NPA) grew to 4.8 per cent as of the quarter ended September, from 4.4 per cent in the previous three months, according to domestic rating agency ICRA.
The report said the "modestly improving reform momentum" will promote "greater economic flexibility and help build fiscal buffers, which are currently weak".
"The country's credit risk remains high, with weak foreclosure laws accentuating challenges despite moderate private sector debt," the agency added.
The banking sector was placed in group '5' under its Banking Industry Country Risk Assessment (BICRA), which is on par with other large emerging economies like Brazil, China, South Africa, Spain, Poland, United Arab Emirates, Peru, Colombia, Trinidad & Tobago and Bermuda.
Banks benefit from high levels of stable core customer deposits, which limit dependence on external borrowings, it said, adding that the system's good franchises, extensive branch networks, and large domestic savings will continue to support the deposit base.
The agency also expressed satisfaction with the regulations, calling them at par with international standards.
It said that the Reserve Bank of India is "strengthening regulations and the supervision of banks and non-banking finance companies."
The agency said the priority sector lending and the dominance of state-run banks "create some market distortion".
With many of the entrenched players expressing fears on the entry of newer forms of banks, like payments and small finance banks, S&P said the impact will be limited in the near-term.
"The domestic banking sector is under-penetrated, with a large section of the population not having access to bank credit, deposits, investments, and other banking services," it said, adding GDP growth and higher savings rate should provide room for growth of "efficient banks".