The past three years have seen the biggest shakeup of the Ukrainian banking sector since its formation in the early 1990s. Financial institutions continue to disappear from the market as part of ongoing reforms, with the number of registered banks now half that of early 2014. Closures have become everyday occurrences with Ukrainians no longer shocked by news of yet another bank forced into administration. Most analysts believe this period of turbulence is currently far from over. In 2017, banks with capital of less than UAH 200 million and remaining market players with Russian state capital are the most at risk. Meanwhile, all private sector participants must compete with a growing presence of state-owned banks, which now account for more than 50% of the overall market. Nevertheless, there are signs that the far-reaching reforms of recent years are laying the groundwork for renewed and sustainable growth in a sector that is essential for the broader health of the Ukrainian economy.
Despite assurances from Ukrainian National Bank Governor Valeria Gontareva at the end of 2015 that the cleanup of the country’s banking system was finally coming to an end, bank closures continued throughout 2016. A total of 21 banks came under Guarantee Fund control in the past year, down from 33 in 2015. The past twelve months also saw the single biggest challenge to the entire banking system since the start of the cleanup, with the nationalization of PrivatBank. Other bankrupt banks were less fortunate and faced liquidation. In addition to the headline-grabbing nationalization of PrivatBank, key events of the past year including the bankruptcy of Khreschatyk Bank, Fidobank and Mikhailovskiy Bank. All of these financial institutions were active players on the Ukrainian retail banking market and continued to attract deposits until literally the very last moment. The closures have continued into 2017, with another notable retail operator, Platinum Bank, declared insolvent in January.
Most of the banks forced to withdraw from the market were unable to comply with National Bank capitalization limits that were set based on stress tests carried out during 2016. However, there were also a number of other reasons. For example, Smartbank and Unison Bank were recognized as insolvent due to opaque ownership structures, while others were forced to end operations due to involvement in illicit financial schemes.
The massive scale of the ongoing banking sector cleanup has created a number of new legal challenges for the industry regulator, with numerous individual banks seeking to contest National Bank of Ukraine (NBU) liquidation orders in court. At the end of December 2016, NBU officials announced that nine banks claimed to have secured court decisions reversing their insolvency and permitting them to return to the market. Outgoing NBU Governor Valeria Gontareva has dismissed these claims, stating that no legal mechanism exists that could allow these banks to resume activities in Ukraine. The country’s Supreme Court has received a request to clarify the situation regarding court rulings on NBU decisions, but there has yet to be an official response.
From Privat to Public
The most significant development on the Ukrainian banking market over the past year was undoubtedly the nationalization of PrivatBank. The decision to nationalize was widely interpreted as a bold and drastic measure, but it was not entirely unexpected. Rumors of such an impending step had been swirling around Kyiv since spring 2016, when a memorandum on Ukraine’s IMF cooperation program outlined the possibility of nationalizing a large but unnamed bank. It was clear to even the most uninformed of observers that the bank in question was PrivatBank.
Officials at PrivatBank played down the threat of nationalization throughout mid-2016, often joking about the issue. Meanwhile, the NBU and Finance Ministry spent at least six months preparing a plan for what would arguably be the most ambitious operation ever attempted in the Ukrainian banking sector. Zero hour finally arrived on 18 December. The move to nationalize came accompanied by a well-coordinated and sophisticated multimedia information operation informing the public about the reasons for the introduction of an interim administration. This information effort was an important success, allowing the state to avoid panic and prevent a rush on deposits. By this point, the rumor mill had reached a crescendo, with many predicting the imminent collapse of Ukraine’s largest bank.
PrivatBank’s problems were first revealed during a routine stress test conducted in 2015. Bank officials were unable to reach agreement with the NBU over necessary capitalization levels, with so-called holes in the bank’s capital attributed to everything from the devaluation of the hryvnia to the Russian seizure of Crimea and the loss of loan portfolios in the eastern Ukraine conflict zone. However, when the moment of nationalization arrived, NBU Governor Gontareva identified the key problem as loans to related parties, which accounted for 97% of the bank’s corporate portfolio. This left the bank needing UAH 148 billion in capital by December 2016. By agreeing to proceed with nationalization, the state effectively took on this loss itself.
Officially, the process was portrayed as a sensible agreement between PrivatBank shareholders and the government. However, it is difficult to depict the process as being entirely voluntary. The National Security and Defense Council, the Cabinet of Ministers, and the National Bank all took part in the collective decision to proceed with the nationalization process, highlighting the strategic importance of PrivatBank to the Ukrainian economy as a whole. It later transpired that the nationalization decision had come following long negotiations with the bank’s main shareholders and after the government had enlisted the support of the International Monetary Fund.
The entire nationalization process managed to avoid any major disruption to the bank’s operations. Payments to legal entities were blocked for a single day, while payments to individual private account holders continued more or less as normal. The smoothness of this operation surprised many and led to considerable praise over the execution of this challenging task. Nevertheless, opinion was sharply divided over the decision to nationalize at all.
Writing in Bloomberg, Leonid Bershidsky summed up widespread cynicism towards the nationalization in an article entitled “Ukraine Nationalizes an Oligarch’s Losses.” Bershidsky noted: “Given its long record of failure to hold oligarchs responsible for anything, the government’s decision to act was a bold move. It was also perhaps an unavoidable one, given the changing political climate and Ukraine’s lack of allies in President-elect Donald Trump’s administration. Ukraine’s champions such as Vice President Joe Biden are on their way out… The oligarch and the government have effectively made a deal, trading the stability of a too-big-too-fail bank for (PrivatBank owner Ihor) Kolomoisky’s too-big-to-jail status.”
Others were more generous in their assessment of the PrivatBank nationalization. Writing for the Atlantic Council, Anders Aslund said the move was a ‘good thing’, commenting: “The government has acted fast and the right measures seem to have been taken. It has appointed former Minister of Finance Andriy Shlapak temporary chief executive. Danyliuk announced that PrivatBank will be privatized as soon as its situation has stabilized. The Ministry of Finance even issued a video to explain the nationalization. All relevant officials instantly stated their support for the nationalization and that the assets were safe. International institutions have followed suit. The IMF called the decision “an important step...to safeguard financial stability,” while the European Bank for Reconstruction and Development said it was the “right way forward for Ukraine now.” European Union High Representative for Foreign Policy Federica Mogherini congratulated the Ukrainian authorities on their decision. It remains to be seen if everything works out, whether PrivatBank continues to function, and whether its related assets are safe, but for now it appears a great victory for economic reform in Ukraine.”
Cautious Return to Growth
Many of Ukraine’s remaining banks spent the last year continuing to optimize their operations by measures such as the reduction of branches and the introduction of additional remote channels for customer service. Meanwhile, the quest for new investors and solvent borrowers goes on. A return to market growth is evident across the sector but has been hampered somewhat by the entry into force in New Year 2017 of laws requiring banks to adopt increasingly cautious credit risk measures.
Statistically, the past year represented a new low. The costs associated with the nationalization of PrivatBank ensured that 2016 set new records for Ukrainian banking sector losses. The annual total for the entire sector was a loss of UAH 159 billion, which was 2.5 times higher than the previous record set in 2015. However, 80% of these 2016 losses were directly attributable to PrivatBank. At the other end of the scale, 62 banks operating in Ukraine reported annual profits in 2016, earning a total profit of UAH 10.8 billion. The best result was posted by Raiffeisen Bank Aval (UAH 3.82 billion), followed by Citibank (UAH 1.44 billion) and OTP Bank (UAH 962 million). “This year we expect this trend to continue, with profitability returning to the Ukrainian banking sector,” commented Vitaliy Vavrishchuk, Director of the Financial Stability Department at the NBU.
As they seek to take advantage of Ukraine’s improving economic climate, banks will have to work in new market conditions with the state playing a disproportionately prominent role. Following the nationalization of PrivatBank, the market share of state banks in Ukraine has now reached 55%. The Ministry of Finance, together with the National Bank, are currently developing a new strategy for the country’s state-owned banks. “External consultants have been recruited to help evaluate all the pros and cons of the situation. As soon as the opportunity arises, we will seek to privatize part of the state package,” said Finance Minister Alexander Danilyuk.
For many of the smaller banks on the Ukrainian market, the biggest challenge in the coming months will be meeting increased capitalization requirements of at least UAH 200 million by 11 July, rising to UAH 300 million by 11 July 2018. It is already becoming apparent that not all banks will be able to meet these targets. By early April, thirty-seven banks were reportedly in the firing line. The easiest ways to secure the necessary capital are via profits or shareholder support. If these avenues are not forthcoming, then the next most favored route remains fresh investment. However, any prospective investors will have to comply with the NBU’s tightened regulations regarding the transparency of bank ownership and the origins of investment funds.
Another category of banks facing huge challenges on the Ukrainian market this year is those with state-owned Russian capital. Russia’s Sberbank has already announced the sale of its Ukrainian subsidiary to a consortium including Latvia’s Norvik Bank. The sale of BM Bank is also reportedly close to completion, while the fate of VTB Bank will be decided by the end of the year. Russian banks have been under increased pressure in Ukraine ever since the outbreak of the Kremlin’s hybrid war in early spring 2014. They have often been targeted by protesters and information campaigns, but had previously managed to maintain a robust market presence despite the tensions surrounding the ongoing conflict. Things came to a head in early 2017 when the parent structure of Sberbank confirmed plans to begin accepting identification documents issued by the so-called People’s Republics of Donetsk and Luhansk. Activists responded immediately to what many saw as the latest step towards creeping Kremlin recognition for the Russian-managed separatist entities in eastern Ukraine. Since 10 March, Sberbank branches across Ukraine have been subject to blockades, with the entrance to a flagship branch in downtown Kyiv bricked up. In tandem to this grassroots pressure, March also saw the introduction of Ukrainian government sanctions against banks with financial ties to the Russian state, while the NBU banned bank-to-bank currency transfers from Ukraine to Russia, and the State Pension Fund suspended the payment of Ukrainian state pensions through banks with Russian state capital.
These measures have sparked fresh debate over the nature of Ukrainian economic ties with Russia during a period of undeclared war between the two countries. While many advocate a hardline approach involving the cutting of all but the most essential bilateral economic connections, others argue that a more pragmatic approach will be in Ukraine’s national interests. Meanwhile, the activist campaign against Russian banks has also raised considerable law and order concerns, with critics arguing that such non-state actions could seriously damage perceptions of the country among international investors.
About the author: Viktoria Rudenko is the director of the “Top 50 Banks in Ukraine” project