Pakistan’s Banking Outlook Stabilizes from Positive

In recent updates, Moody’s Ratings has reaffirmed Pakistan’s banking system outlook to stable from positive, reflecting a gradual improvement in operating conditions supported by improving economic and fiscal prospects. The agency noted these gains are bolstered by the country’s stronger external position.

Despite a discernible recovery, financial performance will remain consistent over the next 12-18 months as banks continue to grapple with asset quality challenges and profitability issues. The sector outlook aligns closely with that of Pakistan’s Government (rated Caa1 stable) given their significant holdings in government securities, which account for roughly half of total banking assets.

Pakistan’s economic forecasts point towards a modest 3.5 percent growth by 2026 from the 3.1 percent recorded in 2025. This improvement is attributed to ongoing reforms that are gradually boosting confidence and activity across sectors. Moody’s expects inflation to rise marginally to around 7.5 percent in 2026, influenced by baseline effects.

Banks’ exposure to government securities remains a significant risk factor. Holding nearly half of their total assets, banks’ exposure stands at about nine times their equity, linking their credit strength to that of the Caa1-rated sovereign entity. Moody’s highlights this as one of the key concerns, noting sector-wide non-performing loan ratios (NPLs) surged in early 2025 after the removal of the advances-to-deposits ratio tax, prompting banks to curtail their loan portfolios.

As activity rebounds across the industrial and services sectors in 2026, NPLs are anticipated to remain stable at around a quarter of total assets. However, delinquencies will persist notably within vulnerable areas such as agriculture and energy, despite buoyant credit demand driven by lower borrowing costs.

Pakistani banks, predominantly customer-deposit funded (with 63 percent of total assets attributed to deposits), continue to enhance their holdings in government securities, a risk-free asset supporting capital metrics. Moody’s expects average annual return on assets to hover around 1.1 percent for Pakistani banking entities over the next year.

While margin pressures are expected due to slowing rate cuts and stable funding costs following removal of regulatory minimum deposit rates (MDR), higher business activity will offset these impacts, ensuring steady operating revenue. Moody’s anticipates a moderate compression in margins but maintains high dividend payout ratios, supported by sufficient retained earnings for capital growth and coverage.

In summary, Pakistan’s banking sector shows gradual improvement amid evolving risks, with continued exposure to government securities serving as the primary concern moving forward.