Chennai, Feb 23 (IANS): Global credit rating agency Moody's Investors Service on Thursday said continuing to increase non-watch list Non-Performing Loans (NPLs) would put pressure on Axis and ICICI banks' credit profiles.

On the other hand, asset quality trends for public sector banks were more benign, and the pace of deterioration was slowed in the past two quarters from the levels seen in FY2016, Moody's said

In its report 'Banks - India: Q3 Earnings Highlight Pressures from Demonetisation; NPL trends mixed', Moody's said: "Both of Axis Bank Ltd (Baa3 positive, baa3) and ICICI Bank Limited's (ICICI, Baa3 positive, baa3) have seen significant additions to their NPLs from outside of their already announced watchlist accounts.

"While we have been expecting asset quality to deteriorate for both, we had expected the deterioration to come predominantly from their watchlist accounts. A continuation of increasing the non-watchlist NPL trend would put negative pressure on the banks' credit profiles," Moody's said.

According to Moody's, asset quality for private sector banks was likely to deteriorate. Increased NPLs from outside the watchlists of Axis Bank and ICICI Bank are pressuring their credit profiles.

The earnings of Indian banks during the third quarter of the current fiscal show that the demonetisation of old Rs 500 and Rs 1,000 notes have slowed down economic activity and demand for credit, the agency said.

"Overall, demonetisation has significantly impacted credit demand and deposit growth, but the effect on asset quality has been mixed, while retail payment systems -- such as card transactions and mobile wallets -have benefitted," Srikanth Vadlamani, Moody's Vice President and Senior Credit Officer said.

According to Moody's, economic growth seems to be recovering from demonetisation, although gradually, which should cushion the impact on the banks' overall asset quality.

The rating agency also said deposit growth for the banks would be around one-two per cent due to demonetisation as the increase would moderate going forward.

Retail payment systems such as a cards and mobile wallets have seen a significant increase in transactions, and should continue to see healthy growth.

At the same time, given the low base, cash will remain the dominant source of retail transactions for the foreseeable future, Moody's said.

Net interest margins would also come under pressure as banks gradually adopt the marginal cost of funds lending rate (MCLR) to price their loans.

So far, less than 20 per cent of the banks' variable-rate loans have been repriced to MCLR as opposed to their base rate.

As the MCLR is around 85 basis points (bps) lower than base rate, Moody's expect the downward trend in net interest margins to persist.