Ukraine’s national anthem contains the famously morbid line, “Ukraine is not yet dead”. Much the same could be said of its banks – they’re not yet dead. Despite a litany of economic horrors, including a more than 15% plunge in GDP, inflation that is well north of 30%, and a currency, the hryvnia, that has lost roughly 70% of its value against the dollar, Ukraine has, so far at least, managed to avoid the implosion of its banking system.
For this, the National Bank of Ukraine (NBU), the country’s central bank, deserves no small measure of credit. At the same time, however, an objective look at the data suggests that the kinds of creative accounting measures and fancy financial footwork that have been employed to date are not sustainable.
Absent a significant improvement in the country’s overall economic outlook, which is possible if unlikely, some kind of reckoning is inevitable for Ukraine’s still undercapitalised and vulnerable banks.
Too many by half
First, a macro-level overview. NBU data show that the number of banks, which experts almost unanimously agreed was excessive, has finally started to come down. By November, Ukraine had only 120 licensed banks, 60 less than it had in the beginning of 2014. Much like its Russian counterpart, the NBU has been waging war on mismanaged and failing banks that are little more than pocket banks to oligarchs and shady enterprises.
Interestingly, foreign banks haven’t seen their overall share of Ukraine’s banking sector change very much: they now account for about 38% of banks’ authorized capital, not all that different from the 42% peak that was reached in 2012. Considering the scale of Ukraine’s macroeconomic carnage, it’s frankly surprising that all of the foreigners haven’t totally bolted for the exits. The combination of capital controls and the fact that a lot of this foreign capital is Russian and might not have a great deal of choice in the matter should surely be kept in mind, but the relative stability of foreign capital is a modest bit of good news. If there’s one thing that bankers are good at, it is moving capital across borders. All things being equal, that damage could have been a lot worse.
After the (relative) stability of foreign ownership, however, there’s not very much good news to be had. In nominal hryvnia terms, Ukrainian banks’ provision-adjusted assets have fallen by around 3% since the beginning of 2014. In real terms, given Ukraine’s environment of borderline hyperinflation, the damage has obviously been quite a bit worse. Consider the following chart, which shows the actual level of bank assets as reported by the NBU and what those assets would have been had they simple shadowed the change in consumer prices. The enormous gap that has opened up by the end of 2015 gives some indication as to the real condition of the banking sector, which isn’t pretty.
The real condition of credit tells a similarly negative story. From January through November last year, the nominal amount of loans granted by Ukrainian banks fell by about 8%. Considering the ~30% inflation recorded over that period, the real impact was a lot more substantial. At the same time that credit has become ever tighter and bank assets shrunk, the share of past-due loans has been on a remorseless upward trajectory, from 7.7% in early 2014 to 13.5% in early 2015, and all the way to 20.4% by November.
Most economic commentary on Ukraine has recently turned quite a bit more positive, but the bottom line is the following: the Ukrainian banking system's capital adequacy ratio has fallen significantly to 11.7%, a full 6.5% below where it was at the beginning of 2014. Given this rapid deterioration in Ukrainian banks' capital adequacy ratios, and despite the fact that even now these are in compliance with Basel III criteria, it seems likely that some form of recapitalization will need to occur in the coming months.
Where is the money for this recapitalisation going to come from? It’s not immediately clear. The usual cheerleaders for reform never actually address this question head-on, they usually just hand-wave at the "impressive" reforms that have already taken place in the banking sector.
To date, the NBU has done an excellent job of plugging leaks in the system, shutting down some of the system’s worst actors while maneuvering to keep the rest afloat. Its ability to maneuver, however, is not unlimited. Although probably part of the normal course of business, the International Monetary Fund (IMF) is now making ominous noises that its bailout programme is under threat.
The Ukrainian banking system remains on a knife’s edge. The banks aren’t an imminent threat of bankruptcy, but any delay in the IMF programme would cause a rapid re-emergence of problems that have been pushed to the side.
Follow @MarkAdomanis – Wharton MBA by day, Russia analyst by night.