Negative outlook for Pakistani banks over security concerns

The fundamental credit outlook for the Pakistani banking sector is negative, reflecting challenging operating conditions as a result of the continued economic slowdown, domestic security instability and the weak sovereign position of Pakistan. However, the banking system remains relatively resilient overall, Moody's Investors Service said in its new Banking System Outlook on Pakistan.
"Overall credit conditions in Pakistan remain unfavourable as the security situation hinders both foreign and domestic confidence, lending rates are high, the political environment remains fragile and structural impediments in the supply of power and gas persist," said Christos Theofilou, a Moody's analyst and author of the report.
Amid the challenging operating conditions, Pakistan's banks have become more risk-averse, preferring the higher perceived security of government-related or backed loans and investments. However, given the low rating of these assets (B3), Moody's views the banks' high concentrations to government and government-related entities as a significant rating constraint. Government ownership in the three largest banks also raises related-party and quasi-related party risk concerns.
Asset quality has traditionally been an issue for the rated Pakistani banks, weighing on their balance sheets and restricting any upgrades. Problem loans have leaped in recent quarters and the success of loan recovery, restructuring and rescheduling operations will play an important role in future asset quality levels and any additional provisioning requirements.
Capitalisation metrics do not indicate any imminent threats to the banking system's solvency, ensuring a level of stability amid the more volatile operating environment. Nonetheless, Moody's believes the banks' equity is compromised to a certain extent and their capacity to absorb losses or any major unexpected credit shocks is now lower than what it was a couple of years ago. The rated banks' liquidity profiles are adequate and are a positive rating driver, while they all have strong franchise positions in the domestic market. Their profitability indicators also remain strong, despite coming under pressure and are in fact commensurate with those of higher-rated banks in other markets.
Looking ahead, Moody's expects both profitability ratios and asset quality metrics to remain under pressure despite the downturn forecasted to have bottomed out. The strength of the economic recovery, a material drop in the still high lending rates and the success of banks in mobilising fresh low-cost deposits should play an important role in the timing and magnitude of any meaningful rebound in private sector loan growth and an improvement in asset quality.
"Despite the negative credit outlook, all of the Pakistani bank financial strength ratings (BFSRs) have stable outlooks, as strong capitalisation levels and adequate liquidity profiles ensure a level of stability. However, if the economic recovery is sluggish or Pakistan's repayment capacity is impaired, leading to a further deterioration in the rated banks' financials, downward rating pressure may result," cautioned Theofilou.