KARACHI: The State Bank of Pakistan (SBP) has cautioned that prolonged uncertainty stemming from the Middle East conflict could pose downside risks to Pakistan’s financial stability, potentially fuelling inflation, straining the external account and disrupting economic growth.
In its annual Financial Stability Review (FSR) for 2025, the State Bank of Pakistan (SBP) said that while the recently achieved macroeconomic stability presents a sanguine outlook for financial stability, the uncertainty around the conflict in the Middle East may pose downside risks.
“A protracted and widespread conflict may keep oil prices higher for longer and disrupt global supply chains,” the SBP said. “Consequently, inflationary pressures may resurge, and the external account could come under strain, potentially affecting the growth momentum,” it added.
The SBP noted that the latest Systemic Risk Survey, conducted in January 2026, also indicates that independent experts foresaw geopolitical risk as the topmost risk at present as well as six months down the road. “This risk may have a spillover effect on the banking and financial sector of Pakistan.”
“Nonetheless, the banking sector is well positioned to withstand severe shocks as it is supported by strong financial cushions, prudent and time-tested supervisory and crisis management frameworks that have effectively weathered severe macroeconomic stresses in the past,” it said.
The banking sector in general and large systemically important banks in particular exhibit resilience to withstand even severe shocks over the projected horizon of three years, the central bank’s report said, citing the latest stress test.
The SBP’s FSR presents the performance and risk assessment of banks, microfinance banks, development finance institutions, non-bank financial institutions, insurance, financial markets and financial market infrastructures.
According to the report, the financial sector grew by 15.1% and maintained operational and financial resilience in 2025. Encouragingly, the financial depth, as measured by the assets-to-GDP ratio, increased to 67.1% while risks to financial stability subsided during the year under review.
The banking sector continued to exhibit steady performance and resilience during the last year. The balance sheets of banks expanded by 17.8%, driven by investments in government securities. Advances showed a YoY decline as of December 2025, mainly reflecting the higher base effect of last year’s ADR-linked tax policy; however, adjusting for this base effect, the advances registered a decent growth in line with the improvements in macro-financial conditions.
With a healthy revival in deposits’ mobilisation, banks’ reliance on borrowings subsided. Asset quality indicators improved, as non-performing loans (NPLs) to gross loans ratio declined to 6.1% in December 2025 from 6.3% last year. On a net basis, however, the credit risk remained low as the provisioning coverage of NPLs further improved to 107.7%, and a large part of the credit portfolio comprised rated borrowers with a steady credit profile and an established background.
The after-tax earnings posted growth; nonetheless, volume-driven earnings led to a moderation in profitability indicators. The solvency position of the sector remained strong as the capital adequacy ratio improved to 20.8% by the end of December 2025 and remained well above the minimum international and local regulatory benchmarks.
Within the banking sector, Islamic banking institutions witnessed the highest ever expansion in branch network and continued their growth momentum. Along with muted credit risk and steady earnings, capital buffers of the Islamic banks remained strong as well. Microfinance banks, on an aggregate basis, though remaining under stress, recorded a significant reduction in losses last year as the recapitalisation and restructuring efforts started to mature.
The report noted that the non-bank financial sector presented a mixed performance. The asset base of development finance institutions contracted while non-bank financial institutions grew at a decent pace. The insurance sector maintained a strong performance during the year.
The debt servicing capacity of the non-financial corporate sector improved owing to declining finance costs, driven by easing monetary policy stance, although the sector experienced revenue pressures and a moderation in earnings indicators. Moreover, the creditworthiness and repayment capacity of the large borrowers of the banking sector also remained sound in 2025.
