This Financial Stability Report deals primarily with risks to Ukraine’s financial sector and economy as the full-scale war drags on.

The protracted war, terrorist attacks on the energy infrastructure, and the resulting further economic depression are the main sources of risks to financial stability. Ukraine’s GDP will fall by about one-third this year. Next year, it will grow at a slower pace than forecast before the massive missile attacks. This will slow the recovery in demand for financial services and cause additional credit losses for the banks.

International support for Ukraine is growing, laying the reliable groundwork for financing the state’s needs, the balance of payments, and international reserves, and enabling the NBU to maintain its active presence in the FX market.

In H2, FX market pressures moderated substantially, thanks to the exchange rate adjustment in July. With FX restrictions eased in July, retail clients were allowed to buy foreign currency to make term deposits with the banks. As a result, FX term deposits started to grow for the first time since the onset of the COVID-19 crisis.

In spite of the enemy’s energy terror and destruction of civilian infrastructure, financial institutions are operating continuously. The banks have already started to implement measures that should enhance their resilience against operational risk and ensure their uninterrupted work even under long blackouts. Continuous payments, settlements, and operation of the branch network have been one of the factors in promoting trust and financial stability.

The banking system in general remains highly liquid, and certain liquidity indicators have hit record highs. That said, the inflows of new deposits into the sector are uneven, with a vast proportion of funds primarily accumulating on current accounts at state-owned banks while certain medium-sized banks experience a lack of liquidity.

The slowdown in business activity caused by security risks and shortages of electricity supply are depressing the demand for loans. In wartime, government programs play the key role in supporting lending. Market lending will resume only with the recovery of the economy.

Credit risk remains the major threat for the financial sector. Actual and potential loan portfolio losses combined are in line with the estimate made by the NBU in June, at around 20%. However, the destruction of the energy infrastructure and a slower economic recovery are increasing the credit risk: losses due to the war may rise to 30% of the portfolio.

Despite heavy provisioning expenses, the sector has generated a profit thanks to high interest income, a recovery in fee and commission income, and revaluations. The sector’s ROE in the first eleven months of 2022 exceeded 9%.

The banking sector’s operating profitability gives the financial institutions the first line of defense and allows the absorption of credit losses. Most of the banks are maintaining heir capital above the required minimum. However, this extra capital stock is likely to disappear.

The NBU does not apply corrective actions against banks breaching regulatory capital requirements if these violations were caused by the war. The financial institutions that have viable business models and are capable of generating operating income will have enough time to restore capital if they need to. By contrast, the regulator will remain vigilant on operationally loss-making banks and may restrict their activities in order to protect depositors’ interests.

In 2023, the NBU expects the economy to stabilize and gradually recover and plans to conduct an assets quality review to confirm the correctness of recognized loan portfolio quality, the adequacy of provisions, and the assessment of the actual size of regulatory capital. Based on the assessment, the NBU will set a transition period for the banks to restore capital to minimum regulatory levels. Most of the banks will be in a position to restore capital thanks to future income. However, some of the banks are likely to need investor support for that.

A resilience assessment of banks in 2023 is in line with previously reported plans

Over the coming years, the NBU will refocus on long-term priorities of the further harmonization of rules for the financial sector with the EU acquis.