If there are two things to remember about banking in Ukraine in 2015, they would be that its problems are older than the recent strife and that the National Bank of Ukraine (NBU), the country's central bank, is finally an active force for reform. But even if banking regulation, enforcement and communication have undergone irreversible change, the industry still faces a bewildering array of macroeconomic, security and corruption risks. In light of the country’s struggle, what would normally be a radical but predictable reform process transforms into the challenge of a lifetime.
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The environment for launching reform could hardly be worse. According to the State Statistics Service of Ukraine, year-on-year core inflation stood at 44.6% in March 2015. The hryvnia, the national currency, plummeted in February 2015 by as much as 47.5% compared with January before, recovering in March at ‘only’ one-third down for the year. This is following a 50% drop in 2014.
Security risk
Foreign currency reserves decreased to an equivalent of $5.63bn by March 1. And behind the macroeconomic hurdle looms the externally driven military strife in the industrial heartland of Donbas, an area which in 2013 accounted for roughly 33% of Ukraine’s exports and 25% of its gross domestic product, and which remains a tangible security risk that must be constantly factored into decisions.
However, Ukraine’s banking crisis has far deeper roots than current events might indicate. “Basically, Ukrainian banking has been in crisis mode since 2008,” says Gerhard Bösch, first deputy chairman of the board of Raiffeisen Bank Aval, the Austrian bank's Ukrainian operation. “The events of the past year-and-a-half just aggravated the situation and made it more extreme – 2014 was tremendously volatile. And we expect it to stay that way. People can stop wishful thinking; what needs to be done is to build reserves to minimise operating risk.”
Long considered overbanked and inefficient, Ukraine’s crises have thinned the field of banks. Between January 1, 2014, and March 1, 2015, 29 banks lost their licences. The consensus is the closures will continue and unlike the 2008 disruption, large banks will not be spared. Indeed, the highest profile licence revocation to date, that of Delta Bank, closed what had been Ukraine’s fourth largest bank by assets in 2013, according to The Banker Database. As the NBU declared in parliament that Delta’s management had acted illegally, both the size and manner in which the bank is being treated are considered bellwethers of the regulator’s intention to bring the banks to heel.
Individual banks may contain surprises as lending portfolios and ownership structures come to light. However, the industry as a whole has been under the microscope for quite some time. There were no secrets waiting for the new government when the change occurred last year, says Dmytro Sologub, deputy governor of the NBU in charge of the central bank’s monetary policy. “In April 2014, we were talking about a perfect storm of problems and afterwards there came extreme uncertainty. There was [the seizure of] Crimea and the external aggression in Donbas set against a global drop in commodity prices, including our primary exports of steel and agriculture. But the banking system’s problems were longstanding and well known,” he says.
Currency devaluation
The extreme uncertainty has led the NBU to temporarily reverse course on occasion to deal with the situation at hand. The regulator’s reaction to hryvnia devaluation in early 2015 is an example. The currency is free-floating – as much due to the reality of international reserves bottoming out at $5.625bn in February 2015 as to the stated paradigm of the current board of governors. However, a run on the hryvnia, which began in February, led to the imposition of temporary administrative controls, such as a much-criticised short-term ban on almost all commercial foreign exchange trading in late February and hiking the prime interest rate to 30% for the next three months.
NBU governor Valeriy Gontareva has said that if there are signs of stability before the three months elapse, interest rates will fall accordingly. She has also stated that the combination of administrative controls and rate hikes had been instituted after communication with the International Monetary Fund (IMF) on a prospective solution.
Tackling systemic problems and calming domestic nerves will be the top priorities for the NBU for the foreseeable future, external shocks permitting, but the fact that Ukraine’s banking sector is finally being cleaned up is noteworthy. In part due to the extreme conditions, but also in part due to the paradigm shift that occurred with the Euromaidan protests of 2013 to 2014, where Kiev sought to be more closely integrated with the EU, the central bank has been one of the first pieces of government apparatus to break away from the old system.
“The NBU has been a first-mover, taking banks to liquidation as early as March 2014,” says Francis Malige, managing director for eastern Europe and the Caucasus region for the European Bank for Reconstruction and Development. “It began implementing reform even before the IMF came.”
Mr Bösch agrees. “In my nine years in Ukraine, I’ve always pointed to the NBU as one, among others, of the obstacles to the proper functioning of the Ukrainian economy. For the first time, I can say that this isn’t the case. It is doing a tremendous job in the most extreme situation possible,” he says.
Are we there yet?
However, more than a year after then-president Viktor Yanukovych’s departure and six months after the parliamentary elections that set Ukraine’s political climate for the next five years, questions are being raised regarding the permanence of the reform process. That reforms have occurred is incontrovertible, but observers at the end of 2014 noted that the politically sensitive issue of bank oversight is lagging.
In March 2015, legislators, including many of the bank owners themselves, passed laws tackling related-party lending and beneficiary ownership disclosure. March was also the month when the NBU put Delta Bank into administration, which was seen as a sign that the NBU would definitely enforce regulations across the board.
“It shows that the regulator is willing to go after the big banks and not just the small pocket banks,” says Mr Bösch. But the question now is if the momentum can be sustained.
“The devil is in the implementation and not in passing legislation,” says Mr Sologub. “For example, Ukraine’s 1999 central banking legislation was considered rather progressive for its time, but putting it into action was another issue.”
Looking forward, Mr Malige sees opportunities, but acknowledges that they will not come easily. “The banking system still does not work as the circulatory system of the economy in Ukraine. And this problem is not isolated from the investment climate. Fixing all that is going to take continued, constant political support and for the government to do what it needs to do,” he says.
Double-edged sword
What does 'do what it needs to do' actually mean, though? The self-organising nature of Ukraine’s reform movement in general has been a double-edged sword.
“When the reforms started, a lot of people told us that we should follow the Georgia model – [which would have been] a big push. But the Georgians had time to roll out an overhaul. We don’t have that luxury. Instead, we have taken a gradualist approach that’s given us a series of wins sooner,” says Mr Sologub.
“As a result, we don’t have a strategic vision across the government and each institution has its own priorities, and that could create problems down the road. But there are basics – and none of them have anything to do with external aggression – and at least people are seeing some improvement,” he adds.
The do-it-yourself nature of modern Ukraine has been an asset for the surviving banks as well. “Our crisis management decisions are made in Kiev, as issues such as routing armoured cars for deliveries need local knowledge,” says Mr Bösch at Raiffeisen. “And it is not a top-down system; we need everybody to do their job. We have optimised our operations in south-eastern Ukraine, we started pulling documents back to Kiev and reducing onsite cash in April 2014, and if the situation calls for it, we can close a branch in a matter of minutes.
“We have been saying lately that we are learning so many things during this crisis and we hope that we never have to use them again. At the same time, our people have shown incredible resilience.”
And given that more than 100 Raiffeisen employees throughout Ukraine signed up in mid-2014 to host employees relocated due to the cessation of banking activity in the Donbas conflict zone, the changes in the banking industry can take on a surprisingly human touch.
