Moody’s Investors Service on Thursday revised its outlook on Pakistan’s banking sector from “negative” to “stable”, citing its solid profitability, stable funding and liquidity, which it said “provide an adequate buffer” to withstand the country’s macroeconomic challenges and political turmoil.
The International Credit Rating Agency – one of the world’s three largest rating firms – said economic and fiscal pressures in the country were easing as it forecast the economy would return to 2% growth in 2024 after subdued activity in 2023. The report also said it expected a drop in inflation from 29 percent to 23 percent. “Pakistani banks remain highly exposed to the government through their large holdings of government securities, which account for around half of total banking assets, linking their credit strength to that of the sovereign,” the global rating agency said.
According to the report, macroeconomic conditions remained weak, while government liquidity risk and external vulnerabilities were high. It said recovery from the 2022 floods and “low base effects” would support a modest economic recovery.
“However, high interest rates and inflation will continue to constrain private sector spending and investment,” it said, adding that banks are financing the country’s large fiscal deficits, leaving little room for lending to the real economy. and aid for key sectors will support credit demand only partially,” he added.
The report said the banking sector’s asset risk was associated with high exposure to government securities, as government securities accounted for 51 percent of Pakistani banks’ total assets and about nine times their equity capital, the highest level among Moody’s-rated banks globally.
“We expect NPLs to stabilize at around 9% of gross loans, partly due to banks’ reluctance to lend in this challenging environment,” he said.
It also said equity would remain more or less stable as subdued bank growth and solid profits offset dividend payouts.
The reported Tier 1 capital ratio for rated Pakistani banks was 15.3 percent of risk-weighted assets as of September 2023, up from 14.4 percent in 2022 and well above the regulatory minimum, the company said. the risk-weighted asset ratio is a low 5.2%, reflecting a 150 percent risk weight for government securities in line with the sovereign’s Caa3 rating.
The report said profitability will gradually decline to normal, adding that Pakistani banks’ interest income is expected to moderate in 2024, with monetary policy beginning to ease as inflation and interest rates gradually recede from 2023 highs.
“Subdued business and lending activities will keep loan interest and non-interest income under control. Operating costs are likely to stabilize in line with easing inflation and banks’ efforts to control costs. Persistently increased tax rates and potentially higher loan loss provisions will have an impact on bank profitability, with return on average assets hovering around 3%.
The report said stable funding and liquidity are strengths for the country as deepening financial inclusion and remittances have expanded domestic deposit inflows.
“Banks are predominantly deposit-funded […] and rely very little on more volatile market funding because they have limited access to international debt markets,” the report said.
“However, the cost of funds is rising slightly as high interest rates have led to a migration to interest-bearing deposits from non-interest-bearing deposits, which have declined to 74 percent of total system deposits at the end of 2023 from 75.2 percent per annum. a year ago,” it read.
While Moody’s upgraded its outlook for Pakistan’s banking sector, it downgraded its outlook for the banking sector in a number of European countries. It changed the outlook to negative from stable for the banking sectors of Germany, Britain and France, Belgium, the Netherlands and Sweden.
“The deteriorating operating environment, with low economic growth and high borrowing costs, will hit both credit growth and credit performance in Europe’s largest countries, particularly in the corporate sector,” Moody’s analyst Effie Tsotsani said.
