Moody’s Sees Russia’s Weak Macro Outlook Impacting on its Banks

Russian banks’ asset quality and profitability will weaken as the country’s economy is likely to contract this year, says Moody’s Investor’s Service in its latest report.

The credit ratings agency last month said it believes that Russian gross domestic product (GDP) will contract by around 1% in 2014, with the recent financial market volatility exacerbating a secular shift to lower growth, which began in 2011.

This deterioration in the operating environment has led Moody’s to maintain a negative outlook on Russia’s banking system for some time. It has contributed to many of the CRA’s recent negative rating actions on Russian banks that preceded the report, which is entitled
‘Economic outlook in Russia will put pressure on banks’ asset quality and profitability’
.

As a result of the structural issues that have reduced Russia’s medium-to long-term growth outlook, which have been exacerbated by recent market volatility, Moody’s expects a slower rate of credit growth in 2014, at around 10% in nominal terms – compared with 17% in 2013, and 20%-30% in

2011-12 – that could reveal weaknesses in some banks’ previous underwriting criteria and practices.

Banks that have shown the fastest growth in recent years have unseasoned loan books and are thus vulnerable to the weakening macro scenario now unfolding. By segment, loans to consumers and small- and medium-sized enterprises (SMEs) are the most exposed.

However, Moody’s expects that weaker corporate profits, slower growth in household income and higher interest rates for some loans will foster asset-quality deterioration across all loan segments.

Growing loan-loss provisions and negative pressure on net interest margins will cause a decline in profitability. With low demand for new loans outside the consumer segment, banks have only limited ability to pass onto borrowers their increased cost of funding following the central bank’s rate hike and increased risk premia for Russian banks given the current volatility.

Although lower profitability will affect banks’ ability to generate capital, Moody’s does not expect capital buffers to shrink further because slower loan growth should offset the reduced returns on equity. However, capital buffers have declined in recent years as a result of rapid credit expansion.

A key challenge for Russian banks in the coming years will be to adjust to this secular low-growth environment, characterised by higher levels of credit risk, more intense competition for the more creditworthy clients, and lower profits. The banks best positioned to meet these challenges will have large loss-absorption cushions in terms of capital, reserves, and recurring pre-provision income.

Those banks with low funding and operating costs are also well positioned to meet these challenges. Moody’s believes that the new conditions will tend to favour the large government-owned institutions and create an incentive for further consolidation in the banking sector, particularly for larger private banks.

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