Pakistan’s banks increased their exposure to short-term and floating-rate government securities during the first half of 2026, signaling expectations of higher interest rates, according to the State Bank of Pakistan (SBP).

The SBP’s Mid Year Performance Review of the Banking Sector showed that banks significantly increased their investments between January and June 2026, with most of the increase going into government securities.

Holdings of Market Treasury Bills (MTBs) increased by Rs. 2,943 billion during the period. Investments in Ijara Sukuk rose by Rs. 1,255 billion, while Pakistan Investment Bonds (PIBs) increased by Rs. 834 billion.

The composition of government securities also shifted toward shorter-term instruments. The share of MTBs in total government securities increased to 20.1 percent by June 2026 from 14.8 percent in December 2025.

Meanwhile, the share of PIBs declined to 60.7 percent from 66.5 percent.

Banks also showed stronger interest in floating-rate PIBs. Their offered-to-target ratio increased to 12.9 in the first half of 2026 from 4.7 in the second half of 2025.

For fixed-rate PIBs, the ratio fell to 3.7 from 4.7. The offered-to-target ratio for MTBs also increased to 2.8 from 2.5.

The shift suggested that banks were seeking to protect their returns if interest rates moved higher.

Average secondary market yields across major maturities increased by 1.1 percent during the first half of 2026. Banks earned Rs. 85 billion from selling securities, compared with Rs. 49 billion in the same period last year.

The SBP said the gains reflected banks’ efforts to sell securities and limit further losses in the value of their holdings as market yields increased.

Banks’ Profits Under Pressure

Despite the changing interest rate environment, banks’ after-tax profits increased slightly to Rs. 370 billion in the first half of 2026 from Rs. 365 billion a year earlier.

However, net interest income declined to Rs. 1,140 billion from Rs. 1,157 billion.

The decline came mainly from higher interest expenses following a 100 basis point increase in the policy rate in April 2026. Banks’ interest expenses rose to Rs. 1,946 billion from Rs. 1,866 billion.

The SBP noted that savings deposits are generally repriced faster after a policy rate change, while banks’ earning assets are repriced based on their contractual maturity or repricing dates. This timing gap can put pressure on banks’ margins when interest rates rise.

Higher noninterest income helped offset some of this pressure. It increased to Rs. 370 billion from Rs. 289 billion, supported by foreign exchange dealings, fees and commissions, and gains from securities sales.

Banks Could Shift Toward Lending

The outlook for the second half of 2026 is different from the investment trend seen in the first six months.

The SBP expects banking activity to remain steady as inflation stays contained, the currency remains stable and economic activity recovers.

Credit demand is also expected to increase, with seasonal factors and higher exposure limits for some large private-sector borrowers likely to support lending.

The SBP expects banks’ earnings to remain resilient even if interest rates decline, as lending to the private and public sectors is expected to increase.

Credit risk is also expected to remain manageable as financial conditions improve and borrowers’ ability to repay strengthens.

This points to a possible shift in banks’ strategy. After favoring short-term and floating-rate securities during the first half of the year, banks may increasingly focus on lending in the second half as the interest rate cycle changes.