Banks' gross NPA levels to be at 8-8.5% in FY17: Icra

"Significant improvement in asset quality will hinge upon economic recovery in credit intensive sectors, as well as successful execution of deleveraging efforts by some stressed corporate groups," he said.

The report said credit growth is likely to be in the range of 11-12 percent in 2016-17, primarily driven by retail and other smaller ticket loans.

In the last fiscal, banks' aggregated deposits grew by merely 6.4 percent as against 10.3 percent in 2014-15.

"Sluggishness in deposit growth could be on account of psychological impact on depositors following a decline in nominal interest rates on deposits, significant raising of tax-free bonds over the last few years providing alternative safe savings avenue, increase in limit for remittances and banks reducing dependence on large ticket deposits on the back of muted credit growth," the report said.

According to the agency, deposit growth will be in the range of 10-11 percent in the current fiscal.

The report said relaxations in Basel III norms in March 2016 improved state PSBs tier-1 capital by 30-100 basis points.

Despite relaxations, infusion of Rs 25,000 crore by the government and low credit growth, state-run banks' capitalisation remained low with aggregated tier 1 at around 9.1 percent as on March 2016.

"PSBs will need Rs 40,000-50,000 crore tier 1 capital raising in this fiscal as against as against government capital infusion plan of Rs 25,000 crore," it added.

Over the next three financial years, state-owned banks will need tier 1 capital of Rs 1.7-2.1 trillion.

The rating agency said public sector banks' profitability is not expected to improve significantly in 2016-17 and return on equity (RoE) will remain in single digits.