Banks in India risk seeing their capital severely depleted if there is a rise in corporate defaults, warned global rating agency Moody’s.

“Indian banks are the most vulnerable because they have lower capital ratios, and their capital will be wiped out under our stress scenario,” Moody’s said, analysing banks in 13 Asia Pacific economies.

A prolonged period of low interest rates has resulted in companies building up leverage, which is hurting them now, in times of low economic growth coupled with growing trade and geopolitical tensions.

Most banks in the region have a good capital buffer, but those in India and Indonesia.

“Stress test on the impact of income shocks shows India and Indonesia are most prone to deterioration of corporates' debt repayment capacity, followed by Singapore, Malaysia, and China,” Moody’s said.

Under the stressed scenario assumed by Moody’s, capital ratios will decline by 1 percentage point to 4 percentage points in most economies “which will still leave banks with sufficient buffers,” but “Indian banks are the most vulnerable”.This is because while the ratio of corporate debt to GDP is relatively lower in India and Indonesia, “the distribution of debt is skewed toward highly leveraged corporate borrowers with low interest coverage ratios, and this has resulted in high loan default rates that have plagued Indian banks since 2011 and large stocks of restructured loans in Indonesia,” Moody’s said.

Companies in these two countries are also most prone to the deterioration in corporates' debt-servicing capacity.

“Our stress test shows that if Ebitda decline by 25 per cent, India and Indonesia will have the largest share of debt owed by corporates with debt/Ebitda ratios of more than 4 and interest coverage ratios (ICRs) of less than 1, as well as those with negative Ebitda.”

The weak corporate financial health is the result of a significant debt-driven expansion during 2009-12, which was followed by adverse business conditions, including an unexpected slowdown in economic growth, higher interest rates, and an acceleration of inflation, Moody’s said.

Key stressed sectors, such as power and other infrastructure, also face excess capacity and structural inefficiencies, including difficulties in obtaining regulatory permits, which lead to project delays and cost overruns.

But Indian companies have been deleveraging over the past few years, and banks have already recognised most exposure to troubled large corporate groups as bad debts, it said.