OREANDA-NEWS. Results of the asset-quality review (AQR) published by the National Bank of Belarus last month confirm that, under stress, the capital adequacy ratios of many of the country's banks do not hold up well, says Fitch Ratings.

The banks are highly exposed to a downturn in the operating environment, such as economic slowdown and exchange-rate weakness. We forecast that GDP in Belarus will contract by 2% in 2016, following a contraction of 3.9% in 2015. The depreciation of the Belarusian rouble against the US dollar has been significant: 8% in 1H16, following a steep 56% fall in 2015.

Asset quality in the banking sector is deteriorating rapidly. Regulatory returns show that the three riskiest categories of non-performing assets more than doubled to 14.8% of gross credit exposure at end-August 2016 from 6.8% at end-2015. Loan-loss cover, at 38%, is low, exposing the banks to sizeable unexpected losses.

Under the AQR's stress scenario, the sector's regulatory capital adequacy ratio would fall to 10.8% at end-July, which only just meets the 10.625% regulatory minimum, although this is set to rise to 11.25% in 2017, and is far lower than the actual 17.1% reported ratio. Stress assumptions were not disclosed which means the AQR outputs have little value to investors and creditors.

We believe the AQR was based on end-2015 balance sheets, which were still not showing high levels of NPLs. Our own stress test assumes a further 30% increase in non-performing loans from end-1H16 levels and improved loan-loss cover to 80%. Under this scenario, the banking sector would have lost 42% of its end-1H16 regulatory capital.

Belarusbank, Belarus' largest bank, which represents 41% of sector assets, performed relatively well in the central bank's AQR. Under stress, its capital ratio fell only moderately to 17.5% against a reported 18.8% at end-July. A large proportion of the bank's loans are extended to borrowers which benefit from government support, either in the form of subsidised interest payments or loan repayments under state guarantees. This, coupled with the bank's already high loan-loss cover ratios, explains its more resilient capital ratios.

Five foreign-owned banks, representing 27% of sector assets and mostly controlled by Russian shareholders, were also reported to have passed the AQR. However, details of the AQR impact on their capital ratios were not published, making it difficult to assess their potential capital weaknesses.

Two state-owned banks, Belinvestbank and Belagroprombank, representing 21% of sector assets, and Russian-owned Alfa Bank (2% of sector assets) fell below regulatory minimum levels under the stress assumptions. But the regulator does not view these banks as "problem entities" because they are implementing remedial strategies, including recapitalisations and problem asset transfers (in case of state-owned banks).

Fitch believes this initial review is an important step to ensure that the regulator adopts a forward-looking approach in its supervision of the banking sector. We understand the authorities intend to incorporate the AQR findings into their risk-management framework, which should help boost capital requirements and address some of the banking sector's vulnerabilities.

Existing weaknesses are already factored into our bank ratings. We rate six banks in Belarus at 'B-'/Stable, highlighting that material default risk is present, but that a limited margin of safety remains.