OREANDA-NEWS. Imminent recapitalisation of Ukraine's banking sector is unlikely despite the additional stress of currency devaluation, recession and economic dislocations faced by banks, Fitch Ratings says. Fitch believe the regulator will be less demanding and demonstrate some forbearance in the capital stress test exercises required as part of Ukraine's IMF package, given the crisis situation. But problem loans are mounting.

Fitch rate all Ukrainian banks 'CCC' reflecting very high country risks in terms of near-term political uncertainty, poor economic prospects and the weak sovereign credit profile.

Non-performing loans to total gross loans reached 13.3% at end-1Q14, with unreserved NPLs at a high UAH68bn (USD5.2bn) or 38% of sector capital, according to National Bank of Ukraine (NBU) data. Asset quality problems are likely to worsen, taking into account the high proportion of restructured loans, which was on average 27% of loans at end-2013 for the 13 banks Fitch rate (representing around half of the sector's assets) and could be substantially higher at weaker banks. Fitch also believe NPLs are somewhat higher than indicated by the NBU, with rated banks reporting an average of 17% loans overdue by 90 days or more.

The uncertainty over Ukraine's economic prospects means it is too early to assess the full hit to asset quality. The hryvnia continues to depreciate and is down 64% year-to-date, putting greater pressure on the debt servicing capacity of unhedged borrowers. Corporate defaults and several bank Eurobond restructurings indicate the difficulties companies are facing.

Fitch believe the UAH15bn set aside for banking sector recapitalisation is very modest relative to potential needs, especially considering the likely asset quality deterioration. Capital ratios at 15.8% for the sector at end-July continue to benefit from significant regulatory forbearance in terms of recognising and reserving asset quality problems. Fitch expect the NBU to continue this approach, even with the capital stress tests, such that no material recapitalisation of the sector is likely in the near term. Preliminary results of the capital stress tests for the largest 15 banks suggest there is no rush to recapitalise the banking system, according to recent statements by the NBU governor.

Foreign-owned banks (around a third of the sector) may still receive capital from parents if necessary, but owners are likely to be reluctant to invest at this time. Ukraine's parliament adopted a law Tuesday that would enable the country to impose sanctions against Russian individuals and companies, although at present it does not appear that Russian-owned Ukrainian banks are likely to be targets of such sanctions. Ukrainian banks that are not systemically important and run into trouble will probably be liquidated, like the banks closed and put into liquidation in 2Q14. Systemically important state-owned banks are better capitalised than most peers, reducing potential capital shortfalls and the cost of any support for the authorities.

Liquidity appears to be generally manageable despite a notable 16% deposit outflow in 1H14 (adjusted for exchange rate effects). The situation has been helped by withdrawal restrictions by the NBU and tighter limits by individual banks, liquidity support from the NBU and a decrease in new lending.