The financial sector remains in excellent condition, resilient, and profitable. The banks are ramping up lending on the back of their high liquidity and capital ratios. The current profitability of the banking sector and sizeable stock of capital indicate timeliness of the regulatory changes scheduled by the National Bank of Ukraine, namely setting capital requirements for operational risk and higher risk weights for unsecured consumer loans and foreign-currency-denominated domestic government debt securities. In addition, banks have to build up capital buffers by 1 January 2024.
Access to global financial markets is becoming more complicated. Therefore, maintaining cooperation with the IMF is important
Economic growth expectations have deteriorated because of escalation of the conflict by Russia, a surge in energy prices, and the spread of new COVID-19 variants. Thus, risk premium for investing into Ukraine has risen. Advanced economies continue to wind up monetary stimuli, and yields on risk-free instruments are on the rise. This complicates Ukraine’s access to global financial markets. Therefore, maintaining cooperation with the IMF is important. The economy is resilient enough to face these risks. However, its growth is slower than expected. Investments are needed to boost the growth.
At the same time, the banking sector does not depend directly on international capital markets, as external borrowing is currently low, and these are mostly loans from IFIs. For the first time in a long while, foreign investors have shown interest in the Ukrainian banking sector, primarily focusing on the segment of unsecured consumer lending.
Demand for corporate and retail loans is increasing, while quality of loan portfolio improves
The hryvnia corporate loan portfolio of banks has expanded at the rate of over 40% yoy, with lending to the segment of micro, small and medium businesses rising at the fastest rate. High demand for corporate loans is fueled by the rising output, the overall decrease in interest rates, and, partially, by the state support programs. The quality of corporate loan portfolio is improving.
Consumer lending has accelerated to over 30% yoy, the rates seen before the crisis, thanks to demand from households and attractiveness of the segment to banks due to its profitability. An increase in risk weights on unsecured consumer loans to 150% effective 1 January 2022 will promote an appropriate capital cushion to cover credit risk of this portfolio.
Bank funding is sufficient to continue lending
Deposits on current accounts dominate in the current bank funding structure. The structure poses no barriers to active lending. However, the inflow of household deposits to banks has slowed. Higher inflation, policy rate hikes, and their intention to extend funding maturity encourage banks to offer higher interest rates on term deposits.
Banking sector generates record-high profits
Active lending has promoted growth in net interest income, while material volume of transaction business pushed up net fee and commission income. This, coupled with lower expenses on provisioning and moderate administrative costs, ensured record-high profitability of the sector.
Loan rates still have a certain potential for a decline, primarily the rates on mortgages and loans micro, small and medium businesses. At the same time, the NBU expects the cost of funding to increase moderately in 2022. Therefore, the downward trend in banks’ net interest margin is to persist.
Banks are to build capital buffers up over the next two years
The 2021 stress tests of the largest banks showed that capital risks have decreased noticeably compared to the previous assessment of 2019. Credit risk is not the major source for capital needs now, with the interest rate risk outweighing it. The banks that were identified as having material risks are already working on mitigation thereof under restructuring plans.
Windfall profits of the banking sector and large capital cushions allow the banks to comply with a number of capital requirements to be introduced in early 2022. More specifically, the NBU will require the banks to cover 50% of their estimated operational risk with capital and increase risk weights to 150% for unsecured consumer loans and to 50% for foreign-currency domestic government debt securities. Now is also a good time to activate capital conservation buffer and systemic importance buffer. The banks will have to build up 50% of the capital conservation buffer and 100% of the systemic importance buffer by 1 January 2023. By 1 January 2024, both buffers are to be built in full.