Limassol: The outlook for Pakistan’s banking system remains negative, says Moody’s Investors Service in a new report published on Thursday. The outlook reflects (1) Moody’s expectations of continued challenging operating conditions that will weigh on banks’ business generation and asset quality; and (2) banks’ high and increasing exposures to Pakistani government securities (Caa1 negative), tying the system’s solvency to sovereign event risk. Over the outlook period, however, Moody’s also expects banks to sustain low-cost and stable deposit-funded profiles, partly mitigating these negative pressures.
The new report, entitled “Banking System Outlook: Pakistan”, is now available on http://www.moodys.com/page/viewresearchdoc.aspx?docid=PR_294278&WT.mc_id=NLTITLE_YYYYMMDD_PR_294278.
Moody’s expects the Pakistani economy will grow in real terms by 2.8% in 2013-14 and 3.6% in 2014-15, below historical trends, owing to the poor domestic security situation and infrastructure bottlenecks, such as the continuing electricity outages, which weigh on manufacturing output and investment. In this environment, Moody’s expects subdued credit growth of around 3%-5% in 2014 (against 10% inflation), as the banks continue to devote a substantial portion of their balance sheets to finance the government’s large fiscal deficits (5.5% of GDP in 2013-14). Furthermore, while the recent agreement with the IMF could act as a catalyst for the country to implement structural reforms and improve its growth potential, the impact will not materialise within the outlook horizon.
Moody’s notes that the banks’ exposure to government securities remains the major source of credit risk, as it links banks’ credit profiles directly to the high credit risk of the sovereign. Banks’ exposure to government securities and loans to public-sector companies reached 644% of Tier 1 capital as of September 2013 and the rating agency expects this to rise further. In addition, despite tightened underwriting criteria, the challenging operating conditions will prompt a rise in the level of the banks’ non-performing loans (NPLs) to 15%-16% by the end of 2014 from 14.3% as of September 2013.
While Moody’s expects banks’ reported capital ratios to remain at roughly the current levels — with the sector Tier 1 ratio at 13.2% as of September 2013 — these levels would remain insufficient to absorb potential losses under the rating agency’s scenario analysis. In addition, Moody’s estimates that the Tier 1 ratio would drop to below 6% if government securities, which are currently zero risk-weighted, are instead risk-weighted according to common standards applied to similarly rated securities.
Moody’s expects Pakistani banks to remain well-funded because of their strong deposit bases. Customer deposits accounted for 79% of banking sector assets as of September 2013, while the rating agency projects deposit growth of 10% during 2014 owing to strong inflows of remittances from migrant workers and progress in penetrating the unbanked population. Also, the sector maintains good liquidity buffers, including cash and interbank placements (12% of total assets) and investments (41% of total assets). While investments are primarily in Pakistani government securities, which lack liquidity in the secondary market, banks have access to liquidity via State Bank of Pakistan’s (SBP) repo facilities.
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