Moody's sees 'very high' foreign exchange risk for banks in Ukraine, Turkey

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LONDON (Reuters) - Banks in countries such as Ukraine and Turkey face a "very high" risk from restrictions on capital flows, weak international reserves and a high level of foreign currency debt, Moody's (NYSE:MCO) Investors Service said in a report on Monday.

Belarus, El Salvador, Nigeria, Kyrgyzstan and Tajikistan complete the list of countries also exposed to high levels of dollar deposits, according to the report that covers 39 banking systems in emerging market economies where foreign exchange deposits are 10% or more of total deposits.

"High dollarization causes multiple problems when the local currency drops sharply in value," according to the report headed by Moody's vice-president and senior credit officer Eugene Tarzimanov. "The banks become vulnerable to an increase in defaults on foreign currency loans granted to unhedged borrowers which hurts the banks' profitability, while their liquidity and capital can also come under pressure."

Local currencies across emerging markets have weakened against the U.S. dollar this year as the U.S. Federal Reserve lifted rates amid rising inflation. MSCI's index of emerging market currencies is on course for its sharpest drop since 2015.

Currencies in Ghana, Argentina and Egypt have fallen the most this year, the credit agency said. El Salvador uses the U.S. dollar as legal tender.

Macroeconomic vulnerabilities in Armenia, Georgia, Kenya and Uganda could also affect banks. "Altogether 20 banking systems face high or very high foreign-currency risk," the report added.

Moody's sees that international reserves in most emerging market economies have fallen since Russia's invasion of Ukraine, as governments fund current account deficits and defend their currencies against the U.S. dollar.

Foreign exchange risk is at the lowest in emerging markets such as Chile, Ivory Coast and Indonesia.