Moody’s keeps banking sector outlook at ‘negative’

Banks likely to increase exposure to government and public sector.

KARACHI:

Moody’s Investors Service, a credit rating agency, has kept the country’s banking system outlook unchanged at negative due to the weak operating environment and likelihood that banks will increase their already high exposures to the government, according to a statement issued on its website.

Credit and business conditions will likely remain fragile, driven by the government’s weak fiscal position and the subdued investment climate.

Partly mitigating these negative factors are the banks’ low-cost deposit-funding profiles, which will continue to support overall liquidity and solid earnings, adds the statement.

Furthermore, escalation of ongoing political instability and potential deterioration in business sentiment following the recent termination of the IMF standby arrangement downside risks may further weigh on the banks’ operating environment over the outlook horizon.

As a consequence of the uncertain operating conditions and a projected budget deficit equivalent to 5.4% of GDP in fiscal year 2012, Moody’s believes that the banking sector will further increase its already significant exposure to the government and public sector, which the rating agency estimates at 31% of total assets as of 2010 end.

Although the banking sector is sufficient to absorb a severe deterioration in loan quality, a simultaneous government default scenario – Moody’s sovereign ratings on Pakistan imply a significant default probability over the medium-term – would render many banks insolvent, entirely eroding their capital base.

However, despite these material risks, Moody’s does not expect significant further deterioration in asset quality over the outlook period. Under Moody’s central scenario, short-term economic growth, lower interest rates and de-risking of the banks’ loan book will drive a stabilisation in asset-quality metrics. Non-performing loans (NPLs) will likely peak at around 16% of total lending by year-end 2011, from 15.3% at end-June 2011, and then remain at these elevated levels throughout 2012.

As a counterbalance to the system’s structural challenges, the banks benefit from sound funding profiles and low-cost current and savings account deposits, which amounted to 67% of total deposits in June 2011.

Published in The Express Tribune, December 17^th, 2011.