The management quality of Ukrainian banks is gradually improving, but they continue to face difficulties from legal and political uncertainty, with some foreign-owned banks already giving up the struggle.

Ukraine’s banking heyday came to a sudden halt with the economic crisis that whipsawed through the country in 2008. Some of the issues that fomented the fall would be familiar anywhere, including lax lending practices and eye-wateringly expensive merger and acquisition deals. Five years on and most of the country’s commercially oriented banks have implemented the lessons learned and professionalism in the Ukrainian banking industry has improved.

However, Ukraine’s banking sector as a whole lies in the doldrums, brought on by the government’s lack of will to tackle reforms in critical areas such as the judiciary. As a result, the gains from rising lending to retail and small and medium-sized enterprises (SMEs) and improving financial sector transparency have been offset by the departure of foreign banks, negligible lending and the inability to collect on non-performing loans (NPLs). This has also resulted in the increasing presence of conglomerate-serving pocket banks.

Bank numbers

At first glance, Ukraine seems overbanked with 177 lenders registered by the National Bank of Ukraine (NBU). However, as Alfa-Bank (Ukraine) points out, in 2012 the top 35 banks handled more than 80% of retail deposits. Why, then, are there so many banks?

The answer lies in the related-party lending in Ukraine, which continues to be a problem. Banks are created as a part of diversified holdings, not just to provide financial services for them, but to act as a treasury for the group as a whole. Their effect on banking in Ukraine remains contentious, with some analysts claiming that the system itself will not function properly until beneficial ownership issues are resolved.

Others take a relatively ambivalent approach. “Related-party business banks are not necessarily a drag on the system, but they are a problem. Most NPLs, for example, have been of not-related [lending in] origin,” says Alexander Pavlov, senior banker and head of Ukraine financial institutions at the European Bank for Reconstruction and Development (EBRD).

The exceptions can result in large failures. In 2009, one-time top-10 ranked Bank Nadra accepted temporary administration from the NBU. The bank’s failure and government-backed rescue were controversial at the time, and related-party loans were at the forefront of the scandal. In the ensuing noise, however, an understanding of the complexity of uncovering related-party lending in Ukraine became lost. Bank Nadra had undergone due diligence in preparation for a 2006 private equity placement.

“When Dragon Capital and HSBC organised a private placement for Nadra Bank in 2006, truly uncovering the extent of related-party lending would have involved due diligence on the several thousand companies that the bank was dealing with,” says Brian Best, managing director of investment banking at Dragon Capital, which has a minority stake owned by Goldman Sachs.

Collection woes

The Ukrainian government’s handling of Bank Nadra is by no means unique in the banking world and NPLs generally are falling. Nadra was bought by Centragas, an Austrian company owned by Ukrainian billionaire Dmitry Firtash, in 2011. System-wide NPLs net of provisions fell to 25.1% of capital by third-quarter 2012 from a peak of 32% in the fourth quarter of 2009, according to the NBU.

However, the issue of collections remains vital to such an extent that the NBU required banks to reclassify NPLs from the fourth quarter of 2012 to include not only those in default but also some of the most at-risk performing loans. Collecting on debt provides a clear example of the critical disjunction between Ukraine’s laws and its judiciary that earned Ukraine a place at 144, alongside the likes of Syria and Bangladesh, in Transparency International’s 2012 Corruption Perceptions Index.

Political interference, corruption and a system that remains both ponderous in practice and open to abuse leaves banks that pursue collections open to protracted and uncertain processes, even when the borrower is undeniably delinquent. Stefan Gullgren, ambassador in Ukraine for Sweden, puts the problem succinctly: “The difficulty lies in enforcing court decisions and in getting predictable decisions. In banking it is more apparent because as a bank you are very dependent on a well-functioning judiciary.”

The EBRD’s Mr Pavlov agrees, noting that: “The enforcement of otherwise good laws is a fundamental issue for Ukrainian banking. The rules need to be the same for everyone, and this means tackling corruption in the judiciary, false bankruptcies and political interference.”

Some classes of NPLs remain uncollected, though, for commercial reasons. Residential mortgages, especially on flats, sometimes remain uncollected when any sort of terms can be reached with the residents to keep yet another repossession off the books. Also, with residential values and sales (and new mortgage generation) at a low due to the more risk-averse attitudes of both lenders and borrowers, a repossessed apartment could end up staying in the bank’s possession for years with the ensuing communal payments creating a seemingly interminable cost.

Ukraine asset quality indicators

Heading home

The inability to operate in a cogent manner has led foreign-owned banks that were already refocusing their operations to leave or reorient their Ukraine positions. Swedbank and SEB, both from Sweden, are examples, with Swedbank announcing on April 1 that it was pulling out of the Ukrainian market after losing SKr11bn (€1.32bn) since 2007 and closing retail operations in 2011. SEB, which sold its Ukrainian retail operation in June 2012, remains focused on serving corporate clients from Scandinavia and central Europe. Mr Gullgren notes that his country’s banks were well received, but that more was needed. “The Swedish brand as a factor can be an asset, but in the end it is not enough if the banking environment as such does not meet Swedish codes of conduct,” he says.

The arrival of western Europe’s financial institutions, starting with Raiffeisen International’s $1bn purchase of Aval in 2005, caused concern over the loss of domestically owned banks. The departure of western European banks, though, has also produced commentary. Mr Gullgren notes that while he recognises the commercial decisions made, “it is a pity for Ukraine that the banks leave, because the country could benefit from their presence. A competitive sector needs more strong banks.”

Big banks, small borrowers

Since the 2005 purchase, Raiffeisen Bank Aval has become Ukraine’s largest foreign-owned lender to SMEs and second only to the domestic giant Privat Bank. Lending in this category faces several hurdles, such as a lack of financial markets sophistication compared with larger enterprises. Ownership structures and financial data can be unclear and banks that focus on SMEs need to adjust to local conditions.

The deputy chairman of the board at Aval, Robert Kossmann, says: “Banks support SMEs in this environment. Raiffeisen Bank Aval alone lent out more than Hrv1bn [€92.7m] in 2012. The support is there for those who can borrow and do not know how. But all banks in Ukraine need transparency and it is not necessarily a matter of collateral. We tell potential borrowers who are new to the bank that opening an account with us and letting us see their activity works well. If they bank with us, we can support them.”

Support for SMEs is an important private sector function as political parties in the country, no matter who is in power, have favoured the largest conglomerates. Ukraine’s Orange Revolution of 2004 was touted afterward as ‘millionaires versus billionaires’, and small business benefited mostly from the economic boom created by being in the international limelight and not from a policy change. As a consequence, SMEs accounted for 10% of GDP in 2012, versus 14% in 2008 despite their overall lack of exposure to the problems that international trade experienced.

The lack of political will to stimulate small business and engage in judicial reform has stultified demand for SME lending. But the EBRD does not look at the banking sector and its banks as being inherently unable to lend. Mr Pavlov says: “The main question is what shake-ups in the macro environment will do to them. Given the lack of visibility about the future in the country, there’s no ability to plan. Three-year projections are basically useless and have to be revised yearly. Likewise, interest rate volatility makes lending for more than one year difficult and most SME lending that does occur gets used as working capital. Also, the legacy of the 2008-09 crises will be carried forward given the state of the judiciary and creditor rights.”

Interest rate volatility was a major factor in impeding both commercial and retail lending in Ukraine in 2012 NBU data shows monthly changes of 0.5% to 1% as common. Whole quarters without such major interest rate changes were rare.

Bright spots

Despite the formidable headwind, the future of Ukrainian banking is not uniformly bleak. There is a consensus that banks’ relations with the NBU are cordial, even if the central and commercial banks are not always on the same page. “Banks are better regulated than any other sector in the Ukrainian economy,” says Mr Pavlov. “It is a benchmark in the country in terms of quality of reporting and controls.”

Aval’s Mr Kossmann sees credit bureaus as maturing as well. “Credit bureaus are developing in the right direction and in the next three to five years they could be a healthy part of the banking environment. There does need to be a mandate for banks to use credit bureaus as this would help underpin borrower responsibility,” he says.

Not all analysts agree that credit bureaus in Ukraine can provide the answer. Still, lenders seem to welcome any prospect of greater clarity regarding a potential borrower’s history. As Mr Kossmann succinctly puts it, in terms of the current collections environment: “Being secured is almost the same as being unsecured in Ukraine. Collecting is costlier than being unsecured and limited in the ability to collect in the first place. The protection of creditor rights is an issue for any lender here.”

Fortunately, there is a general agreement that the level of professionalism in the banks has risen since 2008, with bank employees and the banks themselves finding that it is time to improve or face becoming redundant. This continues a trend that began even before the acquisition craze of the mid-2000s. Bankers learned quickly after the 1998 currency crisis that having a few large clients was not enough; the change in mindset required to bring about a customer-oriented culture began. Since 2008, though, even the ‘too big to smile’ state-owned savings bank has turned around at the teller’s window.

The largest banks are also adopting current retail banking trends to the degree that they can. Improvements to banks’ IT departments started before the 2008 crisis. ATM use is less expensive than in many markets because banks have joined together to keep their own costs down. However, much still needs to be done on the regulatory side to bring electronic banking to western European levels. Viktor Marchenko, head of the financial institutions group at Dragon Capital, says: “While the largest banks have made significant investments into IT and most banks have some sort of client bank online, there is basically no offsite buying or selling of services. Customers still need to go to branches and show their documents or sign agreements.”

Post-Cyprus depression

Commercial banks in Ukraine seem to have felt little direct impact from the recent banking-related crisis in Cyprus. Some conglomerate holding companies may have had exposure to Cyprus, but the smart money pulled out long ago. “When the problems in Greece started and it was noted that Cyprus was exposed, we pulled our own assets out,” notes one banker. However, a significant number of entities (corporate and private) had money in Cyprus, and the face of private banking in Ukraine, as in the rest of the region, is permanently changed. 

As Dragon Capital’s Mr Best points out: “Private banking clients in Ukraine include an echelon of self-made business owners who are very sophisticated in their knowledge of investing. The next tier until recently took a ‘money safely in a bank’ approach to investing, even with Cyprus.”

While bankers, governments and investors grapple with the changes wrought by the Cyprus bailout, Ukraine’s relations with the EU as a whole continue to focus on the need for the government in Kiev to engage consistently in broad reforms that have already been defined. This is not something that the international community can push upon a sovereign state, but it is something that can be supported. This assistance has been present in Ukraine and experts have and continue to be available for technical or conceptual aid. But the impetus must come from Ukraine.

As Mr Gullgren says: “There has been no lack of reform programmes and they are quite impressive on paper. What has been lacking is implementation. Without broad reform, there is no support to lend to Ukraine.” 

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter