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The European Banking Authority (EBA) said today that the second-round effects of the Ukraine invasion on EU banks are "worrying" in terms of financial stability.
The EBA's Risk Dashboard shows that Russia's invasion of Ukraine has had "limited direct impact" on EU banks, but it does point to clear medium-term risks from the war's second-round effects.
"Cyber and information and communication technology (ICT) related risks remain high," the authority warns today.
According to the report, first-round effects are primarily linked to EU/EEA banks' exposures to counterparties based in Russia, Belarus, and Ukraine, as well as increased market risk due to heightened volatility and abrupt risk premium repricing.
"Second-round effects are more worrying from a financial stability perspective. The key drivers of these concerns are the current high level of uncertainty about the outcome of the war in Ukraine and the potentially large impact on the wider EU and global economy of this war " ," according to the EBA.
"Key drivers include the direct economic fallout of the war including the fiscal impact, the impact of sanctions (from all actors involved), cyber risks and the longer-term impact on supply chains in the global economy," according to the report.
Higher energy prices, inflation, and slower economic growth are all likely to have an impact on bank profitability. Russia's counter-sanctions restricting oil and gas exports would exacerbate the problem.
A deteriorating economic climate may put a damper on new lending, preventing it.
The 'common effects' of a rising rate environment are preventing banks from benefiting.
There is also the possibility of lower asset management income"With increased uncertainty, customers are more inclined to place their savings in safer and less fee-generating products like deposits," EBA says.
Higher funding costs as a result of higher policy rates, as well as investor concerns about lower profitability and increased risk.
According to the report, "increased compliance costs due to sanctions" will also have an impact.
"Fines related to sanction breaches might increase," the officials conclude, "especially if the scope of sanctions is further widened."
Banks are likely to have significant indirect exposures to Russia and Ukraine through customers with commercial ties to the two countries. "Russia is the 5th largest trading partner of Europe and the 11th largest economy in the world. Hence when economic relations between Russia and the rest of the world are disrupted, EU/EEA banks will be affected As a result, if economic relations between Russia and the rest of the world deteriorate, EU/EEA banks will suffer," the EBA warns.
As a result, credit risk for EU/EEA banks could rise across the board.
Lower economic growth could negate the benefits of higher interest rates. Low and negative interest rates were putting pressure on banks' NII, which could be alleviated by monetary policy normalization to combat inflationary pressures.
Lower economic growth will also have an impact on banks. Furthermore, rising interest rates and slower economic growth may reduce lending demand. It is possible that asset repricing will take longer than liability repricing.
Cyber-attacks pose a significant threat. However, no major attack on Europe's banks has occurred to date. One of the main targets of such attacks has been Ukrainian businesses, including banks and the government.
The EBA summarizes the sanctions imposed on Russia as follows:
• exclusion of selected banks and central transactions from SWIFT;
• preventing the Russian Central Bank from using its international reserves;
• ban on export and import of selected critical sectors and technologies;
• asset freezes targeting individuals and their families as well as legal entities;
• capital controls put in place by Russia to limit currency outflows.
According to the authority, there are risks associated with unintended consequences of sanction compliance, such as the denial of financial services to refugees.
Sanctions will also have an impact on broader economic and financial market developments, such as trade flows and foreign exchange markets. This indicates that banks will face increased risks in the medium to long term.
"SWIFT-related measures might affect commodity markets including oil and gas. The response will likely be a search for alternative payment methods and systems. Some of these may not be ready to handle significantly higher volumes. To mitigate the impacts of sanctions and the overall conflict, governments are setting up support measures for households and NFCs. The effectiveness of these measures will also determine the overall impact on the economy," according to EBA.
The first set of effects stems from the fact that Russia loans and advances account for more than 80% of total exposures, primarily to non-financial corporations (NFCs) (more than 50% of reported exposures in both countries) and, to a lesser extent, to households. Loans and advances to Russian NFCs and households totaled EUR 40 billion and EUR 16 billion, respectively, while loans and advances to Ukraine totaled EUR 6 billion and EUR 1 billion.
Because of supply and demand factors, the macroeconomic environment is expected to deteriorate as a result of the war. More supply chain tensions, strained trade relations, and sanctions could stymie overall supply.
On the demand side, rising energy and commodity prices have a negative impact on household and NFC income, while the ongoing war has a negative impact on investment and consumer confidence.
Exposures to Russian general governments totaled EUR 4 billion, while exposures to Ukrainian general governments totaled close to EUR 2 billion.
Manufacturing (EUR 16 billion), wholesale and retail (EUR 10 billion), and mining and quarrying (EUR 10 billion) were the industries with the most loans and advances to NFCs reported by European banks (EUR 9 bn). Loans to Russian mining and quarrying NFCs accounted for more than 10% of EU/EEA banks' total exposure to this sector.
Sanctions imposed on Russian entities, as well as further supply chain disruptions caused by the war, are expected to have a negative impact.
The combined volume of deposits from Russian and Ukrainian counterparties is around EUR 82 billion. Overall total asset exposures of around EUR 76 billion for Russian counterparties compare to deposits of around EUR 69 billion. Overall deposits of around EUR 13 billion are nearly EUR 2 billion higher than total asset exposures for Ukrainian counterparties.
In the case of Russian and Ukrainian counterparties, household deposits outnumber household loans. Loans to Russian NFCs, on the other hand, are significantly higher than deposits to Russian NFCs, whereas deposits and loans to Ukrainian NFCs are fairly balanced. Given that the majority of exposures are through subsidiaries, and market funding is scarce in these countries, several banks may be forced to rely on intragroup funding.
By fLEXI tEAM