Ukrainian banking sector is profitable, well-capitalized and is in a good shape overall, while the macroeconomic environment promotes financial system stability. Low cost of credit risks, acceptable debt burden on businesses and fast growth of households' incomes facilitate resumption of long-term lending. However, rapid increase of unsecured consumer lending may pose risks. In order to limit the increase of these risks, the National bank of Ukraine (NBU) plans to increase risk weights for those loans. These are the messages of the latest issue of the Financial Stability Report.
The key challenges are the situation at the state-owned banks, decreasing profitability and litigations around the PrivatBank
Results of the stress tests of 2019 showed that there was still a few banks in the system, including two state-owned ones that potentially faced material problems. They may require substantial amounts of capital should adverse macroeconomic scenario materialize. Their financial resilience is low; these financial institutions are vulnerable to potential crises. The NBU focuses further on state-owned banks as they have a big impact on the banking system. The NBU expects quick decisions of their independent supervisory boards aimed at clearing the non-performing loans off the balance sheets, change of business models, and optimization of operating costs.
The key medium-term challenge for the banking sector is the expected decrease in profitability. The paces of increase of banks operating incomes are slowing down after a sensational surge in 2018. The NBU expects further narrowing of interest margins and spreads, as well as smaller rates of growth in fee and commission incomes. Therefore, optimization of and control over operating costs will become a key issue for Ukrainian banks.
Over large-scale challenges for macrofinancial stability include outcomes of litigations around the PrivatBank. The NBU will continue to take steps necessary to protect interests of the State at courts and to ensure financial stability.
Banks will spend more capital on unsecured consumer loans
Consumer lending is surging. Banks relax further standards for approval of loan applications. Some financial institutions actively expand their presence in the segment and try to boost aggressively their market share. The NBU believes that banks are not conservative enough in assessment of risks related to unsecured consumer loans. Assessment of probabilities of default (PDs) and loss given default (LGD) are low even under current economic environment. Despite the fact that penetration rate for these loans is currently below 5% of GDP, the growth rates of the loans are extremely high. Over January–September 2019, the ratio of new consumer loans to private consumption has reached almost 9%. Lending is becoming a notable driver of domestic consumption. In order to mitigate a build-up of systemic risks, the National bank intends to introduce higher risk weights for these loans starting from early 2021.
High risks of primary real estate market will limit resumption of mortgage lending
Resumption of mortgage lending hinges on resolution of a number of fundamental problems of the primary real estate market. Currently it is extremely non-transparent; household investors have no efficient instrument for protection of their rights. As this market is a socially significant one, its regulation should be as strict as banking regulation. Ownership structure of developer companies should become fully transparent; these companies should be held liable for construction works not done in due time. If the primary real estate market is not properly regulated, resumption of mortgage lending will be very slow in spite of expected fall in interest rates.
The NBU's near-term plans include steps under the 'split' project and introduction of requirements on enhanced bank resilience
The key task for the National bank for the coming year is a successful implementation of measures under the 'split' project for orderly transition of non-bank financial institutions under the NBU regulation from July 2020. Over this time span, the National bank plans to build institutional capacity and enhance expertise in the new fields, to work on legal amendments and sectoral regulations.
At the same time, the National bank continues to introduce requirements for the banking sector that should enhance its resilience. By the end of 2019, the NBU is expected to approve a regulation on calculation of a new long-term liquidity requirement, the NSFR, as well as a regulation on minimum requirements for capital to cover operational risks. In 2020, banks will start test calculations under these regulations.
Next year, the NBU also plans to harmonize requirements on regulatory capital structure with the EU directives and to develop a regulation on capital required to cover market risks. Introduction of all new regulations will be gradual and will provide for a few-year-long transition period. That should allow banks to schedule their capital needs and adjust their dividend policy accordingly.