Ukrainian banking landscape has changed dramatically over the past two and a half years. CE Financial Observer talks with Kateryna Rozhkova, the central bank's deputy governor.
Thanks to enormous efforts by the central bank, supported by the International Monetary Fund (IMF), the sector has been cleansed of dozens of lenders with obscure ownership and also of banks involved in money laundering and other illegal operations. However, more challenges lie ahead, as the regulator is implementing a massive program aimed at recapitalization of Ukraine’s banks and unwinding of related parties from their lending portfolios.
The National Bank of Ukraine (NBU) has been able to pursue a massive cleanup of the banking sector during a comparatively short timeframe. The regulator admits that its actions were a shock to the sector but says that none of the banks were withdrawn from the market unfairly.
"From the very beginning we said to banks: we are building a new country and a new banking sector. We are not going to search for 25-year-old skeletons in the closet; however, we must agree to work in a transparent and proper way from now. To work in accordance with rules that always existed, but were never respected," Kateryna Rozhkova said.
She adds that some banks were unable to change their illegal behavior. "They were involved in totally illegal activities. That's why they were dissolved," Rozhkova underlined.
Since spring 2014, the central bank has withdrawn 80 banks from the market. The number of banks operating in Ukraine has now declined to just 100.
The NBU was also able to dramatically increase the transparency of the banking system. Only four small-sized banks (less than 2 per cent of the banking sector's assets) have failed to provide proper information about their beneficiary owners so far. In contrast, two and a half years ago, 27 per cent of the banking system was non-transparent, according to the central bank's estimates.
Meanwhile, a significant part of 80 insolvent lenders were withdrawn from the Ukrainian market due to losses in liquidity, which was a result of enormous lending to related parties during the pre-crisis years. "The crisis in the country just uncovered this problem," Rozhkova said.
With the aim of creating a sustained post-crisis banking system, the NBU has embarked on a diagnostics process for the remaining lenders, based on which the regulator is agreeing three-year recapitalization plans, which also include measures to unwind the related-party exposures of these banks.
"The NBU completed the first two rounds of new bank diagnostics for the 39 largest banks (accounting for 95 per cent of the system assets), focusing particularly on the sustainability of borrowers’ cash flows and the quality of loan collateral," the IMF wrote in its report published in October. "Results showed material capital shortages in 28 out of the largest 39 banks."
According to the IMF, poor quality of collateral resulted in an increase of the estimated levels of non-performing loans (NPLs) and provisioning requirements which underscored the need for banks to enhance their credit risk management and loan underwriting practices.
According to the NBU's plans supported by the IMF, the 20 largest banks are already required to have reached a capital-adequacy ratio (CAR) of 5 per cent of risk-weighted assets, while the deadline for the next 19 largest banks to reach 5 per cent CAR is February 2017. "Our banking system will have a CAR of 10% by January 1st, 2019," Rozhkova explains.
"The program secured by the IMF is a magic wand for the NBU," the NBU's official adds. "Our approach was tough - we want to purify and recapitalize the banking system, and we are ready to provide time [to banks]. The IMF is our ally, they support our efforts."
Rozhkova said that Ukraine had already drafted a similar program for the recapitalization of the banking system in 2009, when the country secured a support package with the IMF. However, Kiev failed to implement these plans. "The regulator didn't really press for it at the time. Today, this unfinished diagnostics and recapitalization have taken their toll on the banking system," she underlines.
According to Kiev's obligations to the IMF, Ukrainian banks with related-party exposures in excess of prudential limits are now required to unwind them by early 2019.
"Related-party exposures that exceed limits are being addressed by banks in line with clearly defined quarterly targets," the IMF's report reads. "Plans to unwind these exposures may be factored in the recapitalization plans if credible binding commitments are provided by the bank’s shareholders (e.g., by pledging related deposits that could immediately be used to repay related loans if these are not repaid on time)."
With the aim of preventing a new concentration of risks in the banking system, the NBU is reporting monthly on new potential related-party exposures, especially for banks already subjected to unwinding plans. The regulator will also set up a credit registry in line with "international best practices", the IMF underlined.
The central bank's officials admit that targeting these ambitious goals is a tall order. Lending to insiders has been a common practice in Ukraine over the past 25 years, especially in banks controlled by domestic oligarchs and wealthy businessmen.
"Some countries ban oligarchs from owning banks due to a very high risk of these lenders becoming captive [providing services to companies inside a group] which will negatively affect the whole financial market and even the country's economy," Rozhkova explains. "We never had such a ban in our country."
Ukrainian banks are required to achieve a ratio of maximum credit exposure to related parties compared with its regulatory capital of 25 per cent by early 2019. According to official data, this ratio stood at 28.19 per cent as of October 1st, declining from 45.56 per cent as of February 1st.
The regulator is avoiding disclosing the ratio of exposure to related parties in individual banks. However, Ukrainian experts are worried about the future of the country's largest lender by assets, Privatbank, controlled by oligarchs Ihor Kolomoisky and Hennady Boholyubov.
According to the bank, the ratio reached 29.29 per cent as of September 1st. At the same time, the Wall Street Journal wrote that Privatbank’s loans to related parties are believed to account for at least 40 per cent of its total loan book.
Worries over Privatbank's future were fuelled by the IMF report, according to which the Ukrainian authorities "have formulated a set of principles that would guide a possible resolution of systemic banks", as the lender is one of three banks qualified by the NBU as systemic, besides the two state banks - Oschadbank and Ukreximbank.
"A decision for state participation in the recapitalization of a problem systemic bank will be made on the basis of a technical report prepared by the NBU that assesses inter alia the bank’s capital needs and viability, with the aim of avoiding losses to the state," the IMF's document reads. "Public funds will be injected only after shareholders have been completely diluted and non-deposit unsecured creditors and related deposits are bailed in."
On top of that, the Ukrainian authorities have agreed with the IMF an option of bank recapitalization totaling UAH151.7bn (USD5.9bn) in the second half of 2016, and UAH42bn (USD1.6bn) in 2017. This fact has raised suspicious on the market that the amounts were calculated with the possibility of state participation in the capitalization of Privatbank.
"If banks fail to implement their programs [of recapitalization and unwinding of related party exposure], there are only two options for them: either insolvency or nationalization, in case of systematic banks," Dmytro Sologub, the central bank's deputy governor, tells the CE Financial Observer.
The official adds that the NBU is currently verifying the results of banks’ implementation of recapitalization plans that had to be delivered by October 1st.
More troubles ahead?
Meanwhile, new challenges loom on the horizon for the NBU, as political infighting is unfolding in the country's parliament. Recently, a group of lawmakers, led by the head of the parliamentary committee on financial policy and banking Serhii Rybalko, registered a bill that proposes to strip the NBU of its institutional, political, and financial independence.
"Examples of other post-crisis countries, especially those with weak institutions and a high level of corruption, demonstrate that the best way to proceed is to stick to a tough policy and to create independent [government] agencies," Sologub believes. "Nobody likes an independent central bank in countries where other institutions are weak."
The regulator's deputy governor believes that populist politicians who have initiated the current attack on the NBU are trying to put on the central bank all the responsibility and the blame for the slow economic growth in Ukraine after the two years of economic and financial meltdown. According to the state statistics service Ukrstat, the country's GDP grew 0.6 per cent q/q and 1.4 per cent y/y in the second quarter of this year, in seasonally adjusted terms.
According to the bill, one of the NBU's main objectives should be artificial control over the exchange rate in Ukraine. The regulator believes that this would lead to the build-up of macroeconomic imbalances, eventually triggering a surge in inflation. Currently, the NBU implements a policy that targets inflation, and considers this the most essential part of its operation.
"Politicians’ proposal to make an exchange rate the main focus of the central bank sounds like an empty slogan, because it is impossible to simultaneously secure a fixed exchange rate and inflation control in an open economy," Sologub says.