KARACHI:
Against the State Bank of Pakistan’s (SBP) confidence in the banking system, Moody’s has revised down the outlook for Pakistan’s banking system from “positive” to “stable,” citing structural vulnerabilities, particularly banks’ heavy exposure to government securities.
SBP Governor Jameel Ahmad, in a recent in-camera briefing, stressed that local banks are “far better capitalised than what is required by international standards” and maintain buffers well above regulatory minimums, enabling them to absorb potential shocks.
Pakistan’s banking sector lending is highly concentrated in government treasuries, said Sana Tawfiq, Head of Research of at Arif Habib Limited (AHL). “The Investment-to-Deposit Ratio (IDR) of UBL is 200%, indicating a high concentration of risk on a single counterparty,” she highlighted as an example.
Exposure to government securities amounts to around half of banks’ total assets and about 9.4 times their equity, which links their credit strength to that of the Caa1-rated sovereign, said the report. Sector-wide non-performing loan ratios spiked at the beginning of 2025 following the removal of the advances-to-deposits ratio (ADR) tax, which led banks to reduce their loan books.
Although loans accounted for only 23% of banks’ total assets as of September 2025, the report said it expects double-digit credit growth in 2026, supported by improving macroeconomic conditions.
Despite acknowledging strong capital and liquidity buffers, Moody’s cautioned that financial performance is likely to remain stable rather than improve over the next 1218 months, according to its Banking System Outlook – Pakistan. The agency highlighted modest margin compression due to declining interest rates, elevated taxation and ongoing asset-quality challenges.
A key risk, Moody’s noted, is the banking sector’s heavy exposure to government debt. Roughly half of all banking assets are invested in government securities, creating a direct link between the fiscal health of the state and the resilience of banks. This concentration, often referred to as sovereign risk, limits the potential for an improved outlook and keeps the system highly dependent on government borrowing requirements.
Arham Ahmed, Banking Sector Analyst at AHL, said the main reason for the outlook change is the increasing investment in government securities despite private credit demand. “While Moody’s frames this from a sovereign credit risk perspective, locally it is considered the safest option for banks,” she added. Moody’s forecast real GDP growth of around 3.5% in 2026, compared with the SBP’s projection of 3.75 to 4.75%, supported by ongoing reforms and easing inflation. Nevertheless, it flagged vulnerabilities including external financing pressures, fiscal constraints and sectoral credit risks in agriculture and energy.
The agency expects credit growth to rebound in 2026 as borrowing costs decline and economic activity gradually improves. However, the pace of expansion may remain moderate due to lingering macroeconomic uncertainties.
Moody’s also projected that banks’ returns on assets would remain modest amid tightening margins following monetary easing. Several structural indicators highlight the sector’s unique challenges. The IDR exceeds 100% for many banks, meaning investments in government securities surpass total deposits and are funded through borrowing from the central bank.
“While this strategy offers a risk-free return, it limits diversification,” said Ahmed. “Banks are essentially lending to one ‘borrower,’ which is safe from a default perspective but leaves the system exposed to sovereign risk.” Fresh SBP data also support the regulator’s confidence in the banking sector. As of June 2025, 29 out of 31 banks reported Capital Adequacy Ratios (CAR) above 15%, comfortably exceeding minimum requirements. Only one bank remained below the required threshold, down from three banks in early 2024.
One institution hovered just above the minimum CAR but below 15%, highlighting the sector’s overall robust capital structure. Meanwhile, the total number of banks declined slightly from 32 to 31, reflecting possible consolidation or restructuring trends.
Tawfik also noted the importance of coordination between fiscal and monetary policy. The government’s fiscal surplus in the first half of FY2025-26, partly supported by SBP profits, has eased domestic borrowing pressures. Reduced interest rates have further provided breathing space on debt servicing.
“Whenever the government runs a deficit, domestic borrowing increases and banks are the primary source of funding,” she explained. “Strong coordination is essential to maintain sector stability and prevent systemic risks.”
For investors and policymakers, the Moody’s revision reflects a balance between resilience and caution. While SBP data demonstrates strong capitalisation across the sector, Moody’s underscores vulnerabilities that could constrain future growth.
“Sustained improvement will depend on effective policy implementation and greater external financial support, as risks are still hanging around,” said Waqas Ghani Kukaswadia Research Head at JS Global. This development is not expected to materially alter the overall outlook of the sector.
