Moody’s revises outlook on Pakistan’s banking system to stable

Moody’s Ratings has revised its outlook on Pakistan’s banking system to stable from positive, according to a statement released by the ratings agency.

Moody’s said banks’ performance is likely to be stable rather than improving over the next 12 to 18 months.

“Economic activity is recovering gradually,” Moody’s said, projecting GDP growth of 3.5% in 2026, up from 3.1% in 2025 and 2.6% in 2024. The agency cited ongoing reforms that are boosting confidence and supporting activity, despite recent floods that are likely to weigh on agricultural output. Industrial and services sector activity is expected to remain robust.

Lower inflation and an improved outlook have allowed for monetary easing, Moody’s said. Headline inflation fell to 4.5% in 2025 from 23% in 2024, though inflation is expected to rise to about 7.5% in 2026, partly because of base effects.

Moody’s flagged banks’ heavy exposure to government securities as a key risk, noting that such holdings account for about half of total banking assets and are roughly 9.4 times banks’ equity. “This links banks’ credit strength to that of the Caa1-rated sovereign,” the agency said.

Nonperforming loan ratios spiked in early 2025 following the removal of the advances-to-deposits ratio tax, which prompted banks to shrink loan books, Moody’s said.

While loans made up only 23% of total assets as of September, the agency expects double-digit credit growth in 2026, supported by improving economic conditions.

Problem loan ratios are expected to remain broadly stable at around 8%, measured as Stage 3 loans over gross loans, despite persistent delinquencies in sectors such as agriculture and energy.

Capital buffers are expected to remain solid. Moody’s said the system’s Tier 1 and total capital ratios stood at 18% and 22.1%, respectively, as of September, well above regulatory minimums.

The agency expects banks to continue increasing holdings of government securities, which carry no risk weighting, supporting capital metrics. “Problem loans are fully covered by loan-loss reserves,” Moody’s said, citing 115% coverage for rated banks.

Profitability will be supported by higher lending volumes and non-interest income, offsetting modest margin compression, Moody’s said. The agency expects an average return on assets of about 1.1% in 2026, though elevated taxes will continue to weigh on net profits.

Funding and liquidity conditions are expected to remain sound, with customer deposits accounting for 63% of total assets as of September, Moody’s said. Banks have limited reliance on market funding and hold substantial liquid assets, though most are invested in government securities. Reliance on dollar funding remains limited, with banks generally maintaining matched currency positions.

Moody’s said the government is likely to remain willing to support banks, but its capacity is constrained by fiscal pressures. “These constraints underpin the Caa1 sovereign rating and cap banks’ ratings at the same level,” the agency said.