Ratings Watch - Moodys Changes Pakistans Banking System Outlook to Stable

Moody's Investors Service has on Nov 11, 2015 changed the outlook for the Pakistan banking system to stable from negative, reflecting the improvement in the country's economic growth prospects, driven in turn by the government's commitment to economic reforms under its IMF program.

Moody’s expects the strengthening economy, together with the central bank's accommodative monetary policy, to stimulate lending growth and support the banking sector's loan performance over the next 12-18 months. It forecasts Pakistan's real GDP will expand by 4.0% in the fiscal year ending June 2016 (compared to a 2.8% during 2008-13), mainly driven by higher spending on infrastructure projects as the government aims to ease energy shortages and execute projects associated with the China-Pakistan Economic Corridor (CPEC).

The change in outlook was based on:

• The rating agency expects problem loans will decline to around 12% of total loans by the end of 2016 compared with 12.4% for the end of June 2015.
• In addition, the rating agency expects that Pakistani banks will maintain ample liquidity and continue to benefit from large volumes of low-cost and stable customer deposits.
• The Pakistani banks deposit-based funding structure remains a credit strength as Moody’s expects inflow of remittances from migrant workers will continue to drive the growth in bank deposits and support banks' funding bases.

However the Agency warned:

• The level of credit risk, however, will remain high as banks are heavily exposed to the low-rated Pakistan sovereign (B3, stable) through holdings of securities and government-related loans, which are equivalent in size to 7.3x Tier 1 capital, exposing banks to event risk.
• In the area of capital, the rating agency expects buffers will come under pressure due to moderate asset growth and lower internal capital generation -- a result of weaker profitability.
• Moody's expects earnings to ease slightly over the outlook period, mainly because of the lower coupon on government securities in a declining interest rate environment and as the market's perception of Pakistan's risk profile eases (upgraded to B3 from Caa1 on 11 June 2015). Higher loan volumes and capital gains booked through the sale of government securities will only partially offset the pressure on profitability.