Negative outlook for Pakistani banking system

The fundamental credit outlook for the Pakistani financial institutions is negative, reflecting the expected challenges in the economic and credit environment and the deteriorated sovereign position in recent months, Moody's Investors Service said in its new Banking System Outlook on Pakistan.
"Pakistani rated banks have relatively significant sovereign and public sector exposures," explained Nondas Nicolaides, co-author of the report. "Such exposures constrain the banks' ratings," the analyst said, "given the low B3 sovereign rating with a negative outlook assigned to Pakistan, although Moody's recognises that these are short-term exposures and positions taken due to excess liquidity in the past."
Asset quality has traditionally been a problem for the rated banks of Pakistan. "Despite an improving trend in the past few years," Nicolaides stated, "Moody's expects asset quality to be challenged both by public and private corporate sector payment delays, but also by a weakening of the banks' SME and consumer-lending portfolios, which remain unseasoned and untested by an economic downturn." That said, he adds that improvements in provisioning coverage and credit-vetting procedures, and strengthening capitalisation bode well for the banks' solvency profiles.
The Pakistani rated banks boast strong franchises that support their BFSRs, which have a stable outlook, in what is regarded as an increasingly competitive banking market.
"Franchise development in the past few years has been supported by improving economic conditions, robust lending and deposit growth," said Christos Theofilou, co-author of the report, "with banks taking advantage of the relatively underpenetrated domestic economy and reaping the benefits of their extensive branch networks and established client bases."
The analyst considers liquidity management for the rated banks to be adequate and sees it as a positive rating driver, adding that Pakistani commercial banks generally have comfortable liquidity positions and attractive funding profiles driven mainly by customer deposits.
"We consider liquidity risk not to be a significant concern for the rated Pakistani banks, and we believe that the system has a sufficient liquidity cushion to ensure the continuity of banking operations." That said, Moody's remains vigilant in the aftermath of the October 2008 liquidity squeeze for certain banks in the system and will continue to closely monitor the deposit balances of the Pakistani rated banks going forward.
"Most of the banks' financial indicators now compare favourably with those of international peers and, in fact, are commensurate with those of higher-rated banks in other markets," Theofilou said, noting that "profitability indicators are strong and Moody's regards them as a positive rating driver."
Cost containment has been on the agenda for many banks, with initiatives taken in this area gradually exerting positive pressure on their BFSRs.
"Looking ahead, however," the analyst stated, "we expect profitability ratios to come under pressure because of the deteriorating economic environment."
"Although capitalisation has also been improving, the implementation of Basel II, the expected slowdown in profitability and weakening asset quality, in conjunction with possible further mark-to-market losses from equity portfolios, could adversely affect the banks' currently adequate capital levels."