Banks and international aid: The indirect effect

The banking system is one of the most successful sectors of the economy in times of war. According to the National Bank of Ukraine (NBU), banks earned nearly 67.6 billion UAH in profit from January to May 2023. This is almost three times more than the corresponding period in 2021.

During wartime, international financial inflows have become the cornerstone of the Ukrainian economy.

According to the Cabinet of Ministers, from February 2022 to June 2023, Ukraine received over $185 billion in assistance from the international community. Half of these funds come from the financial assistance of Ukraine's Western allies.

Even though banks are not directly dependent on international aid, it has a significant positive impact on them. Mind spoke with leading bankers and learned why foreign support is important for Ukrainian banks.

Financing from international partners supports the entire Ukrainian economy, from exchange rate stability to the state budget and payments to public servants. This is achieved through the allocation of funds from partners, mainly the USA and the EU, to cover the deficit of Ukraine's state budget. This, in turn, affects the stability of government expenditures, including salary payments, pensions, funding for state programmes, and more.

"Thanks to international aid, the official exchange rate and the cash dollar rate have nearly converged," adds financial analyst Anatoliy Drobiazko.

"Without external funds, Ukraine would have faced a budget credit deficit, which would have prevented financing for all crucial budget items and led to an economic collapse, high inflation rates, and a deep devaluation of the national currency," describes the critical situation Igor Levchenko, Head of Personal Banking Department at UKRSIBBANK BNP Paribas Group.

Gold and currency reserves are increasing. According to the National Bank of Ukraine, as of 1 August, 2023, they amounted to almost $42 billion. A portion of these reserves is formed through grants, loans, and financial assistance from the EU, the USA, and the World Bank.

"Thanks to international aid, the NBU reserves are reaching historical highs and are expected to continue doing so at least until the end of the year," forecasts Oleksandr Pecherytsyn, Head of Research at Raiffeisen Bank.

Budget stability

"The significance of international financial assistance for Ukraine is hard to overstate. Since the beginning of the full-scale war, due to the substantial increase in expenditures for defence, security, and social protection, the deficit of the country's state budget has significantly grown. In 2022, the budget deficit (excluding grants in revenues) amounted to 25.5% of GDP, and in the current year, it is projected to exceed 26% of GDP," say National Bank officials. 

They acknowledge that the budget deficit will remain substantial due to the need to support defence capabilities and economic recovery.

The projected budget deficit for 2023 is approximately $42 billion. According to the Ministry of Finance, the main sources of funding for Ukraine's budget are funds from the European Union ($11.4 billion), domestic government bonds ($9 billion), and the USA ($8.5 billion).

Anton Boldyrev, Head of the Treasury and Investment Services Department at Ukreximbank, states that in the first 7 months of the current year, cash expenditures of the state budget reached around 2.1 trillion UAH, of which 0.3 trillion UAH was directed towards social payments to the population. At the same time, the budget deficit amounted to 0.9 trillion UAH. The sources of its funding include raised international funds – 1.0 trillion UAH, as well as net borrowing from the domestic market.

"Active budget expenditures currently serve as one of the drivers of economic recovery, supporting consumer demand and investment. Data for 2022 indicates that public sector spending contributed to around 30% of the volume of Ukraine's real GDP," Boldyrev explains.

Stability of the hryvnia

Currently, there is a rapid devaluation of the russian ruble: on 14 August, the value of the dollar crossed the psychological threshold of 100 rubles per dollar. For many years, a devaluation of the ruble was often followed by a devaluation of the hryvnia.

"When trade and financial flows between Ukraine and russia were significant, banks had the opportunity to profit from the exchange rate between the hryvnia and the ruble. Therefore, significant turbulence in russia created substantial additional financial flows that affected the stability of the hryvnia. This was the case even after 2014, but everything changed in 2022," explains Anatoliy Drobiazko.

"Supporting a fixed exchange rate is one of the main instruments for maintaining macro-financial stability in Ukraine. The operation of such a currency regime is ensured through the National Bank's regular currency sales interventions," says Anton Boldyrev.

In the first seven months of 2023, over $14 billion from international reserves was used for such purposes.

"The presence of such a 'safety cushion' as gold and currency reserves allows for maintaining the currency market and the economy in the face of potential threats. This has a positive impact on the expectations of key market participants," notes Boldyrev. The NBU reminds that since the beginning of 2023, Ukraine has received approximately $28.1 billion from international partners.

Vitaliy Vavryshchuk, Head of the Macroeconomic Research Department at ICU Group, believes that "by the end of 2023 and throughout 2024, the inflows of international aid will remain sufficient for the NBU to continue increasing reserves, even if the exchange rate remains unchanged."

The path to deposits

As reported by Mind, since the summer of 2022, the National Bank has been attempting to influence banks' policies regarding deposit acquisition. The increase in the key policy rate to 25% in 2022 had little effect on banks' decisions to raise deposit interest rates. Therefore, from February 2023, the NBU resorted to more stringent measures by increasing banks' reserve requirements, as covered by Mind.

By doing so, the NBU incentivised banks to attract funds from the public and businesses through deposits by raising interest rates.

"International aid significantly impacts the liquidity level in the banking system, but even stronger effects are exerted by interest rates," notes Oksana Shveda, Deputy Chair of the Treasury Department at Bank Credit Dnipro.

Additionally, over the course of six months, funds from legal entities in foreign currency increased by 1.2 billion UAH. Mind recently reported on this.

Nevertheless, bankers acknowledge that the NBU's policies and international assistance do not directly affect deposit growth.

"Due to the ability to cover the budget deficit, the state spends funds from the budget, including social payments, salaries for military personnel and other services defending our country from aggressors, and these funds accumulate in banks, increasing the level of deposits," says Igor Levchenko.

"Deposits grew even when the National Bank had to finance the budget deficit through emission. However, of course, international aid is one of the key factors supporting the Ukrainian economy, allowing the NBU to maintain the hryvnia exchange rate. Without this, avoiding an economic catastrophe would have been impossible," notes Ivan Svitek, CEO & Chairman of Unex Bank.

Waiting for lending

One of the strategic tasks of the state under the current conditions is to restore lending, especially considering the significant resources accumulated in the system. Over the past year, account balances have increased by 29% for depositors, with businesses increasing by 49% and individuals by 15%.

According to Blinov, the accumulation of funds in bank accounts is partially mitigated by increasing the norms for deductions to compulsory reserves. This motivates banks to lend to the government by purchasing government bonds because up to half of the mandatory reserve fund can be formed using government bonds.

"This way, the state diverts potential credit resources from the real economy. During times of war, this might seem appropriate, but it threatens to perpetuate state involvement in the economy and finance during the post-war period, especially considering the scale of state participation in the banking system that has developed," says Oleksiy Blinov.

Bank loan portfolios are shrinking. From 1 July, 2022, to 1 July, 2023, the gross loan portfolio of banks for businesses and individuals decreased by 6% – by 69 billion UAH. The portfolio of working, non-problem loans decreased by over 20% – by 155 billion UAH. Another trend is that for several years now, banking lending has been limited to directions with minimal risk, including government programmes.

The recent reduction in the NBU key policy rate theoretically should contribute to cheaper credit resources for businesses and individuals. As a reminder, on 27 July, the regulator lowered the rate from 25% to 22%.

However, experts critically assess the impact of this decision on revitalising lending – due to military risks. For example, financial expert Stanislav Shlapak names obstacles such as high interest rates and a high degree of uncertainty regarding markets for businesses. Economist Oleksiy Blinov believes that the inability to forecast risks during wartime limits decisions regarding investment projects. Therefore, the trend of dominance of limited lending for a few projects, mainly with government involvement, will persist.

According to Stanislav Shlapak's assessment, the largest boost will continue to be received by lending programmes with compensatory mechanisms for interest rates, such as government programmes like Affordable loans 5-7-9% and eOselia ('eHousing').

"In the retail lending segment, certain impetus will be gained by car loans through partnership programmes and very cautious consumer lending. Positive economic forecasts and expectations have not significantly influenced market interest rates for lending so far," predicts Shlapak.

Banks' resilience

It can be said that the banking system has been relatively stable for the time of war for the past six months. The inflation rate is declining, and the market exchange rate has equalised with the fixed official rate. Financial assistance to Ukraine through the budget reaches Ukrainian pensioners, officials, and the military, who spend the money on their everyday needs and keep some of it in their accounts.

"All settlements within the country go through the settlement banking system. Banks that serve state organisations for salary payments, etc., have stable financial flows. This is evident from the constant growth in customer account balances; the banking system has an ample liquidity reserve," says Anatoliy Drobiazko.

"The withdrawn smaller banks were associated with gambling business schemes; their relative share did not have a significant impact on the banking system," evaluates the situation Drobiazko.

On the other hand, the systemic bank Sense Bank was nationalised for political reasons.

To what extent is the regulator predictable in decisions on bank resolution? Right now, measures to assess the quality of banks' assets and stress tests are starting.

"The NBU pursues a reasoned and balanced policy. Stress tests provide the NBU with an additional picture of each specific bank, after which regulatory and supervisory positions will be developed for each of them," explains Shlapak.

To what extent will the decrease in international aid impact the stability of the banking system?

Bankers say that the banking system is robust enough to minimise the adverse effects of potential cuts in foreign financial inflows.

"In the current model of relations between the banking system and the NBU, I don't see significant risks for reducing the stability of the banking system due to the decrease in international aid. The banking system underwent a rigorous test at the beginning of the war and demonstrated its reliability and viability," notes Igor Levchenko. His viewpoint is based on the fact that systemic banks maintain a high level of liquidity, which will enable them to meet all obligations to clients. Meanwhile, the level and quality of credit portfolios are not critical for the banks.

Ivan Svitek is confident that in a short-term perspective, the Ukrainian economy has accumulated sufficient strength due to partner support.

"In light of this, there is a certain reserve of strength. It's more challenging to assess the budget's needs, considering its specificity during wartime," notes Svitek. "The situation in six months is unpredictable. Currently, the NBU anticipates a sufficient influx of financial aid and credits from partners for the next 6–12 months."

The NBU itself provides an optimistic forecast – the regulator is confident that the banking system will overcome the challenges of a full-scale war.

"At present, the National Bank is evaluating the resilience of the banking system to gain a complete picture. Following its completion, if necessary, there will be a recapitalisation of the banking sector. The NBU expects that most banks will have the capability to conduct recapitalisation independently through the profits they are currently accumulating and cannot redistribute [except for state-owned banks] due to the relevant NBU prohibition. It is anticipated that the banking system will continue to operate stably despite the challenges and consequences of the full-scale war," as highlighted by the NBU.

"International aid will remain the primary source even in the first years after the end of the state of war," says Yuriy Oleksiyenko, Head of the Investment Department at OTP Capital. "Its reduction will have a negative impact, but it can be compensated by other factors such as increased exports and remittances from migrant workers, tariff and tax management, as well as close cooperation with international creditors."

Oleksandr Pecherytsyn from Raiffeisen Bank believes that everything will depend on security risks at the time of aid reduction.

"If the reduction in international aid occurs after the conclusion of the war, then defence budget expenditures will correspondingly decrease. If this doesn't lead to the necessity for the National Bank to resort to additional budget support, it shouldn't greatly affect the stability of the banking system," predicts Pecherytsyn.

Are there internal resources within the country to attract funds if there are problems with partner aid?

Not only Ukrainian banks are generating substantial profits. As reported by Mind, this phenomenon is characteristic of banks in EU countries in the years following the lockdown.

These windfalls are linked to measures by Eurozone governments to support their economies during the COVID-19 pandemic.

However, such a situation is not sustainable without external support. Thus, both the banking system and the Ukrainian economy are reliant on international donors.

The country's investment ratings are low for a variety of reasons. For example, Ukraine's ratings from Fitch are at CC (long-term issuer default rating), from Moody's at Ca, and from S&P at CCC with a negative forecast. Without guarantees from international partners such as the United Kingdom or the United States, or agreements with strategic investors, successful external borrowing by Ukraine remains a significant question mark.