Economies are rebounding from recession across the region, supported by high global commodity prices, and this is having a positive impact on banks' asset quality and performance. At the same time, the agency notes that banking sector recoveries have mostly been slow and uncertain to date, and significant vulnerabilities remain.

The strength of banking system recoveries have diverged markedly across the region. Kazakh and Ukrainian banks have been hardest hit during the crisis, and most have continued to struggle in 2011. Russian and Georgian lenders, in contrast, saw a clear turnaround in 2010 and have continued to perform better than regional peers in 2011. Azerbaijan banks' performance is between these two extremes, while Uzbekistan has been largely insulated from the global crisis. The Belarusian banking system and broader economy faces severe challenges following the May devaluation.

Russian banks' profit levels has improved in recent quarters, supported by the stabilisation in asset quality, while capital and liquidity cushions, built up during the crisis as the system deleveraged, are generally comfortable. However, increasing competition, driven by high liquidity, a limited pool of good-quality borrowers and state-owned banks' more aggressive strategies , is gradually pressuring margins, and in the long term is likely to challenge the viability of many small and mid-sized lenders.

Furthermore, the failure in July 2011 of Bank of Moscow (BOM; 'BBB-'/Stable), and its acquisition by VTB Bank ('BBB'/Stable) with minimal prior due diligence, have highlighted the potential for major negative surprises in the Russian banking system, and also called into question the quality of governance at state-owned banks and the effectiveness of central bank supervision. Fitch expects the provisioning of problem loans at BOM to have a material negative impact on aggregate sector asset quality and capitalisation ratios, probably in Q311.

Kazakh and Ukrainian banks' balance sheets remained burdened by high levels of problem assets in H111, while sector results are still marginally negative, as some lenders continue to create provisions. Fitch expects banks in these markets to pursue loan workouts more actively over the next 18 months, and the slowdown in NPL accretion should see positive results from H211. However, balance sheet clean-ups will likely still be far from complete at end-2012, reflecting the depth of problems and legal constraints.

Leverage in both the Ukrainian and Kazakh systems has reduced as a result of equity injections, debt write-offs, limited new lending and rapid deposit growth. However, significant systemic vulnerabilities remain. Fitch views capitalisation as still weak in both markets, due to the large volume of accrued interest (in Kazakhstan) and under-provisioned restructured loans (in Ukraine). Performance is also under heightened pressure in Kazakhstan due to a squeeze in margins, and the level of debt funding in the Kazakh sector remains considerable.

While the Outlooks for most CIS banking sectors are Stable, the Outlook for Belarusian banks is Negative. In Fitch's view, Belarusian banks' asset quality and capital positions are likely to deteriorate, potentially sharply, as a result of the devaluation, the expected abrupt credit slowdown, reduced economic activity, high inflation and probably more selective government support of the corporate sector. In addition, the system's foreign-currency liquidity is tight and highly dependent on the confidence of depositors, with the authorities having limited capacity to make foreign exchange available to the banks.