CIS, CEE banks continue to face extra risk from FX lending

High levels of foreign currency (FX) lending have been and will remain a constraint on many bank ratings in the Commonwealth of Independent States (CIS) and in Central and Eastern Europe (CEE), according to a Moody's special comment.
The report covers the three largest banking systems in the CIS — Russia, Ukraine and Kazakhstan, and two banking systems in the CEE — Hungary and Poland — where the share of FX loans has historically been high (although these levels vary significantly, from 30% of gross loans in Russia to over 70% in Hungary).
"Moody's estimates the additional expected FX lending-related loan losses for Russia, Ukraine and Kazakhstan to be at 2.4%, 4.6% and 5.0% of the banks' loan portfolios, respectively. For Hungary and Poland, where an extra credit risk was mainly observed in mortgage and home equity loans, the additional expected loan losses will be at 1.0% and 0.9% of mortgage portfolios or 0.5% and 0.3% of gross loans, respectively," said Lev Dorf, author of the report.
"The main contributors to the rapid growth of FX lending in CIS and CEE were the attractive interest rate differentials between loans denominated in local and foreign currencies, availability of cheap foreign funding and underestimation of credit risk associated with FX lending. The bulk of these loans were provided to unhedged borrowers. The global financial crisis and the subsequent sharp depreciation of local currencies in a number of CIS and CEE countries towards the end of 2008 and early 2009, have left many of these unhedged borrowers unable to pay their loans, thus putting additional pressure on banks' profitability," added Dorf.
Moody's believes that in most countries covered in this report the majority of FX lending-related losses, and the related loan loss provisions, will have materialised by YE 2010. This means that starting in 2011 provision requirements and pressure on capitalisation and earnings will ease. However, we also note that the complete work-out of losses will take several years. Banks will need to cover remaining losses out of earnings flows as they emerge over time. As a result, the practice of FX lending will remain, at least for the foreseeable future, a rating constraint for many banks in the CIS and the CEE.