The banking sector in times of war: current situation and challenges

Russia’s ongoing full-scale war in Ukraine is causing severe losses, damages and sufferings on multiple levels: human, social and economic. With a part of the physical infrastructure and the capital stock destroyed, damaged or occupied, millions of people displaced, and important trade routes blocked, it is not surprising that the economy is shrinking at an alarming pace.

Against this sobering background, it is quite remarkable that Ukraine’s banking sector is still operating in a stable mode, thereby supporting households domestically as well as those living abroad and those enterprises in the economy that are still working.

Crucially, a bank-run has been prevented, and the trust in local currency deposits has been preserved. What are the factors underlying this resilience? In our view, there are three main reasons for this
development.

First, the National Bank of Ukraine introduced a set of anti-crisis emergency measures at the start of the war and adjusted them over time. This relates to the introduction of a fixed exchange rate as new (temporary) anchor, coupled with the introduction of several FX and capital controls.

Such measures are quite common in times of war as history shows. The temporary relaxation of certain prudential norms and the provision of sufficient liquidity to banks also helped to prevent a panic and ensure financial stability.

Furthermore, the sector was already well advanced in terms of digitalisation (also due to the COVID pandemic), which made it easier to adapt to a new environment.

The previous banking sector reforms after 2014 also contributed to the resilience of the sector, as they created a more stable, better governed banking system.

Still, it is already obvious that the ongoing war will create long-lasting scars and challenges in the banking sector. The eventual transition back to a flexible FX rate system without controls will need to be managed gradually, and in a prudent way.

The current practice of (partly) monetising the budget deficit needs also to be abolished in this process. Once a sustainable peace has been achieved, the conduct of stress tests will reveal the true picture of the hit to banks’ balance sheets.

In case recapitalisation funds are required to deal with the expected surge in NPLs, international partners should contribute to their provision. But apart from dealing with bad debt caused by the war, the perspective of Ukraine and its partners should also be forward-looking, as new lending is needed to support the growth and recovery process in Ukraine.

This new lending should be based on market conditions, with only selected government interventions in areas or segments where market failures can be expected.