FS face increased risks with rising loan losses due to the Russia-Ukraine war

By Puja Sharma

Moody’s Investors Service said in a report, The finance sector faces increased risks via four main channels: a commodity price shock, led by surging oil prices; business disruption, mainly caused by prolonged supply chain hold-ups; liquidity tightening and market volatility; and security and operational risks. Russia’s invasion of Ukraine is causing increased risks for banks and other parts of the finance sector.

The exposure of financial sectors across the globe varies under these two scenarios. The sensitivity of each sector reflects four channels of risk transmission. Banks closest to the epicentre of the conflict are most exposed.

Banks in the Baltics: slowdown in lending

“Banks in the Baltics and the Commonwealth of Independent States are most exposed to spillover effects from the military conflict and have limited buffers to absorb the impact if it is prolonged,” said Olivier Panis, Senior Vice President at Moody’s. “European, African and Turkish banks, aircraft lessors, non-life insurers, US non-bank residential mortgage lenders and business development companies are at highest risk under Moody’s downside scenarios.”

They have among the highest share of direct trade with Russia. Economic stress will filter through to the banks through rising problem loans and higher loan-loss provisioning costs. Economic stress will filter through to the banks through rising problem loans and higher loan-loss provisioning costs.

Baltic banking systems are also more vulnerable than most to sharp shifts in investor confidence due to their proximity to the military conflict. They have the advantage of being primarily deposit-funded, however, and they hold significant excess liquidity due to a slowdown in lending caused by the pandemic. A history of tense relations with Russia means security risks are particularly high for these countries.

European banks: rising loan losses

A return to recession in Europe would severely weaken loan quality and profitability at European banks as well as increase claims for trade credit insurers.

European banks would face rising loan losses if economies tip into recession As prices rise, interest rate hikes are likely. We now expect the ECB to begin raising the deposit rate later this year, rather than in early 2023. The Bank of England will also likely continue to tighten its monetary policy. Rising interest rates across the region will offer some protection for banks’ profitability by improving their yields on loans. Banks in France, Germany, and Italy will benefit less than their European counterparts, however, because they have a lower-than-average share of net interest income in their revenues.

Risks to African banks: factors affecting the creditworthiness

Risks to African banks are channelled through heavy exposure to their government Risks to African banks stem primarily from their outsized exposure to their governments via government bond holdings and lending to government-owned entities. This exposure is typically more than double their capital and links the creditworthiness of the banks to that of their governments. African sovereigns regularly subsidize food and energy costs for their populations to avoid social discontent and soaring prices will hit their finances and balance of payments.

African sovereigns, like most high-yield debt issuers, are also vulnerable to tightening liquidity conditions – either because of subdued investor confidence or rising dollar interest rates that lead to capital outflows. Similarly, domestic inflation and rising domestic interest rates further fuel social risks and fiscal pressures.

Turkish banks are vulnerable to rising commodity prices and market volatility As a large importer of energy and other core commodities like wheat, Turkey will be hit hard by rising prices. High inflation under our baseline will likely accelerate loan delinquencies and loan-loss provisioning costs for Turkish banks due to lower corporate earnings and household disposable incomes in real terms. Problem loans are low for now, however, at 3.1% of total system loans. Substantial investments in Turkish government securities with floating interest rates linked to consumer price inflation will also help to shield banks’ profitability.

North American banks and Asian banks: Capital to remain steady

North American banks and Asian banks have limited sensitivity to the main channels of risk. Given the modest expected slowdown in GDP due to the Russia-Ukraine conflict, Moody’s expects little impact on North American banks’ loan performance. The impact on the region’s banks will be limited, thanks to their solid capital and liquidity.