There are two key elements to banks fulfilling their obligations – sufficient liquidity and access to market liquidity management tools. From early 2014, bank deposits have decreased by over UAH 100 billion net, significantly undermining banking system liquidity. Both these elements seem to have been badly affected by the rapid hryvnia devaluation and the unstable exchange rate. This appears to have made it more difficult for banks to fulfill their obligations to depositors and creditors by doubling the need for liquid hryvnias.

Individuals’ panicky behavior has made refinancing existing debts and obtaining additional financing from external creditors and parent companies an important but extremely difficult task.

The weaker hryvnia may also entail an increase in the actual percentage of non-performing assets in the banking system. NBU data shows that the percentage of fourth and fifth category loans in terms of their quality rose by 3.5 times, to 13.7% in 2009, compared to 3.9% in late 2008. In late 2013, this figure was 12.9%, although the actual percentage of non-performing assets was estimated to be about 30%-40%.

Today, as then, apart from depreciation, various disparate factors are impacting the economy and the financial system. Indeed, although the size and percentage of households’ foreign currency credit portfolio were significantly larger in 2008, the system was not affected by geopolitical risks.

With the potential need to build up more reserves, the key element here is the impact of the exchange rate on asset quality rather than recalculating foreign currency loans and reserves at a new exchange rate (other things being equal, the effective refinancing rate is not subject to change). I’m basically referring here to borrowers’ behavior and capability of/willingness to service their obligations.

If we proceed from the simplified assumption that most borrowers will be able to pay a hryvnia equivalent of what they were paying before the devaluation occurred, provisions against non-performing foreign currency loans will likely be increased in proportion to the devaluation.

In this light, some banks will require additional capital injections. The stress-tests of first and second group banks carried out in mid-2014 were largely aimed at identifying how much additional capital the banks will need under negative scenarios, such as a decrease in the quality of their assets, among other things, due to devaluation. The outcomes varied greatly across banks. With the purpose of enhancing the banking system’s transparency and stability, it would be a good idea to introduce the practice of conducting stress tests on a regular basis, say once a year, under scenarios adapted to current events.

Going back to additional capital injections, even foreign investors are likely to have difficulties raising the amount required, judging from the stress-tests of European banks and the rising capital needs of Russian banks. In spite of that, some banks have also taken / are taking steps to raise additional capital, as required by the NBU.

Based on stress test results, some Russian banks have already raised additional capital, or said they will. Meanwhile, under current conditions, one should not expect that banks will increase their capital beyond the required minimum. Also, the most important aspects of raising additional capital are capital quality and transparency in banks’ using their capital. This will help ensure that banks do not increase their capital only to see it immediately leave the banks to serve the interests of their owners.

Presently, the state is providing liquidity support to banks via NBU recently reviewed refinancing facilities. The state mostly injects capital into private banks after all other measures have proved ineffective, when it needs to save systemically banks. With limited resources even under this scenario, the state might have to resort to private investors.

However, however, this might prove extremely difficult as private investors are either unwilling to get involved in Ukraine, or have high requirements regarding banks’ profitability or other preferences.

Oleksiy Aristov is the director of the Corporate Finances Department at Deloitte in Kyiv.