The 200bln retribution: Banks will have to answer for their unwillingness to respond to the NBU's monetary hints

On February 11, new reserve requirements come into effect. For current accounts, banks have to add UAH 215 billion in reserves and launch a variety of products to attract customers' money to term accounts.

This requirement was the result of problems with the monetary transmission, i.e., the lack of reaction of most banks to the NBU's decision on the key policy rate, which was last raised from 10 to 25% in June 2022. It was expected that financial institutions would then revise their loan and deposit rates upward. To date, only a few have done so. As a result, funds on demand accounts have been growing and have accounted for almost ¾ of the banking system.

The NBU has repeatedly experienced difficulties with the monetary transmission, i.e. the transformation of its decisions into market rates. However, in 2022, this problem took on a threatening proportion, especially given that a significant portion of current accounts is concentrated in state-owned banks. There was a risk that with any fluctuations and/or panic, people could devastate banks by withdrawing their deposits, which would significantly weaken the system, up to bankruptcy. "As of December 1, 2022, 72% of funds in banks are demand deposits. Any shock events can lead to a sharp outflow of funds, which is a risk for the system," says Yevgen Dubogryz, banking expert at CASE Ukraine.

Mind explains what will change now.

Why has the amount of funds in banks become threatening? In the summer of 2022, the NBU raised the key policy rate from 10% to 25%. Inflation targeting is, according to the classical theory of money management, an ideal situation when the key policy rate allows the entire financial market to be regulated.

However, de facto, in Ukraine, the transmission mechanism does not work and the refinancing rate does not directly affect the market. For example, in 2022, when the discount rate increased from 10 to 25%, loan rates on the market rose to a maximum of 12%. "Our banks took refinancing loans at 8%, but with a floating interest rate, and had bought long securities from the government at 13%. When the rate went up from 8 to 25%, banks found themselves with long resources at 13%, and it had a very negative impact on many banks," explains Anatoliy Drobyazko, a financial analyst and former advisor to the NBU governors.

For example, in 2022, the share of term deposits in hryvnia deposits of individuals decreased from 38% to 21% at PrivatBank, from 48% to 36% at Oschadbank, from 42% to 16% at mono, and from 56% to 44% at FUIB.

The percentage of term deposits of individuals at Ukrgasbank changed slightly, from 39% to 38%. The only bank in the group of the largest that had the opposite trend – an increase in the share of term deposits, was Sense, which increased its share from 53% to 58%. "In times of crisis, people are not ready to freeze their money on term deposits. It was the case during the pandemic all over the world, as the same in Ukraine. The largest banks do not charge interest on account balances at all, but it does not motivate people to open term deposits en masse," says Ivan Svitek, CEO of Unex Bank.

As of January 2023, demand deposits of individuals in the banking system amounted to 65%+, while before the full-scale war, they accounted for about half. Demand deposits of legal entities account for more than 80%. "However, in times of war, the biggest risk is liquidity risk. If a bank has a substantial demand deposit base, it can only buy certificates of deposit and, partially, government bonds. In this case, it is impossible to lend. How can you lend if the resource is entrusted to you for a day? There is no loan without a deposit," explains banking expert Stanislav Shlapak.

Read also: Mind nominations 2022: Сompanies and persons that impressed during the year. Banking

What innovations come into effect on February 11? The NBU will increase by 5 percentage points the required reserve ratios for demand deposits and current accounts of legal entities and individuals, deposits and current accounts of other non-resident banks, and loans from international organizations.

Earlier, the NBU has already introduced a requirement to increase reserves on demand accounts. From January 11, 2023, they increased by 5 percentage points.

"The introduction of new regulations and an increase in the existing reserve requirements are aimed at dealing with the structural liquidity surplus in the banking system and dedollarisation. For term accounts of customers nominated in hryvnia, the reserve requirement is 0. However, the NBU sets certain ratios for all current accounts (hryvnia/foreign currency) and term foreign currency accounts," explains Oksana Shveda, Deputy Chairman of the Board for Financial Markets at Credit Dnipro Bank.

Has the NBU tried to encourage banks to adjust their rates without resorting to administrative measures? Yes, it has. When the NBU raised the key policy rate to 25% in the summer of 2022, almost all the largest banks ignored it. "Banks enjoyed a substantial margin of 10 per cent or more between the cost of raising funds and placing them in certificates of deposit," Shlapak says.

However, Ukrsibbank believes that the regulator's hints have not been obvious enough. "The way these drastic changes were introduced should be noted. They have been introduced without prior notice to the market, although overall market liquidity has not changed significantly, which raises questions about the consistency of monetary policy. Although the reasons for the latest decisions are quite clear, the changes are in principle negative for the banking market, and the achievement of the desired monetary policy outcome cannot be guaranteed," says Piotr Konieczny, Deputy Chairman of the Management Board of Ukrsibbank ВNP Paribas Group.

Did all banks ignore the key policy rate increase? No. The most disciplined ones turned out to be the medium-sized players, who managed to increase their loan portfolio.

"In our bank, the maximum rate on retail deposits is 18%. In 2022, the deposit portfolio grew by UAH 278 million, or 23%," says Sergiy Mamedov, Chairman of the Board of Globus Bank.

Last week, Unex Bank decided to raise interest rates on term deposits. The highest interest rate is offered for 3 and 12-month deposits – 18% per annum in hryvnia. "It is a reaction not only to the regulator's decision to increase reserve requirements, but primarily a response to the changing overall competitive situation. Banks outside the top twenty, on the basis of which, by the way, the UIRD indicator is calculated, reacted much faster to the key policy rate increase last summer. Most of them are close to the profitability threshold, which is in the range of 18-19% per annum. There is no point in further rate increase," explains Ivan Svitek.

Among the systemic banks, Sense Bank was the first to offer term deposits. In the second quarter of 2022, Sense offered deposits in foreign currencies for up to five years at a rate of 2-4% per annum. "We expected a further decline in deposit rates due to excessive market liquidity and monetary stimulus measures by leading central banks as a result of the Covid crisis. The same measures of the central banks were expected to lead to an increase in inflation. Therefore, we took the opportunity to significantly improve liquidity through long-term deposits," says Volodymyr Lototsky, Treasurer of Sense Bank. For hryvnia deposits, Sense offered 9-10% interest rates for 3–6 months. FUIB and Universal (monobank), which are active in the retail segment, offered similar rates.

What do the new regulations mean in practice? Now, banks will have to withdraw about UAH 200 billion of free liquidity from deposit certificates and reserve it.

As a result, they will be interested in reducing the volume of current accounts and increasing funds on term deposits. At least, that is the NBU's view.

Hryvnia deposits of households in banks amount to UAH 600 billion, and UAH 930 billion in total, 65% of which are demand funds. The realistic delta of decrease is up to 55%, while at the beginning of the invasion, the share was just over 52%.

Volodymyr Ponomariov, Director of Risk Management at Ukrgasbank, also believes that the new rules will encourage banks to buy government bonds, as the NBU allows part of the reserves to be invested in these securities. "It will ensure non-issue financing of the state budget, which will contribute to financial stability in the medium term," Ponomaryov said. According to him, Ukrgas has already increased the rates on term funds in national currency for both individuals and legal entities.

Read also: Allies or competitors: Four state-owned banks occupy almost 60% of the business lending market. Are they not cramped in this niche?

What are the expectations from the introduction of the new reserve requirements? The NBU expects that the increased reserve requirements will help reduce the liquidity surplus in the banking system.

"To reduce the provisioning amounts that directly affect banks' revenues, several actions are needed related to the structure of customer funds change to reduce demand deposits and increase the share of term deposits," said Igor Levchenko, Head of Personal Banking at Ukrsibbank BNP Paribas Group. According to him, such a change can be made either by simply increasing interest rates on term deposits or by reducing interest on demand deposits in parallel. All this will lead to a rise in the cost of the resource base for lending and, as a result, may affect the cost of credit funds.

What are the long-term consequences of the NBU's decision? There will likely be launching programmes to attract term deposits, especially in foreign currencies, as market rates are close to zero. Some banks have almost no term deposits on their balance sheets.

In addition, starting in April 2023, the NBU will launch a process of stress-testing banks. "Based on the results of stress tests, many institutions will be subject to new capital adequacy requirements. It will affect banks' restraint in lending in 2023. Banks will still actively invest in NBU certificates of deposit and government bonds," said Sergiy Mamedov.

"Excessive liquidity creates systemic risks for the macroeconomics, in particular, due to further inflation and devaluation. Raising the reserve requirement ratio is primarily a step by the NBU to "tie up" excess liquidity in the banking system. When the economy grows, this liquidity will be needed, but we do not expect it to happen in the coming months. Speaking about the market in general, I do not think that this will significantly change the level of interest rates on retail deposits," Volodymyr Mudry, CEO of OTP Bank, summarizes.