COMMENT: Ukraine's banking is mission not accomplished

COMMENT: Ukraine's banking is mission not accomplished
The Kyiv offices of the National Bank of Ukraine (NBU)
By Alexander Valchyshen in Kyiv April 5, 2017

Seldom are the words “corrupt” and “banking” seen together on the Financial Times’ pink pages. But there they were in an article featuring Valeriya Gontareva, governor of the central bank of Ukraine (NBU).

And unfairly, in my opinion, since Gontareva has had the great courage and considerable stamina to tackle the long-established status quo of Ukraine’s private commercial banks with their insider lending, sub-zero capitalisation and fraudulent accounting. In the three years since she became governor, banking laws have been reformed, the banks have been stress-tested according to international standards, and steps have been taken to comply with capitalisation rules.

This resulted in certain tycoons losing their licenses and being forced out of the banking business, something that was unthinkable prior to Gontareva’s term. Of course, this was immediately followed by strenuous outcry from some experts, lobbyists and politicians, who blamed all the woes of the deep recession on the central bank governor. That she endured threats to her life is well documented. As FT reveals, one occurred during a face-to-face meeting inside the gothic palazzo-style central bank building itself.

Sadly, Gontareva now feels her mission is accomplished, and she plans to step down when a suitable replacement is found.

Her tenure will likely be determined in mid-April when Prime Minister Volodymyr Groysman faces a confidence vote in a divided parliament. In my opinion, this government has a fair chance to stay in place even if it ends up bowing to political pressure by replacing cabinet members.

The next big test will be whether a new, technocrat central bank governor will permit a return to business-as-usual in the commercial-banking sector. The very people who corrupted the banking system and who “still dominate” in politics and the media, as Gontareva says in her FT interview, will both test and influence her replacement.

Their aim is to soften the current rules on commercial banks recapitalisation and oversight. They are promoting the now-popular narrative that bank lending should fuel Ukraine’s economic growth of at least 7% a year on average over next decade and beyond. I see this as a coded message to green light a return to the business-as-usual that Gontareva fought against.

In my view, a key weakness of Ukraine’s central bank is its view that commercial banks are intermediaries, ie, they take depositors’ money and channel it to borrowers for a profit. (This is an over-simplification; see this explanatory note by Bank of England staffers.)

Instead, Ukraine’s central bank should pattern itself on the Bank of England, which explicitly treats commercial banks as money creators that do not wait for deposits to be provided by the clients, which later will be lent to willing borrowers. Instead, banks create deposits by lending.

Viewed through this lens, insider lending by local bankers takes on a new meaning, to say the least. The threats of physical violence against Gontareva as reported by FT are an indication of the corruption of bankers who want to regain the ability to create money by their own actions and for their private use, as they had been.

I have some advice for Gontareva’s replacement. Treat commercial banks as money creators, as the BoE does, and abandon the banks-are-intermediaries narrative. This should win the public’s support while at the same time dealing with corrupt bankers who used their influence for personal gain. The NBU needs the support of the public to complete Gontareva’s mission: end insider lending, prohibit sub-zero capitalisation and fight fraudulent accounting practices.

This would translate into a public support of the new monetary regime introduced under Gontareva with a managed float of the hryvnia in the FX market and operational control over short-term interest rates, which is under the threat of being dismantled by the opposition. It would also eliminate risk of massive runs on local-currency reserves that happened in the past by those same bankers who converted them into foreign-currency reserves, depleting the country’s official FX reserves.

On March 15, 2016, former US State Department official Victoria Nuland testified at the Senate Foreign Relations Committee that “2016 can and should be the year Ukraine breaks free from the unholy alliance of dirty money and dirty politics, which has ripped off the Ukrainian people for too long.”

I heartedly agree with Ms. Nuland. No return to business as usual in 2017 and beyond. Otherwise, mission not accomplished.

Alexander Valchyshen is Head of Research at ICU, a Kyiv-based financial-services group that provides investment banking, securities trading and asset management for private and institutional investors, which was co-founded by Valeriya Gontareva. He was formerly head of Macro/Fixed Income Research for ING in Ukraine. Follow him on Twitter at @AlexValchyshen