Ukraine/EU banks: when aftershocks are worse than the earthquake

EU banks may have to wind down their businesses in Russia and Ukraine following the larger nation’s invasion of its smaller neighbour. On Wednesday, UniCredit of Italy outlined maximum potential losses of €7bn from Russian operations. France’s BNP Paribas said it had €3bn of exposures.

But the European banking sector has not dropped 15 per cent in response to risks as modest as these. Instead, the fall prefigures fears of a European downturn and new, politically motivated curbs on payouts to investors.

Food and fuel prices are soaring. Growth is likely to disappoint. The European Central Bank, which had been preparing to raise rates towards the back end of this year, appears certain to hold fire. Skinny net interest margins are set to stay that way.

A gaggle of EU banks, including UniCredit, BNP and Intesa of Italy, had pencilled in dividend and buyback ratios exceeding 100 per cent of earnings this year. Regulators, fearful of political blowback, can be expected to demand greater restraint.

UniCredit has confirmed it will pay dividends owed for last year. But it has raised a question mark over plans to start returning €16bn this year. The Ukraine war already stymied UniCredit’s attempt to buy Otkritie, a Russian bank now subject to western sanctions. A rumoured takeover of smaller local lender Banco BPM is now unlikely.

The run of bad luck afflicting chief executive Andrea Orcel could worsen. UniCredit may have to write off its entire Russian business, comprising €14bn of total loan exposures and €2bn of net equity. The cost would be 2 percentage points of common tier one equity or about €7bn.

Common equity tier one would then fall to 13 per cent. Any lower, and proposed buybacks of €2.6bn this year would stall automatically.

UniCredit’s estimated losses from a total wipeout would eclipse those at Société Générale, which has €19bn of total counterparty exposures linked to Russia. The French bank thinks a similar extreme scenario would cost it just 0.5 per cent of CET1, or about €2bn.

Europe’s banks remain well capitalised. They have large stocks of unused provisions built up during the pandemic. Potential capital returns for this year stand at €90bn, roughly split down the middle between cash and buybacks.

The pandemic forced banks to hoard their largesse. A lengthy conflict in Ukraine may leave them sitting uncomfortably on excess capital for just as long.