The Moody’s Ratings agency on Monday revised the outlook of Pakistan’s banking sector to stable from positive on the back of a gradual economic recovery and improving fiscal and external position.
In a statement, the global ratings agency said the gradual recovery was improving Pakistan’s macroeconomic backdrop, with growth expected to strengthen over the next two years. It projected GDP growth of 3.5% in FY2026, up from 3.1% in FY2025 and 2.6% in FY2024. “However, banks’ financial performance will be stable over the next 12-18 months as they continue to face asset quality and profitability challenges,” it added.
According to Moody’s, ongoing reforms 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, it said, adding lower inflation and an improved outlook have allowed for monetary easing.
Headline inflation fell to 4.5% in 2025, it noted, from 23% in 2024. Inflation is anticipated to rise to about 7.5% in 2026, it said, partly because of base effects.
In its rating update, the agency 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 the equity of banks. “This links banks’ credit strength to that of the Caa1-rated sovereign,” it said. “Pakistan’s long-term debt sustainability remains uncertain, because of its still weak fiscal position, high liquidity and external vulnerability risks,” it added.
Nonperforming loan ratios spiked in early 2025 following the removal of the advances-to-deposits ratio tax, which prompted banks to shrink loan books, it noted. While loans made up only 23% of total assets as of September 2025, 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, said the ratings agency. It said the system’s Tier 1 and total capital ratios stood at 18% and 22.1%, respectively, as of September 2025, 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,” it said, citing 115% coverage for rated banks.
The profitability of banks, said Moody’s, would be supported by higher lending volumes and non-interest income, offsetting modest margin compression. It 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 2025, said Moody’s. 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,” it said.