Banks and Bank Regulation

In the beginning of the year 2010 Fitch's ratings of Ukrainian banks were capped at 'B-' in line with the sovereign ratings, and the agency believes the banking sector will require substantial further capital support going forward. Fitch expects only moderate capital injections at most foreign-owned banks during 2010, as parent institutions are likely to wait for an improvement in the operating environment and a clearer picture of eventual losses before embarking on more full scale recapitalisation. On the other hand, greater political stability, economic policy discipline and financial stability following the recent election could result in sovereign and bank Outlooks, all of which are currently Negative, being revised back to Stable.

Since the crisis began in H2’08, the Ukrainian banking sector has suffered from deposit outflows, a liquidity squeeze, a sharp deterioration in asset quality, and numerous defaults and restructurings. In 2010, an improvement, or at least no further deterioration, in the prospects for the banking sector will have a major bearing on sovereign creditworthiness, while greater political, macroeconomic and exchange rate stability would support recovery in the banking system and the wider economy alike.

Impaired loans, including non-performing and restructured exposures, rose to an average 34% at Fitch-rated banks at end-H1’09, due in particular to rapid pre-crisis growth, weak risk management, substantial foreign currency lending, and the sharp economic downturn. Fitch forecasts in its base-case scenario that sector impaired loans will peak at 40%, although further downside risk could materialize, should political and macro developments remain negative in 2010.

Sector capitalization has been supported during the crisis by moderate regulatory reserve requirements, significant capital injections, solid pre-impairment profit, and some deleveraging. However, given the scale of asset quality problems, Fitch estimates that the system may need as much as a further UAH 92bn or US $11bn) of new capital contributions to restore solvency. This is an amount equal to almost double that injected in the 12 months to end-Q3’09.

Customer deposits, and hence system liquidity, have stabilized since Q2’09 after a sharp contraction in Q4’08-Q1’09, while foreign debt roll-over rates have been high, reflecting support from international parent banks for Ukrainian subsidiaries. However, liquidity remains moderate at many institutions, and the now high loans/deposits ratio—it was 214% at end-Q3’09—and relatively high sector penetration of loans/GDP of 84% at end-Q3’09 suggest limited growth potential in the near term.

Twenty-four banks, accounting for 12% of sector assets, have entered temporary administration since Q4’08, after failing to service their obligations. Five of these banks have since exited administration, of which three have been nationalized. However, government support for failed institutions has to date been limited in scope, and most of the 24 banks are likely to be liquidated. Four Ukrainian banks have defaulted on, or restructured, eurobonds, and Fitch believes it is likely that several other institutions have renegotiated the terms of non-public international borrowings.

The significant role of foreign-owned banks, which accounted for 47% of sector assets at end-Q3’09, has been a stabilizing factor during the crisis and should considerably reduce the ultimate cost to the Ukrainian state of fixing the banking system. However, most parent institutions are likely to be wary of increasing Ukrainian exposure after the crisis, which will further serve to restrict system growth and likely result in increased competition for local deposits. The role of state-owned banks in the system has expanded as a result of directed lending at Oschadny, in particular, Ukrexim, and the nationalizations of three failed banks.