By Staff Reporter
KARACHI: Pakistan’s banking industry expanded its balance sheet and cut its stock of bad loans to the lowest level in years during the first half of 2026, even as a spike in Middle East tensions rattled the country’s stock market and squeezed lenders’ margins, according to the State Bank of Pakistan.
Total banking assets grew 9.1% to 68.997 trillion rupees in the six months through June, the central bank said in its mid-year performance review published on Monday. The expansion was driven almost entirely by banks piling into government debt, with investments accounting for 79.4% of the increase in assets and advances contributing the remainder.
The report offers a snapshot of an industry that absorbed a bout of regional instability without cracking. Pakistan’s KSE-100 stock index tumbled 11.5% between late February and the end of March as fighting in the Middle East flared and oil prices swung, before recovering to end the half up 2.5% on the back of the country’s return to international bond markets, an International Monetary Fund disbursement and a series of bilateral financing arrangements. The rupee, by contrast, stayed largely rangebound against the dollar, and money-market rates tracked the central bank’s policy rate closely throughout the period.
Bad Loans Retreat
Asset quality improved across the board. The ratio of gross non-performing loans to total loans fell to 5.5% at the end of June from 6.1% in December, as soured loans shrank by 62 billion rupees while gross advances rose by 460 billion rupees. Agribusiness and individual borrowers accounted for most of the improvement, the central bank said.
Banks also built up their cushion against future losses. The provisioning coverage ratio — the share of bad loans already set aside as provisions — rose to 110.2% from 107.7% six months earlier, pushing the ratio of net bad loans to net loans further into negative territory.
Lending growth was uneven. Gross advances rose just 2.9% in the half, a pattern the central bank attributed partly to seasonal factors that typically weigh on private-sector borrowing in the first six months of the calendar year. Within that total, financing to small and medium-sized enterprises climbed 41 billion rupees, driven by long-term loans that grew 77 billion rupees, while working-capital lending to the segment contracted. The share of fixed-investment loans in total SME advances has risen to 52.6% in June from 32.4% three years earlier, a shift the central bank linked to government-backed lending schemes.
Mortgage lending also gained pace, adding 49 billion rupees during the half, which the central bank attributed to lower borrowing costs and an expanding government subsidy program. Auto loans grew by a slightly larger 56 billion rupees over the same period.
Sector-level lending told a more mixed story. Sugar producers borrowed 205 billion rupees in the half, reversing a 52 billion rupee retirement a year earlier, as higher sugarcane output, lower refined sugar prices and the absence of export volumes weighed on cash flow. Cement financing picked up alongside a revival in construction activity, while textile, energy and automobile firms were net repayers of bank debt. Energy sector advances alone fell 28 billion rupees, extending a multiyear decline the central bank tied to project maturities and ongoing debt amortization — even as lending to public-sector energy entities rose 183 billion rupees on the back of circular-debt-related financing.
Deposits Climb, Profitability Softens
On the funding side, banks pulled in an additional 3.673 trillion rupees in deposits, a 9.3% increase that was led by current accounts as lenders continued to favor low-cost funding sources over interest-bearing savings deposits. Borrowings rose 11.9%, largely through secured facilities from the central bank.
Profitability told a softer story. After-tax profit inched up to 370 billion rupees from 365 billion rupees a year earlier, but asset growth outpaced the gain, pulling down return on assets to 1.1% from 1.3% and return on equity to 19% from 21.3%. Net interest income slipped to 1.14 trillion rupees from 1.157 trillion rupees, pressured by a 100-basis-point policy rate increase in late April that lifted funding costs faster than earning assets could reprice.
Non-interest income partly offset the squeeze, climbing to 370 billion rupees from 289 billion rupees on stronger foreign-exchange dealing income, fees tied to higher trade volumes and remittances, and gains from selling securities as banks repositioned portfolios ahead of an anticipated rise in yields. Credit-loss allowances also swung to a 26 billion rupee reversal from a 9 billion rupee charge a year earlier, aided by improved recoveries. Operating expenses rose more than 18% on higher salary and administrative costs, pushing the cost-to-income ratio up to 49.9% from 43.9% a year earlier.
Capital Buffers Hold
The industry’s capital adequacy ratio eased to 19.6% from 20.8% in December — still nearly double the regulatory minimum — as a rise in secondary-market bond yields produced revaluation losses on banks’ bond holdings that shrank Tier II capital by 14.8%. Risk-weighted assets grew 5.8% over the half, driven mainly by credit exposure tied to loan growth.
Liquidity buffers strengthened even as capital ratios eased. Liquid assets rose to 68.3% of total assets from 66.2%, while both the liquidity coverage ratio and net stable funding ratio stayed well above the regulatory floor of 100%, at 214.1% and 169.5% respectively, though each slipped modestly from December levels.
The central bank’s latest stress tests found that the banking system, and its largest, most systemically important lenders in particular, would remain solvent under a range of severe hypothetical shocks to credit and market risk over a two-year horizon, including a simulated 300-basis-point parallel shift in the yield curve and a 30% depreciation of the rupee.
Survey Flags Commodity, Geopolitical Risks
Pakistan’s central bank also released results from the 18th wave of its Systemic Risk Survey, conducted in July and August among bank executives, insurers, market infrastructure officials, academics and financial journalists. Respondents ranked volatility in commodity prices, including oil, as the top current systemic risk, followed by global geopolitical tensions and rising domestic inflation. Concern over both commodity price swings and inflation intensified from the previous survey wave, even as worries about a shortage of foreign funding eased.
Despite those concerns, survey respondents expressed strengthened confidence in the stability of Pakistan’s financial system and in the central bank’s capacity to safeguard it, according to the report.
Looking ahead, the central bank said it expects credit demand to pick up in the second half of the year, supported by contained inflation, currency stability and a planned increase in the exposure limit for unrated large private-sector borrowers. But it flagged continued uncertainty over the Middle East conflict as a risk to the broader economic outlook, along with heavier government reliance on bank borrowing to help fund a widening budget financing gap in the coming fiscal year.
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