In a key development for the country’s banking sector, Moody’s has revised Pakistan’s banking sector outlook to stable from positive, citing a gradual economic recovery and an improving fiscal and external position.

“We have changed our outlook on Pakistan’s banking system to stable from positive,” said the global rating agency on Monday.

Moody’s noted that the operating environment continues to recover, but only gradually, supported by the country’s slowly improving economic and fiscal outlook and strengthening external position.

“However, banks’ financial performance will be stable over the next 12-18 months as they continue to face asset quality and profitability challenges.

“The sector outlook also aligns with that of the Government of Pakistan (Caa1 stable), given banks’ substantial holdings of government securities, which account for around half of total banking assets. Pakistan’s long-term debt sustainability remains uncertain, because of its still weak fiscal position, high liquidity and external vulnerability risk1,” it said.

Moody’s forecasted Pakistan’s real GDP growth of around 3.5% for 2026, up from 3.1% in 2025, supported by ongoing reforms that are improving confidence and gradually strengthening economic activity.

Headline inflation fell to 4.5% in 2025 from 23% during 2024. Moody’s expects inflation to rise to around 7.5% in 2026, in part due to base effects.

It noted that the improving economic outlook and lower inflation have contributed to easing monetary policy rates.

 “Lower borrowing costs will boost credit demand and keep problem loan ratios broadly unchanged. At the same time, margins will remain steady after a decline following rate cuts, but higher business volumes, non-interest income and stable costs will support profits and safeguard capital buffers.”

Moody’s noted that the recent floods are likely to weigh on agricultural output, but activity in the industrial and services sectors should remain robust.

It shared that sector-wide nonperforming loan ratios spiked at the beginning of 2025 following the removal of the advances-to-deposits ratio (ADR) tax, which led banks to reduce their loan books.

“Although loans accounted for only 23% of banks’ total assets as of September 2025, we expect double-digit credit growth in 2026, supported by improving macroeconomic conditions.

“Borrower delinquencies will persist nonetheless, particularly in more vulnerable sectors such as agriculture and energy, but lower borrowing costs and higher credit demand will maintain broadly stable problem loan ratios, measured by Moody’s as Stage 3 loans over gross loans, at around 8% for the Pakistani banks we rate.”

Moody’s shared that as of September 2025, the system’s Tier 1 and total capital to risk-weighted assets (RWAs) ratios stood at 18% and 22.1%, respectively, up from 17% and 21.5% a year earlier and well above the regulatory minimum.

 “Although financing growth will rise in 2026 on the back of lower rates, Pakistani banks will continue to increase their holdings of government securities, which do not carry any risk-weighting, further supporting capital metrics.

 “We expect banks to maintain high dividend payout ratios, but retained earnings — despite slight margin compression — will be sufficient to fund balance sheet growth and maintain capital ratios.”