DESPITE the challenges faced by Pakistan’s financial system, there are plenty of reasons to be optimistic given the latest report from Moody’s.

The rating outlook on Pakistan’s banking system is “stable”, says the latest report from the key rating agency.

Moreover, the fact that the “biggest challenge facing the banks is their large holdings of low-rated Pakistan government bonds” is also an improvement from a time when domestic banks saw their credit ratings downgraded due to overexposure to government securities.

Last year saw some drastic reductions in government borrowings from banks, and the balance sheets are showing a growing trend towards private-sector lending.

In part, this is born of necessity considering that interest rates had been coming down until recently, and there are large-scale retirements under way of the longer-tenor Pakistan Investment Bonds into which banks had collectively stampeded starting around 2010.

But major challenges still remain if the trend towards private-sector lending is to continue.

For one, domestic banks are still waiting for their slice of CPEC action.

Moody’s says that as growth picks up and CPEC-related investments gather momentum, the banks are likely to find more opportunities in the private sector.

The present trend, however, has led to some scepticism about that claim.

For one, the growing role of consumer finance these days is likely to plateau out.

Corporate lending has more potential over the medium term, but given the trillions that are locked up in government securities, it will be a challenge for the banks to find borrowers in the magnitude required, unless they are willing to significantly upgrade their credit risk evaluation capacity.

The same holds true in agriculture lending.

And rising interest rates could restore some of the allure of government securities, depending on how far the tightening will go.

The banks appear to be emerging from a prolonged period of lending almost exclusively to government, but the road ahead is longer and more difficult than many might bargain for.

Published in Dawn, March 2nd, 2018