Moody’s Investors Service has said in a new report that its stable outlookfor Pakistan’s banking system reflects banks’ solid funding and liquidity.However, a challenging but improving operating environment will weigh onasset quality and profitability.
Senior Vice President at Moody’s, Constantinos Kypreos, said, “Despite adifficult environment, the government’s credit profile is stable due toongoing reforms and increasing policy effectiveness – a positive for thebanks given their outsized holdings of Pakistani government debt link theircredit profiles to that of the government.”
Moody’s expects the slow economic recovery to affect loan quality, withnonperforming loans (NPLs) expected to rise over the coming months from asector-wide level of 9.9 percent of gross loans in September 2020.
Banks’ foreign operations, export-oriented industries, and companiesreliant on government payments and subsidies will be hit hardest, but loanrepayment holidays and other government support measures should helpcontain some risks.
Moody’s expect Pakistan’s economy to return to a modest 1.5 percent growthin fiscal 2021, while government and central bank responses and reformswill partially soften the pandemic’s impact.
The Senior VP added, “Deposit-based funding and good liquidity buffers alsoremain strengths, while the probability of government support in a crisisis high, even if its ability to do so is limited by fiscal challenges.”
He further added that the slow economic recovery would hurt governmentfinances while successive waves of coronavirus infection weigh on consumerspending and business confidence, all of which will affect the bankingsector.
The credit rating agency has projected a government deficit of 8 percentfor 2021, with rising arrears and circular debt in the energy sector alsoaffecting corporates’ repayment capabilities.
“We perceive risks to the Pakistani economy to be lower than forsimilar-rated peers. Pakistan’s relatively closed economy has low relianceon exports and private capital inflows and limited trade and supply chainlinkages. This reduces its exposure to weak global demand, includinginternational tourism,” it added.——————————
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The report also said that wide fiscal deficits, which will – to a largeextent – be financed by local banks, may also take precedence over lendingto the private sector.
In this environment, Moody’s expects private-sector lending to grow bybetween 5 percent and 7 percent in 2021.FATF
On the other end, considering that Pakistan is still on the FinancialAction Task Force’s (FATF) grey list, failure to meet AML requirementscould push international banks to cut correspondent bank relationships,affecting banks’ foreign currency liquidity, business generationcapabilities, and leading to higher refinancing and compliance costs, saidthe report.
Pakistani banks are heavily exposed to the B3-rated Pakistan sovereignthrough large holdings of government securities and lending. This linkstheir creditworthiness with that of the government.
Pakistani banks hold government securities worth Rs. 10.3 trillion. Thereport said, “We expect government exposure to remain high over our outlookhorizon because Pakistani banks will remain the main source of financingfor the government. The government’s commitment to stop borrowing from thecentral bank will also lead to increased government reliance on banks tomeet its financing needs.”NPLs
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Nonperforming loans (NPLs) in the Pakistan banking sector rose to 9.9percent of total loans as of September 2020 (8 percent as of December2018), and we expect a further increase as the economic slowdown takes itstoll on borrowers’ repayment capabilities, Moody’s added.
Loan quality risks will be mitigated by improvements in the legal andregulatory framework to support NPL recovery. “We expect reported capitalratios to remain broadly stable over the next 12 to 18 months, even thoughSBP [State Bank of Pakistan] has eased capital requirements,” said thereport, adding, “Reduced capital generation will be offset by lowerdividend payments and muted growth in risk-weighted assets.”
Profitability for 2021 has been projected by Moody’s to come under renewedpressure, primarily from increased loan-loss provisions reflecting achallenging operating environment, as well as weak loan performance in theGulf region.
These factors will also be compounded by subdued business generation,trading gains, dividend income, and high costs, resulting from investmentsto strengthen compliance and security infrastructure, and potentiallyhigher staff pension payment requirements.——————————
Customer deposits accounted for 74 percent of total assets as of September2020, of which around half are stable household deposits. Deposits atIslamic financial institutions reached 17 percent of total deposits.
A significant share of deposits is, however, sourced from the governmentand related institutions. The recent introduction of a Treasury SingleAccount (TSA), where Federal Government deposits will be required to beheld at the SBP, will lead to some deposit outflows from banks.
Market funding remains high at 18 percent of assets as of September 2020.This is mainly in the form of interbank and SBP repo facilities, used for“carry trades” (i.e., buying government bonds funded by short-termborrowing).
“We expect Pakistani banks to maintain comfortable liquidity buffers, withcore liquid assets accounting for 13 percent of assets as of September2020, complemented by the banks’ investments in government securities,which are accepted by the State Bank of Pakistan as collateral for repofunding,” the report predicted.
Moody’s also expects banks’ foreign-currency liquidity to remain adequate,partly supported by low levels of dollars in the system and SBP policiesthat allow for the exchange rate to act as a shock absorber.
Government and central bank policy responses and structural reforms willsoften the pandemic’s impact but not fully offset it. “In this environment,we expect private-sector lending to grow modestly, by 5 percent-7 percent,over the calendar year,” Moody’s said.
The coronavirus pandemic is weighing on economic activity in Pakistan andreal GDP contracted by 0.4 percent in fiscal 2020. “We expect the economyto return to growth in fiscal 2021, reaching a modest 1.5 percent. Althoughhigh-frequency indicators suggest that economic activity has started torebound, restrictions on movements to prevent the spread of the coronaviruswill keep economic output below pre-outbreak levels for some time. Growthwill, however, accelerate to 4.4 percent in 2022,” it added.
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