Islamabad, March 12, 2025 – The global credit rating agency Moody’s has upgraded Pakistan banking outlook from stable to positive, reflecting improved economic conditions and strengthened financial sector performance.
“We have changed our outlook on Pakistan’s banking system to positive from stable to reflect the banks’ resilient financial performance as well as improving macroeconomic conditions from very weak levels a year ago,” Moody’s stated in its report.
The agency highlighted that the positive outlook for Pakistan’s banking sector aligns with the Government of Pakistan’s (Caa2 positive) improving financial standing. Pakistani banks maintain significant exposure to sovereign assets through their large holdings of government securities, which comprise approximately half of total banking assets.
However, despite the improved outlook, Moody’s cautioned that Pakistan’s long-term debt sustainability remains a critical risk. The country continues to face fiscal challenges, along with high liquidity and external vulnerability risks, which could impact banking sector stability.
Economic Growth and Inflation Trends
According to Moody’s, Pakistan’s economy is projected to expand by 3% in 2025, compared to 2.5% in 2024 and a contraction of -0.2% in 2023. Additionally, inflation is expected to ease significantly, declining from an average of 23% in 2024 to around 8% in 2025.
The report noted that with borrowing costs decreasing due to interest rate cuts, problem loan formation in Pakistan’s banking sector will slow. However, net interest margins may tighten as a result of lower interest rates.
Strength of Pakistan’s Banking Sector
Moody’s emphasized that banks in Pakistan will maintain sufficient capital buffers, supported by steady cash generation and controlled loan growth. Despite high dividend payouts, banks are expected to retain adequate capital levels.
The rating agency also acknowledged the positive impact of improved liquidity and external financing on Pakistan’s banking sector. The approval of a 37-month, $7 billion IMF Extended Fund Facility in September 2024 provides a credible source of financial stability for the country, enhancing confidence in the banking system.
“We expect GDP growth of 3% in 2025 and 4% in 2026, driven further by a 10-percentage point cut in interest rates since June 2024,” Moody’s noted. “Lower inflation and policy rate reductions will encourage private-sector investment and banking activity in Pakistan.”
Challenges and Risks for Pakistan’s Banking Sector
Despite improvements, high exposure to government securities remains a key risk for Pakistan’s banking system. As of September 2024, government securities accounted for 55% of total banking assets, linking financial sector stability directly to sovereign credit conditions.
While problem loans increased to 8.4% of total loans in September 2024 from 7.6% the previous year, the report pointed out that total loans account for only 23% of banks’ total assets, limiting the overall impact.
Moody’s further highlighted that the removal of the Advance-to-Deposit Ratio (ADR) tax for 2025 will reduce pressure on banks to expand lending. Previously, banks were required to achieve a 50% ADR by the end of 2024 or face additional income tax penalties ranging from 10% to 15%.
Following recent interest rate cuts, which brought the policy rate down to 12%, Moody’s expects Pakistan’s banking sector to experience a narrowing of profit margins. Pakistani banks derive a significant portion of their earnings from government securities, and lower interest rates are expected to reduce returns on these investments.
Moody’s projects that banks’ return on assets will moderate to around 0.9%-1.0% in 2025, partially offset by reduced funding costs and increased business activity.
Foreign Exchange Stability in Pakistan
Moody’s report also highlighted a reduction in Pakistan’s foreign exchange (FX) risks, supported by an increase in the State Bank of Pakistan’s FX reserves following the resumption of the IMF program.
Last year, Moody’s noted that interest costs in Pakistan are projected to account for nearly 40% of total government expenditures in 2025, a sharp increase from about 25% in 2021. This underscores the ongoing fiscal challenges that the country faces, despite the improved outlook for its banking sector.
With Pakistan’s banking sector demonstrating resilience and macroeconomic indicators showing improvement, the positive outlook reflects cautious optimism for future financial stability.
