The financial sector proved to be highly resilient and weathered through the crisis without significant losses. High levels of liquidity and capitalization allowed banks to scale up lending, thus supporting economic recovery. Bearing in mind positive economic dynamics, as well as solid standing and profitability of the banking sector, the National Bank of Ukraine (NBU) gradually winds down its anticrisis measures. The NBU also proceeds with introduction of new regulatory requirements in line with the schedule it approved.
The economy is gradually recovering. Delays in cooperation with IFIs pose a risk
Economic recovery continues thanks to high domestic demand and favorable terms on external markets. NBU’s monetary policy remains accommodative despite policy rate hikes in March and April in response to inflationary risks. Foreign investors’ interest towards Ukrainian issuers’ debt revives. However, volatility on global markets and holdbacks in cooperation with international financial institutions (IFIs) pose certain risks for public budget deficit financing and external debt refinancing.
The banks ramp up lending to the real sector and households
The real sector’s recovery is uneven. However, most of industries navigate through the COVID crisis without substantial losses and gradually expand demand for credit. Public lending programs promote growth in portfolios of loans to small and medium enterprises.
Growth rates of retail lending are picking up notably. Unsecured loans segment makes the core of the portfolio. It offers the highest returns, but also higher risks compared to other banking products. Raising risk weights for these assets from the current 100% to 150% by the end of 2021 will help banks to build up capital to absorb potential unexpected losses from conceivable underestimation of credit risks in this segment.
A few banks are actively expanding their mortgage portfolios. High mortgage growth rates may persist for long, given current low mortgage penetration rate, at below 1% of GDP.
High lending standards ensure proper quality of a loan portfolio
The impact of COVID crisis on loan quality have turned out to be easier than the NBU expected at the beginning of the crisis. Provisioning expenses doubled in 2020 compared to 2021; however, they did not affect materially the sector’s profitability. The results of the asset quality review confirmed that the provisions made by banks corresponded on general to materialized and expected credit losses. Conservative lending policy of banks prior to the crisis helped to ensure that losses from credit risks have been moderate. Going forward, high lending standards will promote a balanced growth and proper diversification of a loan portfolio.
Household deposits are a stable source of funding despite their declining maturity
During the crisis, a share of demand deposits in bank funding increased due to lower interest rates and depositors’ wish to have constant access to their savings. However, funding remains stable, and change in its maturity composition does not pose notable liquidity risks. New Net Stable Funding Ratio (NSFR) requirement that came into effect on 1 April 2021 will additionally mitigate potential liquidity risks.
The banks remain highly profitable
Declining cost of funding allowed most of the banks to keep an acceptable interest margin, while expansion of transactions boosted net interest income. From now on, the banks will have to adjust to work in lower interest margin environment. The potential for further decrease in cost of funding is almost exhausted, while a decrease in loan rates will persist.
Fee and commission income also grew at a high pace. It proved to be resilient to effects of quarantine restrictions due to a timely adaptation of financial institutions to a new environment with a focus on remote provision of services. An overall increase in demand from businesses and households for banking services also supported the rise in fee and commission income. Banks incomes cover by a safe margin their operating costs and provisioning, which substantially dropped in 2021.
Average core capital adequacy ratio is more than double of the regulatory required minimum. The NBU will soon outline a schedule for capital buffer introduction. However, the majority of banks are de-facto in compliance with capital conservation buffer and systemic importance buffer requirements.
The regulatory framework update will enhance resilience and transparency of the financial sector
The NBU proceeds with approximation of the banking regulation to the EU acquis. From 1 January 2022, the NBU plans to introduce capital requirements to cover operational risks. Next year, banks are to start test estimations of internal capital under ICAAP. This will enhance the quality of management and capital planning. Further on, the regulatory capital structure is to change; amendments to banking legislation will mandate the regulator to set higher individual capital requirements for banks.
The regulatory environment for non-bank financial institutions is also undergoing an upgrade. The parliament considers new laws on financial services and financial companies, on insurance, and on credit unions. Approval and implementation thereof will facilitate proper regulation and financial sector resilience.