Banking Sector Insight: About to take off

​The Ukrainian banking system is bouncing back from the bottom of the financial crisis which was reached in 1H15. Increased solvency and the abundant level of liquidity at most banks paves the way for a credit revival. 

Financial stabilisation is now on firmer ground. The Ukrainian banking system is showing strong signs of recovering: total deposits rose by 2.2%, net of FX effect, during the period January-May 2016 while UAH liquidity remains abundant with an excess of approximately UAH70bn. This has allowed the National Bank of Ukraine (NBU) to relax FX controls (in June) and lower the key rate by 5.5ppt (since 1 March 2016) to its current level of 16.5%.

All but two banks out of the top 20 have survived the most recent round of the stress test; and the failure of the two weakest has had hardly any impact on the rest of the banking system. The combined capital of the largest banks has increased by more than UAH98bn - or 72% - since 1Q15. Half of the banks obliged to conduct stress test have either demonstrated that they do not require recapitalisation or have completed the three-year programme ahead of schedule. We expect the other half to raise a combined UAH15bn or so in new capital by the end of 2016.

Despite an almost year-long delay in implementing the IMF programme, one of its targets - the establishment of transparent ownership structures - has already been achieved. The NBU reports that none of the solvent banks is hiding its real beneficiaries.

Privatbank makes limited progress. Loans to the sectors of economy where Privat Group has a significant presence represent up to 85% of the total gross portfolio. We believe that it poses the largest threat to the financial stability of the banking system. Privatbank is most likely to abstain from a massive capital injection in 2016 and concentrate instead on raising additional and better-quality collateral against issued loans. In 1Q16 it restructured its UAH2.1bn (as of 1 January 2016) debt to the NBU and is now expected to repay it by August 2017. Given the sweeping changes in the banking sector, it is unlikely that Privatbank will be allowed to continue doing business as usual. Risk reduction may take longer than the expected three years. Moreover, if the bank fails to follow risk reduction programme, it is likely to be nationalised.

Abundant liquidity prevails. Nearly half of all Ukraine's banks have surplus UAH liquidity, which is "sterilised" by the NBU in the form of certificates of deposit (CDs) that have a short maturity (up to two weeks).

Despite their high levels of liquidity, the banks have so far been very cautious about reviving lending. There has been a noticeable expansion of the UAH-denominated corporate loan portfolios of Western banks such as Citi, ING and Credit Agricole; however, their combined market share is not sufficient to be able to say that there is already a lending revival in Ukraine. Together with an inflow of deposits, the expanded loan portfolios have driven interest rates down - by 200-220bps for UAH-denominated deposits since the beginning of 2016 and by 190-260% for USD-denominated deposits.

We expect UAH-denominated deposits to further decrease by 150-200bps by the end of 2016 if the current level of financial stability is maintained. Decreasing rates will boost demand for loans while legislative amendments aimed at protecting creditors' rights will enhance the bank's appetite for credit expansion. We believe that the banks will increase their loan exposure in the corporate sector in 2H16.

Russian banks might leave. Banks with Russian state capital are likely to consider exiting Ukraine in 2016 and 2017. These banks have among the highest NPL ratios - 47 to 80%, compared with 36% for the peer group. They also have significant exposure to Donbass and Russia-oriented businesses that were hardest hit during the recent crisis. Furthermore, some borrowers have taken advantage of the precarious political position of Russian-owned businesses by not paying their debts. Since the situation is not likely to improve on any these fronts in the foreseeable future, exiting Ukrainian market appears to be a rational strategy.

According to our estimates, both Prominvestbank and Sberbank have seen their gross loan portfolios decline, along with the simultaneous reduction in the level of deposits. We expect the further diminishing of their balance sheets in 2016.