Belarus' Government Will Continue To Dominate Both The Banking Sector And The Economy

The government controls around 63% of the banking system. With total assets of Belarusian ruble (BYN) 74 billion (about $36 billion) as of July 1, 2019, the banking system remains very concentrated. Of 24 banks, the two largest state-owned institutions--JSC Savings Bank Belarusbank and Belagroprombank JSC--account for more than 50% of the system's assets and retail deposits.

We understand that the authorities want to make the banking system more attractive to foreign investors. The government is currently considering partial divestments of Belinvestbank and Bank Dabrabyt (formerly Bank Moscow-Minsk), which have market shares of 6.0% and 1.6% in assets. We still do not know how or when this will take place. We do not think it likely that foreign investment in the banking sector, if any, would be material at this stage, given the perceived risky operating environment.

The government's capacity to support the economy will continue to heavily influence the financial strength of Belarusian banks. This reflects the large share of loans the banks have provided to government-related entities (GREs), as well as other loans issued under directly funded state programs on preferential non-market terms. Despite improved economic policymaking in recent years, substantial balance-of-payments and fiscal risks remain, including from Russia's tax maneuver in the oil industry.

We forecast state program lending of BYN800 million for 2019, 35% lower than last year. However, we anticipate that legacy directed loans will continue to represent a notable one-third of total system loans in the medium term. This portion could potentially add to asset quality problems in the sector if there is an economic downturn. Positively, however, the share of directed loans in the system's net new lending is decreasing and the contribution of loans under government programs to the system's new lending could drop to zero by 2020.

Chart 1

The Moderately Supportive Macroeconomic Backdrop Is Helping Stabilize The Banking System

Belarus' macroeconomic fundamentals have somewhat stabilized in that the government has maintained a flexible exchange rate, has tightened its fiscal policy, and currently has access to the capital markets. We forecast that the economy will grow by close to 2% annually for the next few years, while inflation stabilizes at 6%, compared to double digits before 2017.

Although economic performance has strengthened following the recession in 2015-2016, the country's headline growth rates remain below those of countries at a comparable level of economic development. Downside risks to growth remain, particularly if Russia implements its planned tax maneuver without compensating Belarus for lost revenues.

Chart 2

We expect macroeconomic stabilization overall to support the asset quality of Belarusian banks. Specifically, we believe that economic performance and therefore the debt-servicing capacity of key corporate borrowers will remain stable in 2019, which will result in lower annual credit losses of about an annual 2%-3% of the banks' gross loan books in 2019-2020, compared to 3%-4% in 2016-2017.

Reduced State Support Reveals The Sector's True Asset Quality

We do not anticipate a material deterioration in Belarusian banks' asset quality over the next two years given the recovery (albeit slow) in the economy. We believe that reducing directed lending, coupled with cleaning up a sizable portion of accumulated problem loans, could help the banking system get into better shape in the longer run. Official asset quality metrics under local generally accepted accounting principles (GAAP) might show the opposite, however. While we calculate nonperforming loans (NPLs) in the system at about 12%, the figure presented using local GAAP methods is currently below 6%. The GAAP figure will gradually rise, appearing as if the situation is worsening--when in fact it is not. We foresee a gradual decrease in directly funded state programs and government guarantees provided to GREs, which could lead to a moderate increase in reported NPLs for some banks in 2019-2020. At the same time, decreasing directed lending might positively affect the quality of the system-wide loan portfolio and help to decrease market distortions in the longer run, in our opinion.

We estimate that problem loans (measured as Stage 3 plus purchased and originated credit-impaired [POCI] loans defined under International Financial Reporting Standards [IFRS]) are about 12% of banks' portfolios currently. In April 2018, the central bank revised its methodology for calculating problem assets. Under this new approach, reported NPLs dropped to 5.8% as of June 30, 2019, from about 13.0% the year before. In our view, this methodological change does not reflect an actual overall improvement in the banking sector's asset quality. Our base case is that asset quality metrics under local GAAP will likely only gradually move toward those calculated under IFRS.

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We consider that existing provisions under IFRS for Belarusian banks--at about 7% of total loans as of year-end 2018--are not a sufficient buffer and could moderately increase further. This will be reflected in anticipated credit costs of 2%-3% on the back of modest loan growth. Stage 3 and POCI loans coverage by respective reserves in the system remains below 40% (partially offset by collateral).

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Somewhat decreased credit costs should support banking sector profitability while domestic net interest income will likely be flat or even moderately lower. The net interest margin will likely remain under pressure due to an anticipated upward adjustment to funding costs amid tightening competition for domestic funding sources. We believe that further moderate growth in banks' deposit bases will be sufficient to support only 5%-6% (net of inflation) lending growth in 2019-2020.

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Capital Buffers Protect The Sector From Moderate Downside Risks

We expect the sector's capitalization to remain broadly stable over 2019-2020, thanks to moderate asset growth and gradually increasing regulatory requirements (see table 1), which are forcing the largest banks to manage their capital more carefully.

Table 1

Belarus' largest banks enjoyed stronger profitability in 2018 and the first half of 2019. After several years of turmoil, most banks are continuing to adjust their business models and growth strategies to withstand challenging economic conditions. These banks have taken advantage of Belarus' slowly improving economy, which has in turn allowed them to improve their asset quality metrics, require lower credit loss provisions, and stabilize capitalization. Moreover, many banks have managed to lower their operating expenses and improve efficiency.

The largest banks kept up sound internal capital generation in 2018, which has allowed them to maintain stable capital ratios (see table 2).

The initial implementation of IFRS 9 was challenging but manageable in terms of the effect on banks' capital. Decreased credit losses could support capitalization in the next two years, while revenue will likely remain flat. We estimate that the initial effect of IFRS 9 (reporting as of Jan. 1, 2018) amounted to 4%-5% of the system's total capital base. This is broadly comparable with what we observe in peer countries.

However, the scope of the initial negative outcome has varied significantly from bank to bank. This is because the move to IFRS 9 implies a more forward-looking provisioning model, which inevitably requires greater judgment by banks' management teams about future outcomes. In turn, this brings with it a wider divergence in approaches to provisioning, adding a further layer of complexity to peer analysis, both of banks in Belarus and globally (see "Adoption Of IFRS 9 And Bank Ratings," published Feb. 19, 2018, on RatingsDirect).

Table 2

In our view, current capitalization levels and the subdued demand for lending growth should continue to provide a buffer against potential economic and market volatility in 2019-2020. As of July 1, 2019, the system's total capital ratio stood at 18.21% and the core tier 1 ratio at 12.79% (with minimal regulatory requirements of 10% and 4.5%, respectively). We note, however, that the average capitalization of the Belarusian banking sector remains moderate in an international context. Belarusian banks, like banks in many other developing economies, are lagging behind banks in advanced economies in terms of Tier 1 capital buffers.

Tighter regulation in developed economies has pushed banks to build Tier 1 capital. Meanwhile, some developing economies have delayed the full-scale implementation of Basel 3.5 requirements, allowing banks in those countries to continue taking a more relaxed approach to riskier assets.

We believe the gap between the Tier 1 capital ratios of developed banking systems and the Belarusian banking system will persist at least throughout 2019-2020, as risks to the balances of Belarusian banks remain high, and capital generation is modest in a global context.

Retail Lending Has Gained Momentum

We expect Belarus' banking sector's gross loans to grow by about 10%-12% in 2019, largely driven by retail loans.

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We expect retail lending growth in 2019 to slow to about 15%-18%. The spike of 28% in 2018 was largely driven by delayed demand, which had been frozen during the economic turbulence of 2015-2016. Consumer demand rebounded quickly in 2016-2018 due to decreasing interest rates and the banks' restored appetite for consumer finance. We believe that delayed demand had already been replenished. Moreover, lack of funding sources will also cool growth rates in retail lending. Despite remarkable growth, the ratio of household loans to GDP in Belarus remains moderate when compared globally, at about 10%-11%.

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Loans to corporates will likely grow by about 8% in 2019. We see the credit standing of corporate borrowers stabilizing but remaining vulnerable because of the high debt leverage levels of some borrowers and industries and the relatively high proportion of foreign currency loans (around 47%) in the system. Although most foreign currency-denominated loans are granted to borrowers with foreign-exchange cash flows, we think that the operating environment is still too uncertain for corporates to resume long-term lending.

Systemwide Funding Remains Exposed To Foreign Currency Risk

About 60% of system deposits are still in foreign currency and we do not expect this to decrease quickly. In 2017-2018, the government undertook initiatives aimed at the de-dollarization of the funding base, including an increase in mandatory reserves for foreign currency deposits up to 17.0% from 7.5% before 2017. We observe that the more diversified an economy is, the more effective government steps will be to eliminate foreign-exchange mismatches and manage the de-dollarization process.

Chart 8

On the back of macroeconomic stabilization, we have no immediate concerns about foreign-exchange liquidity in the sector, at least over the next 12 months. The banking sector's net external debt decreased over 2013-2019 by more than 2.6x as the foreign-exchange regime is now a managed float and economic conditions are more stable. Coupled with moderate lending demand in foreign exchange, foreign banks' subsidiaries (comprising about one-third of system-wide assets) in Belarus require less foreign-exchange funding and liquidity support from parents compared to previously.

Appendix: Rating Components For Rated Belarusian Financial Institutions

Table 3