Ukraine’s banking sector has been weathering a string of storms, from the coronavirus pandemic to a full-scale invasion by Russia, with remarkable strength, but in the last two months these shocks are starting to tell, and profits fell off dramatically in March and April.

The sector as a whole is still in profit over the first four months of this year, according to the latest data from the National Bank of Ukraine (NBU), but that won’t last for much longer.

The net operating profit of the banking sector for the four months of 2022 increased by 10%, despite falling in March and April. However, including significant funds banks took as reserves after the war started, the sector reported a net loss of UAH7.4bn ($250mn) and banks’ return on equity and assets has fallen below zero, as the chart shows.

 

Banks are building up reserves in anticipation of rising non-performing loans (NPLs) as many debtors have suspended repaying their loans due the uncertainties of the war. However, only a slight increase in NPLs is visible in the NBU data at the moment and the overall level of NPLs has fallen steadily and significantly in recent years.

NPLs in the Ukrainian remain the main problem for the sector and the sector average was 27.35% in April, a high level. But as part of the bank sector reforms launched in 2014, all this debt is provisioned for and does not represent a structural weakness for the sector. The bad debt has simply tied up capital that could have been used for lending instead. With the start of the war, the banks were already battle hardened, and increasing their reserves ahead of any problem with rising NPLs was an obvious and prudent step to take.

Drilling into the distribution of the NPLs, the now state-owned PrivatBank remains the black sheep of the family with NPL ratio of 68% – by far the largest in the sector but down 10 percentage points from April 2020 before the crises struck.

The bank’s management call these debts “fraud loans” and attribute them to the bank’s former owner, oligarch Ihor Kolomoisky, who drained some $5bn out of the bank using shell companies and transfer pricing schemes – an act for which he has never been prosecuted.

Counting out PrivatBank and the other state-owned banks have an average NPL ratio of 27%, while for the privately owned and foreign-owned banks the figures are 11.8% and 7% respectively. If the war had not started then Ukraine’s banking sector would have probably solved the bulk of its NPL problem this year and next.

 

NPLs % of loan book
	Apr 20	Apr 21	Apr 22
ratio of non-performing loans, %	48.92	39.93	27.35
incl. banks:
with state participation, of which:	64.7	56.36	45.6
PrivatBank	78.66	72.54	68.06
state banks ex-PrivatBank	51.73	43.09	27.04
Foreign owned	33.27	27.28	6.98
Privately owned	18.59	13.17	11.78
Insolvent	0	0	0
Source: NBU

 

But due to significant contributions to reserves, the banking sector suffered a net loss in the first four months of this year, amounting to UAH7.4bn. However, reserves increased sevenfold compared to January-April 2021, to UAH32.7bn, of which 83%, or UAH27.0bn, was created in March-April. During January-April, banks' revenues grew by 11% year on year to UAH88.6bn, and expenses by 53% to UAH96bn, reported the NBU.

Loans

Lending has also slowed since the start of the war. During the bounce-back following the appearances of the coronavirus vaccines, retail lending was growing strongly as the economy began to expand and incomes rose. However, as the chart shows, in March the trend reversed, and loans fell from a peak of UAH269bn ($9.1bn) to UAH260bn – still well ahead of levels of previous years, as the chart shows – but will continue to fall as few new loans are being given out.

More of these loans will become problematic as the year wears on due to a perfect storm of difficult conditions. The NBU more than doubled interest rates at the start of June to 25% and inflation is also running in double digits. In addition, with the economy anticipated to contract by somewhere between 30% and 45% this year, incomes are under pressure that will make paying loans back more difficult. Banks have already offer delays and restructuring deals to debtors to prevent defaults as the first signs of trouble appear amongst retail debtors in March, as the chart shows.

The situation with corporate loans is less acute, as the chart shows. While companies borrow about three times more than consumers, they are not very active, as most pay for investment out of retained earnings and commercial loans remain expensive and short-term. Still, what corporate borrowing there has also been curtailed by the war.

 

 

Deposits

The bank sector asset base has been growing steadily in recent years, as the chart shows, but took a slight hit at the start of the war, but the data only runs up to February. However, as the sector remains solid and working there have been no significant runs on any banks and there was even a slight uptick in assets after the first weeks of the war.

Capital adequacy

With deposits falling and cut off from the bond market due to the war, banks have been digging into their own capital to fund lending that has also depressed their capital adequacy ratio (CAR), as the chart shows.

Thanks to the bank sector reforms Ukraine’s banks have been maintaining a healthy 20%-plus CAR in recent years, but the ratio fell to 18% in February – the last month the ratio was reported – and has almost certainly decreased further since then. With a mandatory minimum ratio of 10%, the sector still has plenty of cash in reserve, but the sliding ratio is another sign of the pressure the sector is under.

However, the problems may be short-lived. Now that Russia has withdrawn its forces from most of the country to focus on the Phase 2 of its military operation, concentrated in the Donbas, the rest of the country is slowly going back to work.

The number of refugees leaving the country reversed at the start of May and more people have been returning in May than leaving as they go home.

Card terminal usage in May shows the number of non-cash payment terminals owned by PrivatBank increased by 42% in the last two weeks of May, with small businesses resuming card payments more actively, reported epravda.com.

At the start of the invasion by Russia, the number of active terminals fell by 66% at its lowest point, and the volume of transactions dropped by 39% during the first two months of the war. However, between April 26 and May 10 the number of active POS terminals jumped by 42%, and the volume of transactions increased by 38%. Also, among the areas that significantly reduced the activity of their terminals were specifically clothing and electronics, but they climbed by 64.8% and 44.2% respectively in the same period, epravda reports.

According to Prime Minister Denys Shmyhal there is no panic either among investors operating in Ukraine or among the population that holds deposits in banks in May, and both show confidence in the Ukrainian banking system. “The world is surprised by the patriotic attitude of Ukrainians to their economy and the trust in the banking system,” added Shmyhal.

Emergency measures

In addition to the close supervision of the sector by the NBU, the government has taken various measures to shore up the stability of the sector, while the country is under martial law.

In May the Cabinet of Ministers approved the strategic directions of activity for public sector banks during martial law and post-war economic recovery. In particular, the priority is to provide financing to the public sector banks.

The government also relaunched a scheme to provide soft loans to SMEs and entrepreneurs who have taken out a total of 738 loans under the “Affordable 5-7-9% Loans” programme. At the end of April, 738 soft loans totalling UAH3.09bn ($94mn) were issued within the framework of the state programme, Affordable 5-7-9% Loans.

Since the start of the programme, 38,462 loans have been issued by authorised banks for a total of about UAH102.6bn. Under martial law, one of the priorities of the Ministry of Finance remains state support for business development, which is being carried out, including through the Affordable Loans programme initiated by President Volodymyr Zelenskiy. The loans that have been given include:

• Entrepreneurs received UAH10.2bn ($312mn) for investment purposes;
• UAH57.7bn ($1.8bn) in anti-crisis loans was issued;
• UAH24.8bn ($780mn) was issued in the refinancing of previously received loans;
• UAH9.3bn ($290mn) was issued to farmers and agricultural producers.

Another sign of things slowly getting back to normal is the fact that the banking Deposit Guarantee Fund has resumed the sale of liquidated bank assets. Soon, information about the first lots will be entered into the Prozorro Sales platform. "Real estate properties that are within the assets of liquidating banks will be put up for auction. Due to the Russian aggression, the fund decided to suspend sales of assets of liquidated banks because of a lack of demand and, hence, competition for bidding. Now, after opening the registers, we are resuming the sale of assets, " announced the Fund in May. The first real estate for sale of the banks Land Capital and City Bank. “The Fund expects the first auctions to take place in the Prozorro system in early June," said the Deposit Guarantee Fund Official, Alexander Kulchytskyi.

Likewise, the State Savings Bank Oschadbank has resumed making car loans. Ukrainian customers can now use the Savings Drive programme again. Loans are provided for the purchase of new vehicles, including electric vehicles (EVs), with interest rates from 0.01% per annum. "Growing demand for car loans and the willingness of our key car dealers to actively sell have prompted the resumption of car loans. Importers have restructured supply chains in Ukraine, so the market has a choice of cars from different brands," said Deputy Chairman of the Savings Bank Anton Tyutyun.