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The banking sector proved resilient to COVID-19 crisis and now facilitates economic recovery – the Financial Stability Report

Financial sector successfully weathers through the COVID-19 crisis and appropriately performs all its functions. The banks faced the pandemics without noticeable imbalances, with sufficient capital and high liquidity. The work on cleansing and enhancing resilience of the banking sector launched in 2015 yielded evident positive results. For the first time on the record, banks have not become a driver of economic instability during this crisis. On the contrary, they support businesses and promote future economic recovery through lending.

Measures taken by the National Bank eased the crisis impact for banks

Since April, the National Bank employed key instruments available to a central bank to mitigate the crisis impact. Steps taken by the National bank were similar to those of regulators in other jurisdictions. In particular, the NBU suspended introduction of capital conservation and systemic importance buffers to give banks more leeway. Therefore, the banks may use capital in excess of minimum required to absorb credit losses and increase loan portfolio.

Moreover, the National Bank encouraged banks to restructure loans to borrowers who experienced temporary financial difficulties because of COVID-related restrictions. However, these restructurings have to be viable: they must not conceal fundamental financial problems of borrowers that are unlike to be resolved over the next years.

Credit risks materialized, although to a lesser extent than expected

Economy including the real sector recovers from the COVID-19 crisis. Although the growth rates of industries are uneven, corporate segment in general turned out to be resilient. Quality of banks’ corporate portfolio did not deteriorate substantially. Conservative lending standards promoted borrowers’ resilience. Timely restructurings and low proportion of exposures to vulnerable industries facilitated passing through the crisis without significant stresses.

Consumer lending decelerated considerably as the crisis unfolded; both demand and the supply decreased on this market. Over the second quarter, the segment saw a substantial increase in loans past due. Thus, some banks massively restructured unsecured consumer loans. The NBU believes that risks of the sector to banks are high. Therefore, it confirms its intention to increase risk weights for these bank loans to 150% over 2021.

Loan portfolio gradually increases, with fastest growth reported for loans SMEs and mortgages

Since September, financial system fully restored its financial intermediation function and gradually increases loan portfolio, with the fastest growth in lending to SMEs. Moreover, mortgage lending is on the rise since July. This is an unprecedented phenomenon for Ukraine, given the depth of the crisis and remarkable uncertainty. The key driver of lending recovery is a substantial drop in the cost of loans.

In view of their sufficient capital and liquidity as well as ongoing decline in interest rates, the banks stand ready to further support businesses and households through loans, thus promoting economic recovery.

Profitability risks rise as interest rates on loans are falling faster than those on deposits

Ukrainian banking sector remains highly profitable thanks to resilient operating incomes and absence of large credit losses. Net fee and commission income declined only for a while as the crisis peaked, and swiftly recovered in later months. Net interest income increased thanks to stickiness of large rate spread, as interest rates on assets and liabilities decreased in parallel.

In the medium term, narrowing of interest rate spread is inevitable. Under maintained macroeconomic stability, rates on loans will fall further. At the same time, there is little space for decrease in deposit rates, which are already historically lowest for Ukrainian banking sector. Therefore, narrowing margins on lending is the key risk for banks over the next years. 

Banks enjoy sufficient capital, but must prepare for novel requirements to capital

Capital adequacy of the banking sector stands well above the minimum requirements. On general, the crisis impact on banks’ capital turned out to be milder than the NBU assessed in June based on express stress test. This is a result of lesser economic shock compared to assumptions under the stress test and resilience of loan portfolio.

Over the next two years, the National Bank will introduce several new requirements to bank capital. They all aim at removing certain gaps in regulation and to harmonize Ukrainian rules with the Basel Committee recommendations.

In 2021, the banks have to prepare for phasing in of requirements to capital to cover operating and market risks, thus completing the adoption of Pillar 1 Basel recommendations into Ukrainian legislation. Moreover, gradual introduction of increased risk weights for Ukrainian government securities denominated in foreign currency is to start next year. This requirement will remove the discrepancy between the banks’ capital and amount of credit risk they assumed on their balance sheets.

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