The country's banks have proven resilient to the challenges of Russia's invasion, but the National Bank of Ukraine's move to cut interest rates by 300 basis points to 22% in July — after a hike to 25% in June 2022 — will reduce lenders' earnings from central bank deposit certificates, which have been an important source of income as lending has stalled during the war.
The rate could drop to 19.1% by year-end and 16.6% at the end of 2024, according to central bank estimates. A reduction to 15% would decrease the sector's income by 16%-17%, according to Volodymyr Mudryi, chairman of the Ukraine Banks' Association Council and CEO of Hungary-based OTP Bank Nyrt.'s Ukrainian unit.
"Considering the high level of liquidity in the system, the impact of the change in the central bank's key rate will have a significant impact on the business models of banks and their profitability in the short term," said Mudryi.
Interest blow
Lenders' strong second-quarter profits of 33.6 billion hryvnia, up from a net loss of 4.5 billion hryvnia one year ago, have been supported by near-zero provisioning for bad loans and stable net interest income (NII) growth, mainly from highly liquid assets such as central bank deposit certificates and government bonds.
These deposit certificates and bonds accounted for 52% of the sector's total interest income in the second quarter, the central bank said in its August review. Ukrainian banks earned 35 billion hryvnia from central bank deposit certificates for the year to May-end, compared with 41 billion hryvnia in the whole of 2022, central bank data showed. This could rise to a range of 90 billion-100 billion hryvnia for the full year, according to Mykhaylo Demkiv, financial analyst at Investment Capital Ukraine.
With outstanding central bank deposit certificates exceeding 500 billion hryvnia, a 100-basis-point rate cut translates to local lenders losing over 400 million hryvnia per month in interest income from their investments in the certificates, according to Demkiv. This is the equivalent of 0.16% of the total equity of the banking system, Demkiv said.
While banks will first seek to compensate for the income shortfall by proportionally reducing deposit rates for their customers, deeper cuts will have an increasingly large impact on lenders, Mudryi said.
Ukraine's central bank is less concerned that rate cuts will significantly harm lenders' profitability, given that cost of funding will likely remain low for most banks. "The total amount of interest income will be supported by asset growth, hence we don't expect a substantial decline in net interest income," a spokesperson for the bank told S&P Global Market Intelligence.
The sector's net interest margin (NIM) will remain above pre-war levels despite the monetary policy changes thanks to the large spread between interest income and interest expenses, the central bank said. Sector-aggregate NIM reached almost 8% in the second quarter, up from 6.7% at the end of 2021.
Demkiv noted that the 400 million hryvnia monthly interest income reduction "might seem like a lot but, in fact, is the return to normality." Furthermore, the impact of rate cuts on investments in domestic government bonds will be "much less dramatic" due to their longer maturity, Demkiv said.
Strong foundations
Ukrainian banks head into the new rate cycle on solid ground. The central bank reduced the sector's profitability risk in June, with foreign currency, credit and capital adequacy risk declining compared with 2022-end.
While credit risk in the Ukrainian banking sector remains high, the central bank's pessimistic expectations of lasting adverse effects from power shortages amid the war have not materialized, a spokesperson said. The central bank in June improved its estimate for potential credit portfolio losses from the war to around 20% from the previous estimate of 30%.
The sectorwide nonperforming loan ratio fell to 38.9% as of July 1 from 39.3% in April. The NPL ratio of the country's 10 largest banks owned by EU and US banking groups also dropped slightly in June for the first time since the war started, according to a recent analysis by Market Intelligence.
Ukrainian banks reduced their provisioning in 2023 after recognizing large losses from credit risk last year. The annualized cost of risk ratio was close to 0% after the second quarter compared to 14.4% as of 2022-end. Cost of risk is likely to increase during the year, although it will remain several times lower than last year, according to the central bank.
As of Aug. 30, US$1 was equivalent to 36.70 Ukrainian hryvnia.