18 December 2017
The past year was a successful one for Ukraine’s banking system. Systemic
risks remain moderate, but they may rise next year. The key risks to financial stability
include the suspension of cooperation with the IMF, the slow pace of structural
economic reforms, the low efficiency of state-owned banks, and the weak legal
system. Those are the key messages of the fourth Financial Stability Report,
published on 18 December 2017.
A lengthy delay of the next IMF tranche is the key
risk to financial stability
There were few changes in Ukraine’s macroeconomic environment in the second
half of 2017. Economic growth remained sluggish, but it will accelerate to above
3% in 2018. Exchange rate volatility was modest. Inflation overshot the
expectations communicated in early 2017 and is currently above the NBU’s
target. Higher inflation is an impediment to lending over the medium- and
long-term. In Q4, the NBU hiked its key interest rate twice by a combined 2 pp
to 14.5% to tame inflation risks. However, those rate increases should not
derail the longer-term trend of a decline in interest rates.
In the aftermath of the clean-up stage, the banking sector earned profits again.
This trend is to hold in 2018. The major short-term challenge for banks is
implementation of IFRS 9. The transition to the new standard may affect banks’
equity substantially. The impact on regulatory capital will be less
The key macroeconomic risk to financial stability over the coming years is
the suspension of cooperation with the International Monetary Fund (IMF).
Without support from international institutions, a successful roll-over of the
more than USD 20 billion of sovereign and state-guaranteed debt maturing in
2018-2020 is unlikely. Ukraine would do well to launch negotiations on a new
IMF program before the current program expires early in 2019.
Consumer lending does not pose a risk to financial
stability for now
Lending to businesses and households has restarted after a three-year
break. Lending first recovered in the retail segment, and banks are growing
their retail loan portfolio primarily in consumer loans. Ukraine currently has
the lowest retail loan penetration in Europe, and the NBU expects household
credit to grow rapidly over the next few years.
Retail lending does not currently have a material impact on private
consumption and it does not pose a significant risk to inflation or the current
account. Therefore, the NBU does not yet see a need to act to restrain retail
lending. The NBU will remain vigilant on developments in retail lending to
mitigate potential risks. If necessary, the regulator will tighten requirements
on credit risk assessment at banks for retail loans or introduce macroprudential policy instruments to limit excessive
credit growth. The NBU will report twice annually on consumer lending
developments and will communicate in a timely manner about risks and propose
measures to mitigate those risks.
Interest rates are at record lows for foreign currency retail deposits and
at five-year lows for hryvnia deposits. Given the cheaper funding base, the NBU
expects interest rates on loans to decrease significantly over the next 12-18
The protection of creditor rights must
be enhanced to reinvigorate corporate and mortgage lending
High interest rates are still holding back the recovery of mortgage
lending. However, new mortgages will be more affordable in 2018. Secured
long-term mortgages currently account for less than 5% of new loans, but that
share is due to grow in the coming years.
The shortcomings of the foreclosure procedure when a borrower fails to
service a loan is the major obstacle to the recovery of mortgage lending over
the medium term. The foreclosure mechanism must be reformed
to make housing mortgages more affordable.
The financial standing of companies is no longer an obstacle to a recovery
of corporate lending. Profit margins for most industries in the real sector are
higher than before the crisis. Companies are generating sufficient cash to
service loans in time, and new attractive corporate borrowers are emerging. If macrofinancial conditions remain stable and the protection
of creditor rights is improved, new corporate loan formation will grow,
especially to small- and medium-sized enterprises (SMEs).
The key internal risks to the banking sector have remained the same over
the last few years: the high market share of state-owned banks and the high
share of non-performing loans (NPL) in banks’ portfolios. A strategy for
reforming state-owned banks must be finalized as soon as possible. Any delay to
its implementation will raise the fiscal costs of covering future losses at
state-owned banks. The program must set clear timeframes for the state’s
divestment of banks. Meanwhile, banks must be more proactive in resolving NPLs
by using restructuring and write-off mechanisms.
New NBU regulations will focus on crisis prevention
During the crisis years, the NBU focused on normalizing the work of the
banking sector. Now, the regulator’s attention is shifting towards crisis
prevention. In 2018, the NBU will work actively to formalize requirements based
on the recommendations of the Basel Committee on Banking Supervision (Basel
III) and EU directives.
In 2018, the NBU will introduce a new liquidity requirement, the liquidity
coverage ratio (LCR). The LCR aims to enhance banks’ resilience to sudden
outflows of funds. The NBU will also share with banks a draft regulation on the
new structure of regulatory capital and eligibility criteria for its
components. The requirements will only be implemented after the completion of a
detailed quantitative analysis to study their effects on the banking sector.
Banks will be stress-tested annually, which will become an important
component in ensuring banking stability. Banks with combined assets of at least
90% of the sector’s total will be subject to the stress-test.
The NBU will further enhance disclosure standards for banks’ financial and
prudential reports. Starting in 2018, the NBU will publish reports on the
regulatory capital structure, and disclosure requirements will grow stricter
with time. The NBU’s goal is to ensure the complete transparency of banks’
operations and financial positions.