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Bank Resilience Assessment: Big Banks Should be more Thorough about Creating a Safety Margin to Respond to a Major Crisis

Under current macroeconomic conditions, the banking sector is relatively stable, however some big banks need to improve resilience in order to respond to a major crisis. This fact is confirmed by findings of the Annual Bank Resilience Assessment the National Bank of Ukraine (NBU) has carried out since May 2019.

As part of the resilience assessment, all banks were subject to asset quality assessment, and 29 banks additionally underwent stress testing. According to the resilience assessment findings, the NBU has determined the capital need for a number of banks. The capital need arises if the estimated value of the capital adequacy ratio of the bank is – in the course of asset quality assessment or stress testing according to the basic and adverse scenarios – below the minimum set by the regulator. Stress test horizon is 3 years.

Asset quality assessed by independent auditors confirmed that, in general, banks recognize credit risk of assets adequately. Auditors performed minimum adjustments to the credit risk and capital levels, mostly due to technical errors in the banks’ information systems. According to the findings of the asset quality assessment, a capital need was found in one bank, which was met as at today.

At the same time, according the stress testing findings, some banks have a need in capital. Thus, the basic macroeconomic scenario for 11 banks showed a need in additional capital of UAH 35.2 billion.  The adverse macroeconomic scenario for the same institutions and another seven banks revealed the need of UAH 73.8 billion.

For the most part, this was caused by amortization of collateral, meaning a gradual devaluation of collateral in the assessment of nonperforming loans.

In order to preserve resilience of such institutions in case of a hypothetical crisis, a requirement a of higher minimum of capital adequacy come into effect.

Banks – that according to the stress testing findings – had the capital below the minimum level, in order improve resilience should comply with the capital adequacy requirement set by the NBU or reduce the risk profile, meaning to perform restructuring. These measures can cover improving the loan portfolio quality, optimizing the assets and liabilities structure, and adjusting the business model. If such measures are taken, requirements may be loosened or cancelled.

The deadline to meet requirements is the end of September 2020.

This year’s stress testing was noted for special scrutiny to the consumer loan portfolio. Resilience assessment found that not all banks – among the actively engaged in consumer lending – comply with the conservative approach to estimating the credit risk. These institutions gravely underestimate the possible impairment of quality of the loan portfolio in case of the adverse scenario. Such conclusions of the regulator need to be considered by banks.

The NBU will continue assessing the banks’ asset quality and conducting stress testing annually. The macroscenarios for stress testing will be adjusted in order to identify vulnerabilities of the banking sector and individual banks. At the same time, banks  that according to the stress testing findings in this and the previous year did not require additional capital will be free from stress testing. Such banks will undergo asset quality assessment.

Further information on the resilience assessment findings with a breakdown by banks will be released on the NBU’s website in December 2019.

For reference: The NBU has been assessing resilience since 2018 that covers asset quality assessment and stress testing. All banks underwent asset quality assessment, save for the Settlement Center performing only settlement transactions. An independent auditor was retained for this stage.

As of the beginning of this year, 29 banks that account for 93% of assets in the banking system underwent stress testing. Stress testing was conducted based on two scenarios: basic and adverse.

According to the resilience assessment findings, the regulator will determine the required levels of the regulatory capital adequacy ratio (N2) and the common equity adequacy ratio (N3). The required level of the capital adequacy ratios will be estimated in order to ensure banks’ compliance with the minimum requirements of N3 and N2 according to the baseline scenario (10% and 7%, respectively) and less strict requirements to the said ratios under the adverse scenario (5% and 3.5%, respectively) throughout the entire forecast period of three years (to 2021 inclusively).

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