Global ratings firm Moody's on Monday upgraded the Indian banking sector's outlook from negative to stable as it expects bad loans to grow at a slower pace in coming months.

"The stable outlook on India's banking system over the next 12-18 months reflects our expectation that the banks' gradually improving operating environment will result in a slower pace of additions to problem loans, leading to more stable impaired loan ratios," said Srikanth Vadlamani, vice president and senior credit officer at Moody's.

The firm had downgraded India's banking sector to negative in November 2011 due to deteriorating asset quality. It rates four private sector and 11 state-run banks in India that account for around 70 per cent assets in the banking system.

While Indian banks, especially state-run lenders, have been trying to control their non-performing assets, the rating firm's decision comes after the government announced plans to inject Rs 70,000 crore into banks over the next four years. The plan also included introducing new frameworks of accountability and governance reforms.

Moody's said that though the banks' stock of non-performing loans may continue to rise, the pace of new impaired loan formation in the current financial year will be lower than the levels seen in the past four years.

It said that the stable outlook was based on assessment of five drivers: improving operating environment, stable asset risk and capital, stable funding and liquidity, stable profitability and efficiency, and stable government support.

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