Moody’s reveals risks for large European banks in Russia, Ukraine

Asset risk in Russia and Ukraine has significantly increased since the military conflict began, reads a report of the international rating agency Moody’s Investor Service, Report informs.

Of the large banks, the Austrian Raiffeisen Bank International AG (RBI), the Hungarian OTP Bank NyRt, the Italian UniCredit S.p.A and the French bank Societe Generale (SocGen) are more at risk.

RBI has subsidiaries Raiffeisen Bank JSC in Ukraine and Raiffeisen Bank JSC in Russia, which together generated 42% of the group’s profit in 2021. OTP Bank owns JSC OTP Bank in Russia and JSC OTP Bank in Ukraine, which together accounted for about 14% of the group’s adjusted earnings for the nine months of 2021. UniCredit has a subsidiary in Russia, JSC UniCredit Bank, and SocGen also owns the Russian bank PJSC Rosbank.

“In Ukraine, volatility in the exchange rate was temporarily addressed by the central bank when martial law was declared. However, banks are faced with the widespread disruption in economic activity, destruction of property, as well as a displaced population. These will undoubtedly lead to rising defaults in banks' corporate and retail lending. In Russia, the sharp depreciation of the ruble, the spike in interest rates, restrictions on corporates' access to foreign currency as well as the sanctions imposed on certain large corporates will also drive a deterioration in loan quality, which we expect to mostly manifest in banks' corporate books.

The parent banks will be faced with weakening asset quality and rising loan-loss provisioning needs, reducing the profitability of their subsidiaries. Difficulties will be exacerbated by the lower exchange rates used to convert the net profit into the groups' domestic currencies. There is also a real possibility, given restrictions on capital flows, together with political and other stakeholder pressure, that these banks have to write down their investments in the region entirely,” Moody’s analysts noted.

“All four banks will face rising delinquencies at their Russian subsidiaries. OTP and RBI, however, will see more severe asset quality deterioration in their Ukrainian operations, where there is a massive displaced population, a near halt of economic activity in war-struck cities and significant destruction to property used as collateral against bank loans. The banks may also be hit by weaker credit profiles of the Ukrainian government and other domestic bank counterparties. Technically in Ukraine the banks are not faced with a depreciating currency yet because of the central bank's decision to suspend the operations of Ukraine’s foreign exchange market except for foreign-exchange sales by customers. The central bank also officially fixed the exchange rate as of 24 February 2022.

However, we expect the currency to weaken once foreign-exchange operations resume. The extent of the decline will depend, among other things, on the sum of financial support the Ukrainian government is able to secure. Credit risk is already high in Ukraine. The Ukrainian banking sector's nonperforming loans stood at 41% of gross loans as of January,” Moody’s added.

“Existing Russian sanctions, political tensions and fears over money-laundering have meant that many banks in Europe have reduced their exposure to Russia in recent years. Banks in the Nordics and the Baltics that traditionally operated branches in Russia have closed them over the past decade and have wound down their cross-border business. Money-laundering breaches in the Baltic operations of Swedish banks hastened the process.

Nordea Bank Abp was the last to close its Russian bank at the end of 2020, leaving current exposures of Nordic and Baltic banks to Russia below 1% of their total assets,” the report said.

“In Russia, sanctions adopted by the European Union, the US and others, limit the Russian central bank's ability to use its foreign reserves to defend the currency. As a result the ruble plunged by nearly 30% against other major currencies, prompting the central bank to hike the benchmark rate to 20% from 9.5% on 28 February. The sharp depreciation of the ruble, restrictions limiting the cash balances exporting companies may keep in foreign currency as well as disruptions in economic activity owing to the sanctions imposed on Russian corporates will lead to a deterioration in borrowers’ credit profiles, which we think will manifest itself more in banks’ corporate loan books. Despite the sharp increase in interest rates, loan quality deterioration in retail lending will likely be more contained since retail loans are predominantly on fixed-rate contracts.

The subsidiaries of these large European banks are mainly exposed to large and small businesses, with the exception of OTP Bank which mainly focuses on consumer lending. While this is also a high-risk segment, the bank maintains high reserves to cover its lending risk and benefits from the significant margin, a reflection of the risk taken,” Moody’s analysts said.

“More vulnerable are the credit profiles of corporates borrowing in foreign currency (which is often the case with exporting businesses), as well as of corporate entities whose business will be affected by the sanctions. RBI made an initial estimate in early February 2022 that around 9% of its total Russian lending exposures could become affected by sanctions. However, it said on March 1 that, so far, only around 1% of its Russian exposures have been subject to sanctions,” reads the report.

“Foreign-currency loans are predominantly extended to export-oriented corporates, whose foreign-currency revenues provide a natural hedge against the depreciation of the local currency. However, a recent regulation announced by the central bank of Russia mandating that exporters convert 80% of their export revenues to rubles may reduce borrowers' buffers against their foreign currency loans and their debt repayment ability. Moreover, the balance sheet and risk-weighted asset of Russian banks with lending in foreign currencies will inflate, weakening their capital ratio and may prompt the Russian central bank to request that parent banks boost the capital of their subsidiaries. Such capital allocation would be subject to the approval of parent banks' boards, as well as the European Central Bank, and current conditions make any such increase in exposure highly unlikely.

According to RBI, foreign-currency loans at its Russian subsidiary accounted for around 20% of loans as of December 2021, although the weight has likely increased given the ruble's sharp depreciation since then. SocGen announced on 3 March that its retail lending is almost entirely in local currency while around 32% of loans to corporates are in foreign currency. OTP has very limited lending in foreign-currency in Russia, at around 3% of total loans, while UniCredit did not disclose details concerning foreign-currency lending in Russia.”

“These foreign-owned banks in Russia are among the banks maintaining access to SWIFT. They may even benefit from increased business from exporters/importers as domestic banks lose their access to international counterparties because of the sanctions.

However, we expect European banks to weigh up the opportunities against potential reputational risk very carefully, and we consider they will likely prioritize a reduction of their cross-border risk exposures in these countries,” Moody’s added.

“We expect funding risk to be low as the subsidiaries of the Western banks will likely benefit as Russians shift funds to these more stable banks in the country. The Russian and Ukrainian subsidiaries are predominantly self-funded, meaning that they do not rely on significant financing from their parent banks for their lending and other activities.

Limitations on deposit withdrawals put in place last week in Ukraine will prevent large outflows of funds from the Ukrainian subsidiaries. In Russia, savers rushed to ATMs as the military conflict escalated, to access foreign and domestic currency. Current restrictions imposed by the central bank on conversion to foreign currency will limit outflows in hard currency,” Moody’s said.

“The large-scale depreciation of the Ukrainian and Russian currencies will likely lead to capital erosion for the parent banks. This is because they will have to book the decline in the value of their assets in the two countries in their equity (the translation adjustment in accounting terms). Nevertheless, we consider the parent banks can absorb the impact.

For Societe Generale and UniCredit, foreign-exchange swings will likely have a relatively minor impact on the groups' capital positions because of the smaller size of their Russian subsidiaries. For SocGen, the impact is also reduced due to the hedging policies the group implements. For OTP Bank and RBI, the impact would be greater. RBI increased its hedging earlier this year to protect its capital from foreign-exchange volatility and it now covers €1.4 billion of its €2.4 billion capital base. As a result of the hedges, the group will be able to fully neutralize the impact of foreign-currency volatility on its capital ratio. OTP Bank does not employ hedging, but the translation adjustment booked to equity as the value of its assets decline will be offset by the reduction in risk-weighted assets, the denominator of the capital ratio, keeping capital ratios broadly steady.

Under an adverse scenario, the parent banks could opt to forgo their investments in the subsidiary banks and walk away, or they could lose their investments if their subsidiaries are nationalized. It would mean a reduction in SocGen's capital ratio of around 50 basis points, according to the bank. The reduction would be more significant for RBI at up to 80 basis points in the case of a hypothetical walk-away from Russia, as the bank discussed in an investor call. To shore up its capital ratios, RBI shelved its proposal to pay a dividend from its 2021 profit. The risks for RBI’s creditors are further substantially mitigated by its participation in the Austrian Raiffeisen’s institutional protection scheme, which ensures financial support for RBI by the scheme’s member banks, should the need arise,” the report noted.