Negative outlook for Pakistani banks driven by political developments

The outlook for Moody’s rated Pakistani banks is negative, reflecting the underlying risks faced by banks in the current, unfavourable political environment. The banking system should prove to be relatively resilient in the short term, but may be tested if  the political unrest prevails over a longer period.

“The operating environment remains somewhat challenging in light of recent political events. Investor and business confidence have been somewhat impaired and caused some flight of capital by foreign investors away from the local equity markets,” said Nondas Nicolaides, Assistant Vice-President – Analyst and author of the report.

An extended period of political uncertainty may affect new projects and deter foreign  investors, which will have a knock-on effect on future loan growth rates.

Nevertheless, Moody’s noted that the efficiency of Pakistan‘s financial system continues to improve. Privatisation and consolidation are paving the way for increased competition and efficiency, as well as driving more viable financial fundamentals, improving industry practices and enabling banks to penetrate previously untapped rural areas.

Credit growth is also strong, significantly boosting banks’ bottom line.

“Most banks’ profitability indicators now compare favourably internationally, and in fact are commensurate with those of higher-rated banks in other markets,” said Nicolaides. Capitalisation is improving on the back of good profitability and an influx of fresh capital via rights and subordinated debt issues. This bodes well for the solvency profile of Pakistani banks.

Problematic exposures remain high, however. Although Moody’s recognised the noticeable improvements that the rated banks and the banking system as a whole have achieved on this front, the level of gross NPLs (7.1% as of June 2007) is still sizeable by international standards. Furthermore, whilst the rating agency regards the banks’ increasingly enhanced and diversified earnings base as a positive rating driver, it cautions that the new lending remains unseasoned and untested in a possible downturn of the economic cycle.

Efforts are being made to enhance regulatory oversight, and the State Bank of Pakistan is working towards establishing a well-recognised system of banking supervision on par with international best practices. That said, full implementation of more stringent corporate governance regulations by all banks could prove challenging.

Moody’s noted that the country will also have to work towards further modernising its banking infrastructure. Current efforts represent a “catching-up” exercise for Pakistani banks rather than a feature distinguishing them from other globally rated banks, and the integration of technology into banking operations is still somewhat low generally compared to developed-market peers and by international standards.