Ukraine started 2017 with a bang. The National Bank of Ukraine (NBU) and the finance ministry had just announced the nationalisation of the country’s largest bank, Privatbank. The move was welcomed by the international community, but it significantly changed the equilibrium in the country’s banking sector by inflating the proportion of state-owned institutions to 56% of system assets, compared with only 18% at the end of 2013, according to Ukrainian investment bank Dragon Capital. While the Ukrainian government has sweeping plans to privatise some of its stakes and to announce a new strategy for the country’s state-owned banks, most 2017 targets in relation to that were missed.
On top of that, internationally respected NBU governor Valeria Gontareva resigned from her post in May 2017 and so far no replacement has been approved. So where is the Ukrainian banking sector heading in 2018?
Seeking a governor
Before Ms Gontareva stepped down from her post, her resignation had long been rumoured. A reformer, she told The Banker in February 2017 that at that point the NBU had prepared “more than 20 draft laws on the development of the financial sector” and that “only three of them passed the stage of the first reading” in parliament, hinting at the political difficulties of challenging the status quo. Shortly after, she resigned.
In May, finance minister Oleksandr Danylyuk told The Banker that Ms Gontareva’s successor would be in place “hopefully [by] summer, or beginning of fall [2017]”. However, it took until January 2018 for a new candidate to be put forward to parliament by president Petro Poroshenko. Former first deputy Yakiv Smolii, who had been acting as the NBU’s governor since May 2017, is the president’s appointment – something that had been widely expected. Mr Smolii was made deputy governor in 2014 and has been first deputy governor since December 2016.
“Having an acting governor [rather than an elected one] effectively limits the independence of the regulator, which is why it is positive to finally have an appointment,” says Francis Malige, managing director for eastern Europe and the Caucasus at the European Bank for Reconstruction and Development (EBRD). “There is a big difference between ‘acting’ and ‘being confirmed by parliament’, and that is the duration of your term and the independence of your actions. I think Mr Smolii did a good job as acting governor, keeping the strong line and the strong team that the NBU has been building. We now need him to be approved to preserve the great achievements.”
At the time The Banker went to press, parliament had not approved Mr Smolii’s appointment.
A strategy for state banks
Another issue in Ukraine, which was supposed to be resolved in 2017, is that of formulating a strategy for the country’s state-owned banking sector after Privatbank’s nationalisation. As of the end of June 2017, 62% of total retail deposits were held by state-owned banks, according to Dragon Capital.
In May 2017, Mr Danylyuk suggested that a decision on a new strategy would be made “within two months” as he felt it was important to at least halve the state’s share in the banking sector and prevent “unhealthy competition at the expense of taxpayers”. However, this has been delayed.
In this context, the decision was made to prioritise dissecting Privatbank’s finances and agreeing a plan for the country’s largest lender. Analysis of the business has found a $5.5bn hole in the balance sheet and related party loans of more than 95%.
According to information released by the NBU following an investigation by US corporate investigations and compliance firm Kroll, which was published in January 2018, “PrivatBank was subjected to a large-scale and coordinated fraud over at least a 10-year period”, which was controlled through a “shadow banking structure” within the bank.
In late December 2017, Privatbank, by then under new management, was granted a freezing order against its former owners, oligarchs Igor Kolomoisky and Gennady Bogolyubov, as well as against six companies they are believed to own or control, by the High Court in London. The order was based on allegations that both extracted almost $2bn from the bank through related party loans, and brings Privatbank closer to recovering more than $2.5bn, including interest, from Mr Kolomoisky and Mr Bogolyubov’s worldwide assets. Both men deny any wrongdoing.
Privatbank’s nationalisation resulted in changes to the management and supervisory board at the bank. In January, Petr Krumphanzl was appointed as the bank’s chief executive and chairman of the management board, although, at the time of writing, the appointment had still to be approved by the NBU.
IFI support
International financial institutions (IFIs) are specifically highlighting the need for good corporate governance, the involvement of independent directors on the supervisory boards, and less political influence over such appointments to reform Ukraine’s state-owned banks and prepare them for eventual privatisation. Indeed, IFIs have made this a key requirement of co-operation agreements with two of the lenders.
Ukraine’s second largest bank by assets, Oschadbank, was first to sign a memorandum of understanding (MoU) with the EBRD, in November 2016. Under the MoU, the IFI pledges to support the bank with a comprehensive commercialisation programme and aims to help the bank on the path to privatisation.
Once Ukraine’s traditional savings bank, Oschadbank is now aiming to be “more commercial and profit oriented”, the bank’s deputy board chairman, Volodymyr Lytvyn, said at the Ukrainian Banking Day in December. The bank has the competitive advantage of operating the country’s largest network, Mr Lytvyn adds.
But the nationalisation of Privatbank has made things more difficult for Oschadbank, because both banks, now state-owned, have made the servicing of small and medium-sized businesses and retail clients their key priorities, making a clear definition of the two institutions’ future roles vital.
At the time of the signing of the MoU, Oschadbank was still the largest state-owned bank, and the strategy then included part-privatisation of the bank by mid-2018, a target that now seems likely be put back due to the nationalisation of Privatbank.
The smallest of the four state-owned lenders, Ukrgasbank, was intended to be part-privatised by the end of 2017, another plan that has been delayed. However, since November 2017 Ukrgasbank has been working with the International Finance Corporation (IFC) and is approaching privatisation.
Ukrgasbank, which had in previous years worked with the IFC to establish the bank as the country’s leading institution for green finance, is receiving pre-privatisation support to strengthen the institution’s corporate governance, to “ensure its operational autonomy” and “refine its commercially driven banking model”, according to an IFC press release.
Ukrgasbank board chairman Kyrylo Shevchenko said at the Ukrainian Banking Day that the lender is aiming to finance “30% of the clean energy market” and is looking into the “option of issuing green bonds”.
Clearing parliament
Meanwhile, Ukreximbank is not currently working with either of the two IFIs. An obstacle to attracting international support for a future privatisation of the import-export bank lies in the institution’s involvement in financing the defence industry, a sector which the EBRD, for example, does not get involved with.
But one thing is true for all state-owned banks: to allow for a privatisation of the institutions, legislation will need to be changed.
Any amendments to law require majority backing in parliament, which makes the passing of more controversial draft laws a difficult undertaking. Yet repeated recapitalisation needs at the state-owned banks between 2014 and June 2017 through Ukrainian state bonds, excluding Privatbank recapitalisations, cost Hrv53bn ($1.84bn) across the three banks, with the largest shares going to Oschadbank and Ukreximbank – about Hrv26.5bn and Hrv22.2bn, respectively. This makes a good argument for a change in the law, experts believe.
Overall, equity injections into state-owned banks – including Privatbank’s recapitalisation with Hrv117bn in state bonds in 2016, the financing of Deposit Guarantee Fund (DGF) deposit repayments and unpaid refinancing loans at liquidated banks since the banking crisis in 2014-15 – cost the Ukrainian state some 15% of gross domestic product (GDP), according to Dragon Capital. This excludes an additional Hrv38.5bn or 1.4% of GDP, which was earmarked for Privatbank in the second half of 2017.
“The target is to bring state-owned banks into a normal commercial operating environment,” says Artem Shevalev, alternate board director for Ukraine at the EBRD and a member of a number of state-owned banks’ newly formed supervisory boards. “This has been non-existent: supervisory boards were a rubber-stamping formality, which resulted in weak risk policies leading to lending against insufficient or fraudulent collateral. That’s also why state-owned banks, on average, have the highest proportion of non-performing loans [NPLs] across the sector.”
Tackling problem loans
Problem loans are still staggeringly high in Ukraine, especially at the country’s state-owned banks. This is no surprise in a country where a severe recession between 2013 and 2015 stifled new lending. But with economic growth of 2.3% in 2016, estimates of 2% in 2017 and 3.2% in 2018, according to data from the International Monetary Fund, NPL ratios should slowly decrease.
NPLs across the sector fell to 30.47% in December 2016, from 31.01% in September of the same year, according to data from the NBU. Since then, this positive trend has been dampened due to a change in the NBU’s NPL methodology, as well as by discoveries at Privatbank, where, according to Dragon Capital, higher-than-expected NPLs accounted for an increase in overall NPLs. NBU data suggests NPLs reached 57.73% in June 2017 and fell to 56.44% in September 2017.
Aside from the situation at the country’s largest lender, the problem loan burden is heavier at the three other state-owned banks. According to Dragon Capital, the NPL ratio at the state banks was at 73% at the end of June 2017, followed by foreign-owned banks’ 48% and local private banks’ 25%.
But there is another reason why NPLs at state banks are so high. Under national law, it is a criminal offence for state-owned lenders to offload NPLs or to write them down at a price below par. With problem loans at such high levels, experts note that these laws will need to be changed to allow for a reduction of state banks’ problem assets before any privatisation can take place.
Convincing corporations
Crucially, the largest share of NPLs in the Ukrainian banking sector is related to the country’s big corporations. A study by the national bank highlighted that Ukraine’s top 20 groups of borrowers, which account for 49% of all corporate loans, had 75% of their loans classified as non-performing as of April1, 2017.
The DGF took over assets of 92 banks between the end of 2013 and June 2017, amounting to 30% of total assets in the banking sector in December 2013. The vast majority of these assets are deeply distressed and at least half of the borrowers are not servicing their loans, DGF deputy managing director Svitlana Rekrut suggested at the Ukrainian Banking Day.
The main culprits are large corporations, many of which choose to stop paying interest on their loans once the assets of their lender have entered receivership with the DGF.
Much depends on the attitude of Ukraine’s big corporations, agrees Oleksiy Didkovskiy, managing partner at law firm Asters. He suggests the right legislation is in place – for example, the law on financial restructuring, passed in late 2016 – but it also needs to be utilised.
Ukraine’s law on financial restructuring offers lenders and borrowers a framework of voluntary out-of-court restructurings, intended to allow distressed Ukrainian businesses to return to viability through loan rescheduling, partial debt forgiveness and conversions of debt to equity. It also circumvents the complex Ukrainian court system.
“The law on financial restructuring relies on the willingness of corporations to settle rather than twist things and seek one restructuring after another,” says Mr Didkovskiy. “If you look at the numbers – $200m to $300m of restructurings per year – that is nothing compared with the overall problem.
“There should be a strong message from politicians and administrators to say: stop fooling people and use the legislation in place. Stop running away from problems.”
In May 2017, finance minister Mr Danylyuk suggested that “the cleaning of the banking sector is over – now we have to make it work”.
But more than ever, the onus is on Ukraine’s big corporations to make use of the available out-of-court restructuring options as well as on parliament to pass necessary changes into law and to appoint a new central bank governor to allow the country’s banking sector to function effectively.
