Ukraine finance: banking sector risk

Although the banking sector is generally sound, a number of structural weaknesses remain a concern, as does the rapid rise in lending to households and enterprises in recent years-particularly the extent of unhedged...

CURRENT ASSESSMENT

Although the banking sector is generally sound, a number of structural weaknesses remain a concern, as does the rapid rise in lending to households and enterprises in recent years-particularly the extent of unhedged foreign-currency lending to businesses, and increasingly to households.

The ratio of total loans to assets is estimated to have risen to around two-thirds, and banks have been borrowing heavily abroad to meet demand.

The supervisory framework governing banks has nevertheless improved, capital-adequacy ratios are still generally good, and the sector is finally seeing significant inflows of foreign investment.

The ratio of non-performing loans (NPLs) fell from 30% at the end of 2004 to less than 18% by September 2006. Although this is still high, the ratio of loans not being serviced is much smaller, at less than 5%.

POSITIVE FACTORS

Net banking sector assets have risen steadily in recent years.

The regulator has increased minimum capital requirements (albeit by less than the IMF recommends). It has also tightened capital quality standards and raised provisioning equirements for unhedged foreign borrowing.

The economic slowdown ended in early 2006, and real GDP growth is now expected to average around 6% in 2008-09. A favourable economic environment will help consumers and enterprises to meet their debt-service payments, thereby maintaining asset quality.

NEGATIVE FACTORS

Lending, particularly to households, is increasing rapidly. This has raised concerns about the ability of enterprises and home owners to repay in the event of external shocks, or a downturn in inflated housing prices in the capital, Kiev.

Although capital-adequacy ratios are generally sound, at around 14% or above in recent years, this is undermined by concerns about the lack of transparency with regard to bank ownership.

The further increase in natural gas prices expected in 2008 will harm the competitiveness of enterprises in certain key sectors, which poses a risk to banks` asset quality.

Surging consumer lending doubled bank profits in 2006, but high overheads continue to dampen profitability and ensure wide interest rate spreads.

RATING OUTLOOK

Stable: The sector will become less fragmented, particularly as foreign banks continue to deepen their involvement in Ukraine. A larger foreign role will improve capitalisation, increase competition and bring down interest rates.

Some of the sector`s structural problems will nevertheless persist, which increases vulnerability to external economic shocks and future bouts of political uncertainty-both of which remain substantial risks in Ukraine.

This news was monitored by the Action Ukraine Monitoring Service for the Action Ukraine Report (AUR), Morgan Williams, SigmaBleyzer, Editor.

NEWS ANALYSIS: The Economist Intelligence Unit Limited

UNIAN in Google News