Moody’s Investors Service has revised its outlook on Pakistan’s banking sector from “negative” to “stable,” citing strong profitability, stable funding, and liquidity as factors providing a sufficient buffer against macroeconomic challenges and political turmoil. The international rating agency forecasts a return to 2% economic growth in 2024, easing economic and fiscal pressures for the country, with an expected decrease in inflation from 29% to 23%.
The report highlights Pakistani banks’ substantial exposure to the government through large holdings of government securities, constituting around half of total banking assets. While the macroeconomic conditions are deemed weak and government liquidity risk is high, the report anticipates a modest economic recovery supported by the aftermath of the 2022 floods and “low base effects.”
However, the report notes challenges such as high-interest rates and inflation curtailing private-sector spending, as banks primarily finance the government’s fiscal deficits, leaving limited room for lending to the real economy. Despite initiatives for financial inclusion and support to key sectors, credit demand is expected to see only partial improvement.
The banking sector’s asset risk is tied to its significant exposure to government securities, accounting for 51% of Pakistani banks’ total assets and about nine times their equity, representing the highest levels among Moody’s rated banks globally. The report expects problem loans to stabilize at around 9% of gross loans due to banks’ cautious lending behavior in the challenging environment.
The capital is projected to remain stable, with a Tier 1 capital ratio of 15.3% of risk-weighted assets for rated Pakistani banks as of September 2023, well above regulatory minimums. Despite a tangible common equity to adjusted risk-weighted assets ratio of 5.2%, reflecting high-risk weighting for government securities, it is in line with the Caa3 sovereign rating.
While profitability is anticipated to gradually decline to normalized levels, the report expects interest revenue moderation in 2024 as monetary policy eases. Subdued business and lending activity, stabilizing operating expenses, and potential higher loan-loss provisions may impact banks’ bottom-line profitability, with the return on average assets hovering around 3%.
Despite challenges, stable funding and liquidity are identified as strengths for Pakistan’s banking sector, supported by increasing financial inclusion and remittances. However, rising costs of funds due to higher interest rates are noted as a concern, as a shift towards interest-bearing deposits has been observed.
In contrast to the positive outlook for Pakistan, Moody’s has downgraded its outlook for the banking sectors of several European countries, citing a deteriorating operating environment with low economic growth and high borrowing costs in Germany, Britain, France, Belgium, the Netherlands, and Sweden. Moody’s analyst Effie Tsotsani highlights potential impacts on credit growth and loan performance in these major European economies, particularly within the corporate sector.
