The outlook for Ukraine's banking system remains negative, unchanged since October 2009, Moody's Investors Service said in a new report published on Thursday.

The outlook reflects the rating agency's expectation that Ukrainian banks will continue to operate in a challenging economic environment, causing asset quality to remain very weak, the report says. This outlook also takes into account Moody's expectation of poor profitability and tighter funding conditions in 2013.

The new report, entitled "Banking System Outlook: Ukraine", is now available on www.moodys.com.

Over the 12-18 month outlook period, the operating environment for Ukrainian banks will remain negative with the economy expected to show very little growth - after meager GDP growth of 0.2% in 2012 - largely because of weak external demand for Ukraine's key export commodities, in particular steel, it says.

Moody's says that within this context, Ukrainian banks' asset quality will remain very weak over the outlook horizon. Problem loans will remain at the 2012 level of around 35% of gross loans in 2013, driven primarily by weak export prices and stagnant real-estate prices. Furthermore, loan-loss provisions covered only around 40% of total problem loans (including restructured) at year-end 2012, which Moody's believes is insufficient to cover potential credit losses. The banks will be marginally profitable in 2013 as their earnings will be affected by increased loan loss provisioning, shrinking margins and limited cost-cutting ability. Net interest margins declined to 4.5% in 2012 from 5.3% in 2011, and we expect the negative trend to persist in 2013.

Depositor confidence has proven fragile in the past, and, although deposit growth has been strong in recent years, it slowed down in 2012 and Moody's expects this trend to continue in 2013, leading to tightening funding conditions. Moody's says that the elevated risks of a current account crisis and uncertainties over the stability of the local currency will negatively affect depositors' confidence. In addition, the negative economic environment and reduced access to credit could force companies to draw their deposits from banks.