Moody's also said the Indian banking system is moving past the worst of its asset quality down cycle.
In a statement, Moody's said capital levels remain a key credit weakness for state-owned banks.
The government announced capital infusion falls short of the amount needed for their full capitalisation.
The potential way to bridge this capital shortfall would be to slow loan growth to the low single digits over the next three years, the rating agency said.
According to Moody's Vice President and Senior Credit Officer Srikanth Vadlamani, the stock of impaired loans may still increase for Indian banks but the pace of formation should be lower than what it has been over the last few years.
"The performance of India's state-owned and private banks continues to diverge," adds Vadlamani.
"The state-owned banks will require significant capital over the next three years with limited access to the capital markets, while the private banks benefit from solid capitalisation and good profitability," he said.
Moody's has given a stable outlook for Indian banking system based on its assessment of five drivers: Operating Environment (stable); Asset Risk and Capital (stable); Funding and Liquidity (stable); Profitability (stable); and Government Support (stable).
According to Moody's the operating environment for Indian banks is supported by stabilising economy with a projected gross domestic product (GDP) growth of 7.4 per cent over the next two years, compared with 7.3 per cent in 2015.
