By Victor Grigore
Healthy pre-provision income and strong capital levels will allow banks to manage their remaining exposure to Russian counterparties.
Banks in the European Union have been cautious on counterparty exposures in Russia ever since the annexation of Crimea in 2014, while some Nordic banks have run off their books or exited the country as part of broader de-risking. Currently, major banks in France, Italy and the Netherlands hold most of the exposure to Russian counterparties, but that remains modest at less than 1% of their total lending and largely comprises short-dated lending facilities to large companies in commodity export sectors.
Since Russia’s invasion of Ukraine in February, all EU banks with exposure have confirmed that they have not permitted any new commercial activity in the country and have a clear intention of exiting in an orderly manner. Banks have made good progress reducing exposures since then with balances down 18%, on average, and they are also guiding to further exposure reductions in coming quarters.
We think banks have set aside prudent provisions on current exposures, while noting material increases in risk-weight assets, which will be released as exposures run off. Should remaining exposures to Russian counterparties be written off to nil, along with any equity book value and intracompany lending to local subsidiaries, we estimate a modest impact on bank capital ratios at less than one quarter of underlying capital generation.
As for second-order impacts from Russia/Ukraine, we note that most banks reaffirmed their fiscal 2022 cost-of-risk view in Q1 and only two banks slightly raised it by five to 10 basis points. Assuming no critical stoppage of commodity/energy supplies, we expect fiscal 2022 cost of risk to remain well covered by pre-provision income and to come in well below 2020 levels observed due to COVID-19.
In an adverse scenario of a hard-stop in commodity/energy supplies, we believe major EU banks would still remain well positioned given strong capital levels and pre-provision income generation. Banks also still hold reserves for macro uncertainty that can be used to offset higher underlying risk costs. In our view, loan books enter this period of uncertainty from a strong position as many borrowers with weaker credit profiles coming out of COVID-19 were likely placed in government-guaranteed loan schemes. Moreover, we expect EU member states to further increase fiscal support to affected sectors, as required, while NextGen EU funds should remain a material contributor to economies this year and next.
Overall, we believe credit fundamentals remain strong for major EU banks to manage exits from their remaining exposures to Russian counterparties and any second-order impacts.
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