Four Main Blows. How Sanctions Affect the Banking System of Belarus

• 1.07.2021, 12:13

The restrictions will be a "trigger" for important processes.

The financial part of the EU sanctions provides for a ban on the contracting of loan funds to the government, state institutions and banks, with the prevailing state capital.

Belarusbank, Belagroprombank and Belinvestbank are listed as such.

Economist Dmitry Kruk analyzes in his article for thinktanks.by what consequences it will cause for the financial system of Belarus:

- I believe one can point out four effects these sanctions bring. Each effect is relevant to both the sub-sanctioned banks and the entire banking system, as these banks are systemically important within the entire sector (according to most gross indicators, their share in the entire banking system is 55-60%).

Direct negative effect on the value of liabilities and liquidity in foreign currency

It is precisely the effect that is first and foremost associated with financial sanctions. In our case, this direct effect will not be of such a large scale but stretched in time. The key reasons are as follows:

The sanctions provisions accept the validity of contracts previously concluded (with a number of stipulations). It means EU residents' funds deposited in the sub-sanctioned banks will not be withdrawn instantly. This mechanism is often called a sudden stop. It can trigger serious financial cataclysms. Withdrawals will occur upon the expiration of the contract. In the absence of sanctions, a large share of such contracts would prolong or be replaced by new similar contracts, which could maintain the desired level of funds for non-residents.

The available information suggests that the relevant financial contracts have 1-2 year maturities. Accordingly, the decline in EU residents' funds can be relatively gradual and stretch over this period.

The volume of funds of EU residents in the Belarusian state banks is not so large in relative terms. Today, the Belarusian banking system has about USD 5.4 bn of non-residents' funds. Over the last year and a half, this figure fluctuates within USD 5.0-5.4 bn, which is about 14.5-15.0% of the funding base of banks (the maximum value was in 2013, amounting to about USD 8 bn or about 20% of the funding base). About 20-25% of the abovementioned amount of non-residents' funds originate from the EU countries (based on the latest available data on the country of origin), i.e. about USD 1.0-1.35 billion. Meanwhile, the share of sub-sanctioned state banks probably (based on indirect data, as this information is not public) does not exceed 50% of all funds of non-residents from the EU countries. In other words, given the above estimates, the funds of EU residents in the state banks are in the range of USD 0.5-0.7 billion. In terms of the funding base of the mentioned state banks and all borrowed funds, this amount is 2.8% and 3.2%, respectively. Besides the fact that the relative value of these funds is not so big, they are likely to be partially or fully substituted by funds from other countries.

Although the direct effect is minor in scale and will be stretched over time, it is extremely important in the current environment. The shrinking funding base, as well as the persistently weakened liquidity in foreign currency, are now among the principal weaknesses of both the state banks and the entire banking system. An additional blow, albeit a soft and gradual one, may be the trigger for financial stress.

Negative Information Shock

I believe this effect is a key one and carries the greatest number of threats from a "here-and-now" perspective.

News that the largest Belarusian banks are under sanctions will inevitably associate their clients, counterparties and the general public with threats to their stability and solvency. Customers-depositors against this background, are likely to intensify the withdrawal of their deposits, primarily in foreign currency. This trend has been ongoing for a year and a half now. The sanctions will likely cause a new upsurge. Counterparties in non-credit transactions (especially those with freedom of manoeuvre concerning state banks) will probably be more cautious in their relations with sub-sanctioned banks. The former, most likely, will insist on the inclusion of conditions and clauses giving them more room for manoeuvre, which negatively affects the financial result of the deals for the latter. Besides, one can 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 a precautionary principle.

Mentioned mechanisms of information shock dissemination may reinforce if international rating agencies downgrade sub-sanctioned banks against the background of sanctions, which appears quite probable in the course of forthcoming rating revisions.

Financial Spillover Effects

This effect results from the first one. Therefore, its speed and scale will largely depend on it. Nevertheless, the financial spillover effects of the initial shock can dominate at some point and become an immediate trigger of financial stress or shocks at the economy-wide level.

The financial spillover effects imply an initial shock in related areas of bank management or problems and threats that the bank will face as a result of the management's (macro-level authorities') response to the initial shock. For instance, sub-sanctioned banks may raise interest rates on attracted funds in the domestic market to level out liquidity problems. Other major innovations may occur in the deposit product line to attract new clients. One might also expect more active "drying out" of their loan portfolios and attempts to better align the asset side of the balance sheet with the changes in the liability part. Designed to lower liquidity risk, such reactions may well add to other risks, such as interest rate and foreign exchange risk, and directly cause additional costs and lower profitability.

Lost Profits and Limited Space for Maneuvering

One should consider losses from sanctions not only from the perspective of direct financial losses but also from the perspective of lost profits. In the long run, this kind of losses appears as the key one.

Thus, no access to borrowed capital in the EU will deprive the sub-sanctioned banks - probably other Belarusian banks as well - of one of the core tools of their current bank management. This factor indicates a reduction in flexibility, room for manoeuvre, and resilience to shocks.

The loss of the ability to cooperate fully with the EU banks would also have a negative impact on their development prospects. Interaction with partners, which are more advanced technologically and organizationally, contributes to "levelling up" their standards of banking business. Within the framework of such cooperation, it is easier to see the innovations and development trends relevant to the sector. Being isolated from a part of the developed world, Belarusian banks will increasingly find themselves locked in their own distorted reality.