Moody’s Ratings has changed Pakistan’s banking system outlook from positive to stable. The agency says the operating environment is improving only slowly. It cited a gradually better economic and fiscal outlook and a stronger external position. However, it warned that banks will face challenges with asset quality and profitability over the next 12 to 18 months. Moody’s noted that banks hold a large share of government securities, nearly half their assets. This links their strength closely to Pakistan's government's credit rating of Caa1 stable. The agency said Pakistan's long-term debt remains uncertain because of weak fiscal health and external risks. It expects real GDP growth of about 3.5% in 2026, a slight rise from 3.1% in 2025. Economic reforms and lower inflation have helped reduce monetary policy rates, which could boost credit demand and keep bad loan ratios stable. Moody’s warned that farm output could be hurt by last year’s floods, but industry and services should stay strong. It expects inflation to climb to about 7.5% in 2026 partly due to base effects. Banks’ exposure to government securities remains a key risk. These securities amount to roughly half of banks’ assets and around 9.4 times their equity. While loan growth could reach double digits in 2026, problem loans will persist in vulnerable sectors like agriculture and energy. Lower borrowing costs and higher credit demand are expected to keep bad loan levels steady. Banks will likely keep large dividend payouts but still fund growth through earnings. Problem loans are fully covered by reserves, giving capital protection. Moody’s expects banks to average a 1.1% return on assets in 2026. Margins may compress slightly, but higher business volumes and non-interest income will help revenues. Funding costs are stable after the removal of minimum deposit rates for corporate deposits. Banks remain mainly deposit-funded, with customer deposits making up 63% of total assets. Strong remittances and digital banking help deposits. Still, competition for deposits has raised funding costs slightly. Banks rely little on market funding, which supports liquidity. Overall, Moody’s outlook change to stable reflects ongoing recovery but warns of risks tied to government debt exposure and loan quality.