OREANDA-NEWS. Polish banks will have to face the cost of paying out upfront against failed SK Bank's estimated PLN1.7bn (USD420m) of insured deposits, adding a blow to profitability which is already under pressure, says Fitch Ratings. This payment is equivalent to 12% of total banking sector PLN14.1bn (USD3.5bn) pre-tax profit reported for the nine months to end-September 2015.

Polish banks make annual contributions to the country's deposit insurance fund. Banks are also required to hold liquid assets on their balance sheets, pledging these to the fund to cover the cost of paying out against any insured deposits in the event of a bank failure. The amount of pledged assets is substantial and at end-2014, were equivalent to 1% of total insured banking sector deposits. These resources complement the money gathered in the fund from annual contributions, which at-end 2014 amounted to around 1.5% of insured deposits.

SK Bank is the first Polish bank to fail in 15 years and it will test the deposit insurance mechanism. In the event of a bank failure, the first step is to pay out insured deposits using pledged assets held by the banks, with any shortfalls being covered, in second place, by assets held directly by the fund. Contributions made by the banks out of pledged assets are recognised as a tax deductible cost through the profit and loss account. We expect the SK Bank-related costs will be booked in 4Q15 and estimate that contributions required to cover the insured deposits could be sufficiently large to trigger quarterly losses at some less profitable Fitch-rated banks, namely Getin and BOS.

These costs will add to the expected increased regulatory and fiscal burden for the Polish banking sector. Measures contemplated include the introduction of a special bank tax and the possible conversion of foreign-currency (predominantly Swiss franc) mortgages, which may result in significant losses for the sector. To date, only one measure in support of mortgage borrowers has been adopted. A dedicated support fund was established to provide assistance to retail mortgage borrowers struggling to meet loan repayments. Banks are being asked to contribute to this fund, with contributions based on their share in the pool of non-performing retail mortgages. We expect the sector to contribute PLN600m (all in Q415), equivalent to 4% of 9M15 sector pre-tax profits.

At the outset of 2016, Polish banks' profitability is likely to suffer because deposit insurance fund contributions will be charged upfront. This follows the European Securities and Markets Authority's recommendation that such costs should be made in the first quarter of the year in a single instalment. Contributions for 2016 may exceed the PLN2bn charge for 2015, and details will be announced later this week. The need to recognise the entire cost upfront could mean that some rated banks will report quarterly losses for 1Q16.

SK Bank, a cooperative bank not rated by Fitch, was placed under regulatory administration in August 2015 following the regulator's rejection of a rehabilitation plan proposed by the management team. In its statement following suspension of the bank's activities and the subsequent filing for bankruptcy, the regulator quoted mis-management, governance weaknesses and misrepresentation of the bank's financial position.