Banking Sector of Belarus: Four Key Consequences

Belarus' financial system is under attack.

Being isolated from part of the developed world, Belarusian banks will increasingly find themselves trapped in their distorted reality. Dzmitry Kruk, an economist and senior researcher at the BEROC Center for Economic Research, expressed this opinion in an article published on the Center's website. The expert outlined four effects of sanctions on the banking sector writes the site Belarusians and the market.

The financial part of the EU sanctions includes a ban on contracting loans to the government, government entities and banks with the prevailing state capital. Belarusbank, Belagroprombank and Belinvestbank are directly specified as such.

Each effect mentioned by Dzmitry Kruk is relevant for both the sub-sanctioned banks and the entire banking system, as these banks are systemically significant throughout the sector: according to most gross figures, their share in the entire banking system is 55-60%.

Effect No. 1

It lies in the direct negative effect on the number of liabilities and liquidity in foreign currency. However, in our case, this direct effect will not be large in scale and will be stretched over time, the expert writes.

The sanctions provisions provide for the continued validity of already concluded contracts (with a number of reservations). It means that EU residents' funds deposited in the sub-sanctioned banks will not be withdrawn instantly. Such a mechanism is often referred to as a "sudden halt," and it may cause grave financial cataclysms. Withdrawal will happen upon the expiry of the contractual term. In the absence of sanctions, a large part of these contracts would be prolonged or replaced by new similar contracts, which could maintain the desired level of funds of non-residents.

"Based on the available information, terms of 1-2 years prevail among the relevant financial contracts. Accordingly, one can expect the reduction of funds of EU residents will be relatively gradual and stretch over this period," says Dzmitry Kruk.

The amount of funds of the EU residents in the Belarusian state banks is not so large in relative terms. To date, the Belarusian banking system has about USD 5.4 billion of non-residents' funds. Over the last year and a half, this figure fluctuates in the range of USD 5.0-5.4 bn, which is about 14.5-15.0% of the funding base of banks. Non-residents' funds from the EU countries account for approximately 20 - 25% of that amount (based on the latest available data on the country of origin), or about USD 1.0-1.35 billion. The share of sub-sanctioned state banks, probably (based on indirect data, as this information is not publicly available), does not exceed 50% of all the funds of non-residents from the EU countries. In other words, the funds of EU residents in the state banks are in the range of USD 0.5-0.7 billion. As for the funding base of the mentioned state banks and all borrowed funds, this amount is 2.8% and 3.2%, respectively. Although the relative value of these funds is not so great, they can likely be partially or completely replaced with resources from other countries, says Dzmitry Kruk.

Although the direct effect is minor in scale and will be stretched over time, nevertheless, it's extremely important in the current environment. The shrinking funding base, as well as the chronically weakened liquidity in foreign currency, is now one of the main vulnerabilities of both the state banks and the entire banking system. An additional blow, albeit a soft and gentle one, could be the trigger for financial stress.

Effect No. 2

The expert believes the negative information shock poses the greatest number of threats from the "here-and-now" perspective. Information that the largest Belarusian banks are subject to sanctions will inevitably be associated by their clients, counterparties and the general public with threats to their stability and solvency. Depositors are likely to intensify the withdrawal of their deposits, primarily in foreign currency. This trend has been taking place for a year and a half. It is likely the sanctions will cause a new surge.

Counterparties in non-credit transactions (especially those with freedom of manoeuvre in relation to state banks) will probably be more cautious in their relations with sub-sanctioned banks. The former will likely insist on the inclusion of conditions and clauses in the contracts, giving them more room for manoeuvre, which adversely affects the financial result of the deals for the latter. Besides, it is possible to expect refusal of potential counterparties from transactions with sub-sanctioned banks in a number of cases, even if sanctions are not a direct obstacle to it, but based on the precautionary motive.

These mechanisms of information shock propagation may intensify if international rating agencies downgrade ratings of sub-sanctioned banks, which appears quite probable amidst forthcoming rating revisions.

Effect No. 3

The financial spillover effects result from the first one. At some point, it is the financial spillover effects of the initial shock that may come to the fore, and become the immediate trigger of economy-wide financial stress or shock.

The financial spillover effects imply the initial shock in related areas of bank management or the problems and threats that the bank will face as a result of the reaction of management (authorities at the macro level) to the initial shock.

Dzmitry Kruk assumes that the sub-sanctioned banks will raise interest rates on borrowed funds in the domestic market to smooth out the liquidity problems. The deposit product line can introduce innovations on other essential terms for the same purposes, designed to attract new clients. One can also expect more active "drying" of their loan portfolios and attempts to better align the asset side of the balance sheet with the changes in the liability side. Such reactions, while designed to reduce liquidity risk, may result in increased exposure to other risks, including the interest rate and foreign exchange risk, and directly cause additional costs and reduced profitability.

Effect No. 4

The expert notes that the damage from the sanctions should be considered not only through the prism of direct financial losses, but lost profits. Dzmitry Kruk sees this kind of damage as the key one on the long-term horizon.

"Being deprived of the possibility of access to borrowed capital in the EU, the sub-sanctioned banks - through the information effect, quite probably, other Belarusian banks as well - will lose one of the important tools of current bank management. This is a factor of reduced flexibility, freedom of manoeuvre and resilience to shocks," reads the article on the BEROC website.

The loss of full-fledged cooperation with EU banks will also hurt development prospects. Interaction with partners who are more advanced technologically and organizationally promotes "pulling up" their own level and improving banking business standards. Within the framework of such cooperation, it is easier to see and feel innovations and development trends actual for the sector. Being isolated from a part of the developed world, Belarusian banks will increasingly find themselves locked in their own distorted reality, the economist concludes.