Moody’s Investors Service has stated that robust funding and liquidity and close links with the sovereign underpin its stable outlook for the Pakistan banking system over the next 12-18 months.
“The sovereign credit profile has improved in recent months, benefiting the banks through their high exposure to government securities, which account for around 40% of their assets,” says Constantinos Kypreos, a Moody’s Senior Vice President.
In terms of the operating environment, economic activity in Pakistan will also be supported by ongoing infrastructure projects and improvements in power generation and domestic security. In addition, terms of trade gains and the rupee depreciation will likely raise private investment from low levels.
“Operating conditions for Pakistan banks, although gradually improving, remain difficult amid tight monetary conditions – with the policy rate at 13.25% – and large government borrowing needs crowding out funding for the private sector,” adds Kypreos.
Stable customers deposits and high liquidity also remain key strengths, providing banks with ample low-cost funding. Capital levels will remain broadly stable, but Moody’s considers these modest relative to peers. Profits will increase slightly but remain below historical levels.
Moody’s expects the government will remain willing to support at least the systematically important banks in case of need, but its ability to do so is limited by fiscal challenges reflected by its B3 rating.
Operating Conditions are Improving but will Remain Difficult
The credit rating agency stated that the economic activity in the country will be supported by ongoing infrastructure projects, improvements in power generation and domestic security and by terms of trade gains. In addition, rupee depreciation will likely lift private investment from low levels said Moody’s.
But while economic growth will still remain subdued, the exchange rate has stabilized since June 2019 and markets expect the State Bank of Pakistan to lower policy rates over the next few years.
Non-Performing Loans to Rise
Moody’s expect nonperforming loans (NPLs) to rise slightly as a result of high-interest rates and banks’ troubled foreign operations. NPLs stood at a high 8.8% of gross loans as of September 2019, although risks are mitigated by the fact that banks’ loan portfolios only make up 37% of total assets. The government is working on laws to improve NPL recovery.
Capital is Modest and will Remain Stable
Sector-wide reported Tier 1 capital ratios stood at 14.2%, but Moody’s adjusted these by raising risk weights on government securities to 100% from 0% to reflect risks associated with the sovereign’s B3 credit rating.
The adjustment reduces the ratio to a more modest 7%. Moody’s expect banks to keep capital ratios steady by reigning in dividend payouts, issuing Tier I or Tier II capital instruments or through other capital optimization measures.
Profits will Increase Slightly but Remain Below Historical Levels
According to Moody’s, higher net interest margins (on the back of higher interest rates and government bond yields) and their estimated 10% credit growth will boost revenue, compensating for rising provisioning needs, ongoing pressures at banks’ overseas operations and higher costs.
Stable Customer Deposits and Ample Liquidity will Remain Key Strengths
Customer deposits make up around 69% of total assets, noted Moody’s. The credit rating agency expects these to grow by over 12% this year, providing banks with plentiful low-cost funding.
Cash and bank placements account for around 12% of total assets, while another 40% of assets are invested in government securities – with around 64% in T-Bills, which can be repo-ed with the central bank – offering sound liquidity, it noted in its latest report.
Moody’s noted that market funding increased to 23% of assets as of September 2019, mainly in the form of repo facilities, used for “carry trades”, which expose banks to additional credit and interest rate risks.