The working environment remains challenging for financial institutions: russia continues to employ terrorist tactics and destroy civilian infrastructure as the war drags on. In spite of that, the financial sector operates continuously, and clients have free access to their funds. However, the consequences of massive missile attacks and shellings reduce the growth in demand for banking services and cause additional credit and operational losses for banks.
The banking system retains clients’ trust
The banking system in general has remained highly liquid since the start of the full-scale war, and certain liquidity indicators have hit record highs. On top of depositors’ trust, which the banks have managed to keep, liquidity levels are ensured thanks to regular and substantial government transfers to retail bank accounts. That said, the inflows of new deposits into the sector are uneven, with a vast proportion of funds accumulating on current accounts at state-owned banks.
In H2 2022, the share of term deposits in hryvnia retail deposits decreased, and thus the term composition of funding has deteriorated. That does not pose immediate risks for the banking system, yet it weakens the resilience of some banks to possible sudden moves in depositors’ sentiment. Therefore, the banks should make efforts to improve the term structure of retail deposits, including by raising deposit rates.
Continuous payments, settlements, and operation of the branch network, even under electricity supply disruptions, has also promoted trust to the banks. The banks have already developed and started to implement measures that should ensure their uninterrupted work even under long blackouts. While enhancing their resilience to operational risks, the banks incur material losses, inter alia because of the costs of additional equipment for their branches.
The net loan portfolio of the banks is contracting – gradually for business loans and sharply in the retail segment
The reason for the decline is provisioning against loans, as well as repayments of previously extended loans, which new lending does not compensate for. The decline in economic activity caused by shortages of electricity supply and depressed consumer demand also limit demand for loans. In wartime, government programs play the key role in supporting lending.
Credit losses remain the major risk for the financial sector
The banks have already suffered considerable credit losses. However, the banks have not recognized all materialized and expected losses. Around 20% of the loan portfolio has either turned into NPLs or moved into a risk zone. This is in line with the NBU’s June estimations. However, problems with electricity supply will depress performance even of those enterprises that have so far serviced their loans in a timely manner. Household incomes and operational cash flows of businesses in many cases will not be enough to service loans in full. Thus, we see grounds for downgrading our forecast of loan portfolio quality: if current problems in the energy sector persist for long, the ratio of losses may reach 30% of the portfolio.
Excessive capital stock is set to decline
The banking sector further generates substantial operating income, thus giving the financial institutions the first line of defense and allowing absorption of credit losses. An increase in interest income and resumption of fee and commission income, which in September reached the pre-war level, have contributed to the operating income. Through the year, most of the banks managed to optimize their administrative costs. Thus, despite material credit losses, the sector remained profitable, and its ROE in the first eleven months of 2022 exceeded 9%.
Most of the banks maintain their capital above the required minimum and even manage to replenish it. However, this extra capital stock is likely to disappear.
The NBU does not apply corrective actions against banks breaching regulatory capital requirements if these violations were caused by the war. The regime of regulatory forbearance will stay in place for a while. Therefore, the financial institutions that have viable business models and are capable of generating operating income will have enough time to restore capital if they need to. By contrast, the regulator will remain vigilant on operationally loss-making banks and may restrict their activities in order to protect depositors’ interests.
The NBU reiterates its plans to conduct a resilience assessment of banks in 2023
This will assess the accuracy of reporting on loan portfolio quality, the adequacy of provisioning, and the estimates of the actual amount of regulatory capital. Based on the assessment, the NBU will set a transition period for the banks to restore capital to minimum regulatory levels. Most of the banks will be in a position to restore capital thanks to current income. However, some of the banks are likely to need investors’ support for that.
Over the coming years, as current war-related problems are resolved, the NBU will refocus on long-term priorities of further harmonization of rules for the financial sector with the EU acquis.