Following its most profitable year in recent times in 2019, Ukraine’s banking system is now dealing with the economic fallout of the global coronavirus pandemic. Despite this, those involved in the sector feel that they are in a much stronger position to weather the current challenges than during previous crises in 2008 and 2014 – the former caused by the global financial crisis and the latter by internal political turmoil, conflict in the east of the country and Russia’s annexation of Crimea.
“The Ukrainian banking sector met the coronavirus hit with strong liquidity and capital positions and, for better or worse, the sector has experiences [of] managing through crises,” says Alexander McWhorter, head of Citi Ukraine, which has operated in the country for more than 20 years.
At the same time, many are also hoping the latest round of banking sector legislation currently working its way through parliament will lead to further progress in cleaning up the country’s banking system, and perhaps finally resolve lingering issues related to the nationalisation of Ukraine’s largest lender, Privatbank, in late 2016.
A profitable year
Financially, Ukraine’s banking sector entered 2020 in good shape. Banks posted a cumulative profit of Hrv59.6bn ($2.3bn) in 2019, triple their combined figures for 2018. In fact, according to media reports, just six out of 75 banks operating in Ukraine failed to turn a profit in 2019, with their losses amounting to just Hrv200m.
Deposits in the banking sector also increased by 23% year-on-year in 2019, with growth in both the household and corporate segment. In December 2019, the central bank, the National Bank of Ukraine (NBU), said provisioning would be at its lowest level in more than a decade, while in March 2020, the banking sector’s capital adequacy ratio (CAR) stood at 19.3%, having risen from as low as 7.1% in September 2015.
The operational efficiency of the sector has also been on a positive trajectory, with the cost-to-income ratio in the first nine months of 2019 dropping to 47.4%, from 58% in the same period of 2018.
Banking sector growth continued into early 2020. In the first two months of the year, solvent banks in Ukraine saw their income rise by 17.7%, compared to the same period last year, according to the central bank, with commission income up 16.5%. However, the impact of the global pandemic is expected to have a significant impact on banking operations in Ukraine throughout 2020, and perhaps for far longer.
On April 29, rating agency Fitch Ratings revised its outlook on seven Ukrainian banks from positive to stable. “We expect that the economic downturn, weaker client activity, lower household incomes (due to higher unemployment and lower remittances) and exchange-rate pressures (the hryvnia has depreciated by 11% since the beginning of March, while Fitch forecasts a depreciation of 25% for the fiscal year) will increase performance pressures for banks,” it said.
Fitch added that temporary regulatory forbearance and provision of additional liquidity to banks should help them manage problem loans and solvency ratios in local accounts, but said risk to banks’ credit profiles has significantly increased.
In late March, the NBU announced that it had delayed the timetable for banks to form their capital reserve buffers, which had had a deadline of January 2020, and banks were set to expand from 0.625% of core capital to 2.5% by January 2023. At the same time, lenders will need to maintain their existing stock of capital, the central bank said, recommending that banks refrain from directing their capital towards dividend payouts until the fallout from coronavirus is better understood.
Fate of Privatbank
One key issue right now is the ongoing attempt to pass legislation to bar former owners of those Ukrainian banks nationalised or wound up during the clean-up of the banking sector in recent years from regaining their assets through the courts.
As recently as 2014, Ukraine had around 180 banks, serving a population of roughly 42 million. However, that number has dropped considerably, with the central bank leading a consolidation drive that resulted in the closure of banks with poor business models or non-transparent ownership structures. There are now 75 lenders operating in the country.
One significant bank that was taken over by the state is Privatbank, which was nationalised and recapitalised by the Ukrainian government in late 2016, at a cost of around 6% of the country’s gross domestic product. This was after regulators found an estimated $5.5bn missing from its balance sheet and related-party loans of more than 95%. The former owners have mounted legal challenges to try to regain control of the bank.
In April 2020, Privatbank announced that it was seeking a new claim in the Cypriot courts for damages of $5.5bn from its former owners, related to fraud and money laundering. Now under new management, Privatbank declared a net profit of Hrv32.6bn in 2019, making it the most profitable bank operating in Ukraine, with Raiffeisen Bank Aval, which recorded a profit of Hrv4.7bn, in distant second place.
Legislation urged
Ukraine has been under strong pressure to pass the banking legislation, which is expected to unlock an $8bn aid package from the International Monetary Fund (IMF). The draft bill passed at its first reading in March, but got bogged down in amendments. On April 16, parliament agreed to limit the number of proposals that could be submitted while drafting the legislation, in order to speed up its passage.
Passing the new banking regulations is seen as a key step for the country and for its international credibility. “The elephant in the room is the destiny of Privatbank and that for us is a very important dossier, not only because it has obvious repercussions related to the IMF transaction, but also because it defines the credibility of the country and its investment climate,” says Matteo Patrone, managing director, eastern Europe and the Caucasus at the European Bank for Reconstruction and Development (EBRD).
Mr Patrone says that if the legislation goes through and the country shows that it has international credibility, then the IMF transaction will most probably go through. That is important for a number of reasons, in terms of the investment climate but also in terms of financial stability through having an anchor investor like the IMF.
“If that does not happen, then my guess is that the IMF transaction won’t go through – and this is a scenario that we don't even want to entertain,” he adds.
On May 7, the IMF said it had shifted its immediate discussions with Ukraine towards providing an 18-month standby arrangement, which would come with fewer conditions and would allow the government to respond faster to the pandemic. However, this is unlikely to change the overall position of the IMF and the pressure on Ukraine to pass the banking sector legislation.
Legacy issues
The fate of Privatbank and other nationalised lenders is not the only issue still to be resolved in relation to the banking sector. While significant efforts have gone into cleaning up the banks in recent years, with measures taken to limit corrupt and non-transparent practices, further steps are needed.
“While material progress has been made, there is still a fair amount to be done, including strengthening anti-money laundering [legislation], improving corporate governance and dealing with legacy non-performing loans [NPLs],” says Citi’s Mr McWhorter.
Banks in Ukraine still hold a large quantity of NPLs on their books, a legacy of the crisis years, even as the overall volume of NPLs has been steadily decreasing. In September, the central bank reported that NPLs had now fallen back below 50% of the total, and in its December financial stability report it said that NPLs had decreased by 5.8 percentage points over the previous 12 months.
For the most part, NPLs are now concentrated on the balance sheets of state-owned lenders. “If you compare different groups, the NPL ratio among state-owned banks stands at 64%, while among all other banks the average NPL stands at less than 29%,” says Oleksiy Blinov, head of research at Alfa-Bank Ukraine.
He adds that all NPLs in the sector are accounted for according to strict regulatory rules and are fully covered by existing reserves. However, Mr Blinov says: “The coronavirus crisis has some potential to create new NPLs; that is why it is very important for Ukraine to have a prompt exit strategy that unfreezes consumption and business activity.”
Other issues also remain. In its December report, the central bank said building institutional capacity to regulate the non-bank financial services market will be a key challenge for 2020, though this is likely to have been superseded by more pressing concerns.
Lending also stalls
Those operating in Ukraine’s banking sector see 2020 shaping up to be very different compared to pre-coronavirus forecasts, which predicted continued growth in areas such as lending, and they have had to adjust their targets accordingly.
“We don't expect much lending growth, if any, this year,” says Oleksandr Pysaruk, chief executive of Raiffeisen Bank Aval, who served as Ukraine’s first deputy central bank governor between 2014 and 2015. “Retail lending will definitely not grow, and probably will shrink a bit. Corporate lending is a bit more resilient; [however], it wasn’t growing as fast as retail lending last year and it will definitely not grow much either.”
Mr Pysaruk says his bank continues to see potential in retail banking in Ukraine – particularly related to demand for credit, both consumer lending and mortgages. Retail lending in Ukraine has been growing strongly in recent years and saw a growth of 30% in 2019, according to the central bank, though it remains a quarter of the size of the corporate lending market. “Clearly, the Ukrainian banking sector is under-penetrated in terms of retail lending,” says Mr Pysaruk.
At the same time, bank profitability was expected to decrease in 2020, even before the crisis, “simply because the net interest margins of banks, which were among the highest in the world last year, naturally were expected to come down, and they were coming down quite fast due to the rapid interest rate decreases by the National Bank of Ukraine”.
Fewer banks
The consolidation of banks in recent years has resulted in a Ukrainian banking sector that is far more concentrated and with a significant number of banks now operating under state control.
As such, the potential for any future mergers and acquisitions is limited, says Alfa-Bank’s Mr Blinov, with the state now controlling 55% of total net assets and six big players controlling another 21%. However, he says, these banks may explore selling their portfolios to downsize non-core business and to start solving their huge NPL issues.
Eventually, some of these state-owned lenders will need to be returned to private sector control. “The state-owned banks at some point will need to be privatised,” says EBRD’s Mr Patrone.
“The weight of state-owned banks on the financial system of Ukraine is at an unhealthy level. There is still work to be done, in terms of governance, management practices, composition of the balance sheet,” he says, while adding that he’d witnessed further progress in corporate governance of state-owned banks in 2019, “but with some ups and downs. The journey has not been smooth from many perspectives but the direction of travel is the right one.”
Digital catch-up
There are also ways in which the current pandemic, with its accompanying restrictions on movement, could leave a positive footprint on the Ukrainian banking sector.
When it comes to digital banking, Raiffeisen’s Mr Pysaruk says that there are areas where Ukraine is in line with its neighbouring countries, and maybe even more developed nations, but overall, as a banking sector, he thinks it has "lagged behind" a bit.
“One big reason was the regulatory requirements and legislation in Ukraine, which was too focused on – and possibly still is – the physical presence, physical signature, stamps, papers, and bureaucracy that came from the old days,” he says.
“The good news is that the coronavirus crisis is changing this very quickly. We expect the crisis to give a boost to the paperless drive. The National Bank of Ukraine is trying to push through legal amendments to get rid of physical signatures, to implement electronic digital signatures, electronic archives, electronic know your client compliance procedures. This would help improve the productivity as well as the digital penetration of Ukrainian banks.”
Weathering the crisis
There is a strong sense that Ukraine’s banking sector is in a far better position to handle the current crisis, and deposit holders have shown little inclination to remove their money from banks out of fear that they will be lost. “There has been no bank run attempts, which is one of the key differences between the current crisis and 2008/09 or 2014/15,” says Alfa-Bank’s Mr Blinov.
Banks have continued to meet the requirements of the liquidity coverage ratio, the NBU said in early May, and more than 96% of ATMs and 77% of bank branches are operating as normal.
Even so, it is impossible to predict how long the coronavirus pandemic will last, or how much of a long-term impact it will have on economies like Ukraine’s. Despite this, those who have witnessed the travails of the banking sector over the last decade or more see reason to be cautiously optimistic.
“The whole sector went into this crisis in much better shape than when it went into the 2014-15 crisis,” says Raiffeisen’s Mr Pysaruk. “At that time, the banking sector was in awful shape. Now it is very strong, with sufficient capital and liquidity buffers. I believe that it will be sufficient to go through this crisis, particularly with the very prudent measures taken by the National Bank of Ukraine.”
