The Russian invasion of Ukraine is causing severe damage to the Ukrainian population, society and economy. It has escalated geopolitical tensions and a series of global sanctions on Russia and Belarus, as well as counter-sanctions from Russia to EU and other Western countries.
The war and its repercussions are expected to have substantial impact on EU/EEA banking sector. Thus, ensuring smooth application of sanctions and retaliatory measures, as well as maintaining resilience from the impact of the war itself, comes as important as ever.
Fundamental threat to financial stability – economic fallout of the war and cyber attacks
According to European Banking Authority (EBA), direct exposures of the banking sector to Russia are too low to hold fundamental threat to financial stability, but economic fallout from the war in Ukraine and cyber attacks – is.
In April EBA shared Risk Dashboard on performance of EU/EEA banking sector in Q4 2021 and potential impact analysis on the sector stemming from the consequences of the war.
EU/EEA banks’ direct asset exposures to Russia and Ukraine are concentrated in a few countries and a limited number of banks. Exposures totalling to EUR 76bn towards Russian and EUR 11.5bn towards Ukrainian counterparts were mainly concentrated in France, Italy and Austria. Yet, only Austrian and Hungarian banks reported more than 2% of their total exposures, such as in loans and advances, towards Russia and Ukraine.
More material risk includes 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.
Strengthening financial institutions‘ resilience
When strengthening financial institution‘s resilience, it is important to:
1) Know and thoroughly analyse relevant risks
2) Establish efficient risk management framework and traffic light monitoring system
3) Continuously review and update your risk management framework in line with changing economic and business conditions; consider these risks in your business continuity planning, stress-testing and ICAAP/ILAAP planning frameworks
So, where to pay attention when increasing financial institution‘s resilience? According to EBA analysis, the following are the main risks and vulnerabilities in the EU/EEA banking sector.
Asset quality: consumer loans can be one of the most affected segments
There is an increase in credit risk due to rising defaults of Russian counterparties, as well as EU/EEA and other businesses with strong commercial links to Russia and/or Ukraine. Non-financial corporates are also affected by their dependence on raw materials and an energy supply. Especially in manufacturing, transport and storage, mining, agriculture and hospitality.
Consumer loans can be one of the most affected segments and asset quality could deteriorate as households in particular suffer from rising energy prices and inflation.
Market risk: increased market volatility and lower equity valuations
The war in Ukraine has resulted in increased market volatility and lower equity valuations. Commodity prices have rallied amidst actual and potential disruptions in Ukrainian and Russian exports. Eastern European currencies have depreciated against major currencies.
Abrupt repricing of derivative products in interest rates and commodity markets could cause potential counterparty defaults. Consider and monitor potential losses from fair valued sovereign exposures and other bonds. These losses might add to potential defaults in the overall bond portfolio, especially in the event of a severe recession. Considering rising expenditure for household and business support measures, defence and other spending, higher sovereign spreads might also come under pressure.
Liquidity and funding: banks can be targeted by fake news to cause deposit outflows
Since the outbreak of the war, deposit outflows were reported in several cases, triggered by political and economic uncertainty. Slight tensions were temporarily observed in USD funding markets, and cross-currency bases vs USD widened.
Further escalation of the war might trigger an increase in liquidity risks. As market sentiment remains highly volatile and driven by news flow, banks’ liquidity levels can become vulnerable due to spread of inaccurate information. Such campaigns that spread inaccurate information may result in deposit outflows from targeted banks.
Profitability: decrease in new lending, increase in operating expenses and substantial impact on banks with larger trading or mark-to-market exposures
Higher energy prices accelarate inflation and slow down economic growth. A worsening economic environment might weigh on new lending. Due to increased uncertainty and market volatility, customers might start moving their savings from products (e.g. investment funds or equity holdings) to safer and less fee-generating ones like deposits. Banks with larger trading arms or with substantial mark-to-market exposures might be substantially impacted. Operating expenses might increase due to inflation and sanction-related compliance costs.
Operational resilience: cyber and ICT related risk are high due to Russian cyberattacks
Banks should be ready for operational disruptions due to cyberattacks presumably sponsored by Russia. Also, sanctions imposed on Russia pose legal and reputational risks. Providing basic financial services for refugees arriving in the EU might create anti-money laundering (AML) compliance-related challenges.
Learn more @EBA
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