NBU’s headquarters, Kiev, Ukraine (NBU, CC BY-NC-ND 2.0)
The restrictions introduced in Ukraine in connection with the COVID-19 pandemic have significantly affected the banking sector, mainly the growth of deposits, lending, and profitability. According to the NBU’s report on the situation of the banking sector, despite the significantly relaxed requirements for banks and the expanded opportunities for maintaining liquidity, the conditions of their operation will remain difficult in the near future, mainly due to the deterioration in the quality of the loan portfolio, the increase of risk, and the reduction in the demand for services.
Interestingly enough, according to NBU, the net profit of banks operating in Ukraine, in the period from January to April 2020, amounted to the UAH25.2bn (more than the USD900m), and was up to 39 per cent more than in 2019 (when a profit of the UAH18.1bn was recorded in the same period). The banks’ revenues reached the UAH90bn and the cost reached the UAH64.8bn, while in 2019 these values were the UAH77bn, and the UAH54bn, respectively.
The explanation for this paradox is simple — Ukrainian banks have been deriving a substantial portion of their revenues not from traditional operations, but from the purchased government bonds denominated in the UAH. And despite the crisis, the government has been meeting its financial obligations on time. The true condition of the sector is best shown by the situation in March 2020, when the quarantine had already been introduced, and the banks were not receiving the interest rate from the bonds. Back then the total net profit of all the banks only amounted to the UAH97m (USD3.5m).
On the verge of a bank war
According to the NBU, the conditions of the Ukrainian banking sector will deteriorate sharply by the end of 2020, which will also translate into worse financial results, following three years of high profits. Mainly due to the decline in the quality of loans and the need to create additional provisions for the NPLs. The restrictions associated with the quarantine will also impact a demand for banking services. The banks’ revenues from fees and commissions will likely be lower than last year. The demand for investment loans has also declined and it is unlikely to bounce back to the pre-crisis levels before the end of the year. The situation is different when it comes to loans to finance companies’ working capital. According to the assessment of the regulatory authority, the demand for such loans will remain at a stable level, and will start growing along with the recovery of the economy.
The number of consumer loans slowed down dramatically due to the pandemic. In the Q1’20, the portfolio of such loans grew only by 3.2 per cent. This was the result of the decrease in demand, but also of the banks’ increasing caution in the granting such loans. The customers’ limited interest in loans should not be surprising, not only because of the pandemic but also because the interest rate is enormous and amounts to 34 per cent annually.
In the same quarter, UAH-denominated loans for businesses grew by 3.6 per cent. The highest growth was recorded in March, when it reached 9 per cent. This reflected both a seasonal effect, as well as companies’ escape from foreign currency loans, associated with fears of the possible devaluation of the UAH. The portfolio of foreign currency loans decreased by 7 per cent. A reduction of the interest rates also contributed to the shift towards the national currency.
At the same time, the share of NPLs increased from 0.6 per cent to as much as 48.9 per cent. Over the past few years, the issue of NPLs mainly related to struggling companies. The NBU points out that now this problem – for the first time since 2017 – has also applied to consumer loans. The main reason why borrowers were unable to pay back their loans on time was the devaluation of the UAH in the spring of 2020.
The analysts from the regulatory authority predict that a sharp deterioration in the financial results of the banking sector could take place in the coming months.
According to Semion Babayev, the Deputy Chairman of the Management Board at Pravex Bank, the banks may soon start competing for borrowers. “In conditions of a dramatic drop in interest rates which is now taking place, we could see loan refinancing offers on the market. This will hurt the banks, and especially those with a large loan portfolio,” stated Mr. Babayev during a round table dedicated to the plan of a mortgage rate reduction to 10 per cent annually which has been announced by the Ukrainian President Volodymyr Zelensky.
The fact that customers are turning away from banks could be confirmed by the NBU data on the value of cash in non-bank circulation, which has been growing at a rapid pace. From the beginning of the year until the end of May 2020 it increased by as much as 13.2 per cent and now amounts to the UAH435bn. At the same time, the overall money supply increased by 9.8 per cent, to the UAH1.58 trillion. The difference of 3.4 percentage points could mean that in light of the pandemic the Ukrainians began to turn away from banks, treating cash as a safer and more convenient means of payment. This is also the proof of a growing scale of the informal economy, which emerged after the government introduced restrictions on the legal operation of companies whose activities are of crucial importance from the point of view of the Ukrainian consumers.
Additional insight into the current situation is provided by central bank’s report on Ukraine’s financial stability, published in June. The NBU assesses that the Ukrainian banking sector entered the crisis caused by the pandemic in a good shape and with sufficient capitals. Banks ensured the continuity of the services, despite the dramatic limitation in the functioning of branches. The regulatory authority notes that the situation is much better than in previous crises. Nonetheless, the financial system should prepare for the negative effects of the pandemic in the medium-term.
The NBU carried out stress tests in which it assessed the impact on the capital positions of 26 large banks in a macroeconomic scenario slightly worse than that expected early spring. It turned out that nine banks, including two state-owned ones (out of a total number of four such banks) could have problems with maintaining the necessary levels of capital. Moreover, this is not a new situation. The regulatory body noted that these problems have been highlighted in previous studies, but the management boards of banks have ignored them. At the same time, however, there is no risk of a systemic collapse — the private banks with problems only account for 5 per cent of the sector’s assets. The situation is somewhat less favorable when it comes to the stability of public finances, because in the event of problems the state budget will have to cover the needs of state-owned banks recognized by the NBU as potentially endangered.
The state-owned banking giant Oschadbank (The State Savings Bank of Ukraine) is already facing serious difficulties. The NBU described it as “operationally ineffective”, and its capital reserves could turn out to be insufficient to cope with the effects of the pandemic.
According to the NBU, prior to the crisis, the quality of the Ukrainian banks’ loan portfolios was the best in a decade. However, it is impossible to avoid the losses caused by COVID-19. The decrease in internal and external demand, the restrictions associated with the quarantine, and the unresolved structural problems in a number of sectors of the Ukrainian economy will have an impact on the borrowers’ ability to repay their debts. It can be expected that one out of ten customers will not be able to repay the consumer loan.
Lending a hand
In June 2020, in order to alleviate the impact of the pandemic on the banking sector the Ukrainian central bank introduced an anti-crisis package for commercial banks. The NBU will not punish banks for any breaches of capital, liquidity, and credit risk requirements until June 2021. However, the banks will have to prove that these breaches are due to the quarantine measures announced by the government, and that they are not simply the result of incompetent management. This moratorium will not apply to the entities that will pay out dividends to their shareholders, which is against the recommendations of the regulatory authority. The banks taking advantage of the moratorium will have to prepare a recovery plan together with the NBU and until they reach the required parameters they will not be allowed to enter any operations with any affiliated entities or to pay out any dividends or bonuses to board members.