Ukrainian financial system successfully resists the challenges of war

Ukrainian financial system successfully resists the challenges of war

The deep economic and financial crises caused by russia’s full-scale war against Ukraine will have significant negative and long-term consequences for the financial sector. However, according to the Financial Stability Report published by the National Bank of Ukraine (NBU) in June 2022, banks are successfully resisting the challenges of war due to significant safety margin, timely response of the NBU and the reforms undertaken.

Given the expected scale of financial risks and capital losses by banks, the NBU has temporarily switched to a policy of regulatory easing. The NBU will not take measures of influence if financial institutions violate capital adequacy requirements due to the negative consequences of the war. At the same time, the NBU requires banks and non-bank financial institutions to display their financial condition transparently and authentically. This will make it possible to establish a realistic schedule for financial sector post-war recovery.

As a result of the war, Ukraine’s GDP is expected to fall by more than a third and inflation will increase significantly. To avoid uncontrolled devaluation and capital outflows, the NBU temporarily fixed the exchange rate and imposed currency restrictions, alongside supporting the foreign exchange market with interventions. Budget needs financing and NBU’s international reserves replenishment are possible thanks to large-scale financial assistance from partner countries. At the same time, the closure of foreign debt markets is not a problem for banks, which are mainly funded domestically and do not depend on external borrowings.

Banks operate stably with preserving depositors’ confidence

Banks proved their operational stability by providing daily customer service nearly smoothly in the regions where employees’ and customers’ safety was ensured. Since mid-June, about 85% of country’s bank branches have been operating. However, banks suffered significant losses from operational risk due to war-caused events.

Now there is no concern for banking sector liquidity, but banks need to follow conservative approach and assume that liquidity risk still remains.

In June, the NBU has sharply risen the discount rate up to 25%. This prompts banks to elevate deposit rates in order to increase hryvnia savings attractiveness. This should strengthen the stability of bank funding. The yield of domestic government bonds is also expected to increase. Experts estimate that the steady market demand for government debt securities will further reduce the need for emission financing of the budget deficit.

Lending continues with regard to wartime realities

The real sector is gradually recovering from the first war shock, but a significant proportion of enterprises have not resumed operations, so they will face difficulties with debt servicing. Households and businesses loan demand has weakened significantly during the war, as well as the risk appetite of banks for granting new loans. Only hryvnia corporate lending is growing. This growth is mainly provided via state support programs.

Weak financial condition of businesses and individuals will constrain active bank lending in the postwar period, therefore government programs of partial interest rate compensation and partial loan guarantees should be maintained. The recovery of the unsecured consumer lending segment will be faster, but the pace will not keep up with the pre-war level. Mortgage lending will be suspended for a while. It may be restored only via government support programs mechanism.

Banks can absorb significant losses from credit risk

The NBU expects banks to lose at least 20% of their loan portfolio as a result of the crisis. And banks will use their capital to cover these losses. The capital stock before the breakup of a full-scale war in Ukraine has significantly exceeded the minimum required levels, therefore, Ukrainian banks have high safety margin. In addition, many large banks will maintain operational efficiency and will be able to replenish capital after the war ends via profit-making.

To partially release the capital of banks, the NBU has reduced the risk weights on unsecured consumer loans from 150% to 100%. Increasing risk weights is a countercyclical tool that has prompted banks to pursue prudent lending policies and build up a larger capital stock that can now be used during the crisis.

Non-bank financial institutions have to mobilize their own resources for recovery

The non-bank financial institutions were less prepared for war challenges than the banks and had lower capacity for facing operational risks. However, in all segments of the non-banking financial market there are companies that continue to provide quality services.

The NBU allows market participants to recover without taking measures for a number of violations. At the same time, non-bank financial institutions have to mobilize their own resources for recovery and maintain transparency in displaying their financial condition.

Finally, the NBU gives recommendations to the government in the Report to focus further efforts on:
-expanding state support for loan programs;
-aligning the conditions for domestic government bonds placement to the market value of hryvnia resources;
-resolving the issue of lost housing and potentially problematic mortgages.

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