Moody’s Investors Service downgraded on Friday the long-term deposit ratings of five Pakistani banks to Caa3 from Caa1. The banks are Allied Bank Limited (ABL), Habib Bank Limited (HBL), MCB Bank Limited (MCB), National Bank of Pakistan (NBP) and United Bank Limited (UBL).

Moreover, Moody’s also downgraded the five banks’ long-term foreign currency Counterparty Risk Ratings (CRRs) to Caa3 from Caa1.

As part of the same rating action, Moody’s lowered the five banks’ Baseline Credit Assessments (BCAs) to Caa3 from Caa1, and as a result also downgraded their local currency long-term CRRs to Caa2 from B3 and their long-term Counterparty Risk Assessments to Caa2(cr) from B3(cr).

However, the outlook on all banks’ long-term bank deposit ratings has been changed to stable from negative, said the rating agency in a statement.

In view of the correlation between sovereign and bank credit risk, these banks’ standalone credit profiles and ratings are effectively constrained by the Caa3 rating of the government: Moody’s

Moody’s latest rating action follows its decision to downgrade the Government of Pakistan’s issuer and senior unsecured debt ratings to Caa3 from Caa1 earlier this week, to reflect Moody’s assessment that Pakistan’s increasingly fragile liquidity and external position significantly raises default risks.

Elaborating the rating rationale, Moody’s said that the downgrade of the long-term ratings of the five Pakistani banks reflects: (1) the weakening operating environment, as captured by Moody’s lowering of its Macro Profile for Pakistan to “Very Weak” from “Very Weak+”; and (2) the high interlinkages between the sovereign’s weakened creditworthiness – as indicated by the downgrade of the sovereign rating to Caa3 from Caa1 – and the banks’ balance sheets, given the banks’ significant holdings of sovereign debt securities.

“The deterioration in Pakistan’s operating environment reflects both the rising government liquidity and external vulnerability risks, with foreign exchange reserves declining to critically low levels, as well as the high costs of living with headline inflation likely to rise further as energy prices increase in tandem with the removal of energy subsidies,” said Moody’s

The ratings agency said that the combination of these factors, together with the high-interest rates, will dampen consumer confidence and compromise borrowers’ repayment capacity.

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“In turn, these factors will pressure banks’ earnings, asset quality and capital metrics, and also potentially jeopardise financial stability. These pressures have led to the lowering of the country’s Macro Profile to Very Weak from Very Weak+,” said Moody’s.

Moreover, Moody’s highlighted that the banks’ high sovereign exposure, mainly in the form of government debt securities that range between 36%-61% of their total assets, also links their credit profile to that of the government.

“In view of the correlation between sovereign and bank credit risk, these banks’ standalone credit profiles and ratings are effectively constrained by the Caa3 rating of the government,” it said.

Explaining the stable outlook, Moody’s said that the stable outlooks assigned to all the banks’ long-term deposit ratings are in line with the stable outlook on Government of Pakistan.