Agshin Mirzazade of Foyil Securities -
The Ukrainian banking sector is still struggling with the consequences of the global financial crisis, which have been aggravated by a number of country-specific problems. Access to international money markets is very limited, and the restriction is being compounded by a general lack of faith in banks and a weakened and volatile national currency, all of which is preventing Ukrainian banks from entering a recovery phase.
The drastic economic decline, as reflected in Ukraine's shrunken exports, rise in unemployment and deteriorating disposable incomes, has led to a sharp increase in problem loans, which has forced Ukrainian banks to build up large loan-loss reserves as they sustain losses that are eroding their capital. Today, Ukrainian banks are closely following global economic trends, waiting for the time when the strengthening global economy will reinvigorate Ukrainian business and stimulate the recovery of the banking system.
The country's banking system received its first major blow when Prominvestbank, a large bank that was starting to suffer liquidity problems, was the subject of a hostile takeover, which resulted in a run on the bank by private clients and its subsequent seizure by the government. The situation was compounded by the early depreciation of the national currency, and together resulted in a contagious and massive withdrawal of deposits from the banking system as a whole. To dam up the flood of cash flowing out of commercial banks, the National Bank of Ukraine imposed a moratorium on early withdrawal of deposits and introduced temporary administration into banks that were experiencing severe liquidity problems. Currently, 16 Ukrainian banks are under NBU control, while three banks were nationalized and recapitalized by the government.
However, confidence in the domestic banking sector wasn't restored, and since September 2008, households have withdrawn about UAH50bn (€4bn) from local commercial banks, while businesses reduced their cash holdings in Ukrainian banks by UAH35bn. The upcoming presidential election in January 2010 is also making Ukrainians reluctant to entrust their saving with banks, as many fear that any resulting political instability could spill over into the economic arena and result in bank deposits being frozen. This happened during the fiercely contested 2004 presidential election, which ended with the "Orange Revolution" that swept President Viktor Yushchenko to power.
The low confidence in Ukraine's banking system is being aggravated by a volatile exchange rate (the hryvnia is pegged to the US dollar), which is important because the US dollar remains the preferred savings currency for Ukrainians. Massive conversions of savings into dollars, the large current account deficit and Ukraine's burdensome payments of maturing foreign obligations have caused the national currency to depreciate by 42% over the last 12 months. This in turn has led to a rapid growth of problem loans at Ukrainian banks, since 50% of their assets are denominated in foreign currency. The official rate of problem loans reported by the National Bank of Ukraine has increased from 2.3% at the beginning of 2009 to 7% as of September. However, industry experts are convinced the NBU's statistics are inaccurate and that the true rate of problem loans is about 20% of the total loans outstanding, especially since this second figure was reported by several large Ukrainian banks.
The closure of international capital and money markets has made the National Bank of Ukraine and foreign parents of banks with foreign capital the only sources of additional liquidity. The "stress tests" imposed by the NBU at the beginning of 2009 resulted in the regulator strongly recommending that the largest domestic banks increase their capital, even though their capital adequacy ratios were above the minimum required level. While foreign financial institutions have taken a supportive stance and continue to inject additional funds into their Ukrainian branches via equity and debt financing, locally owned banks are still experiencing difficulties in maintaining their liquidity position and capitalization level.
Most Ukrainian banks have almost frozen lending and continue to lend to long-term, solid clients. Consumer lending is stagnant, with only a handful of banks offering mortgages and car loans - and even then with a minimum leverage of 50% and onerous interest rates varying between 20% and 30% in the national currency. Loans denominated in foreign currency continue to decline as banks use the proceeds to redeem maturing foreign debts, and are restricted by the government's ban on lending in foreign currency. Today, banks are focusing on dealing with the growing problem loans, offering debt restructuring to their clients as opposed to increasing their loan books. Several attempts by the NBU to revive lending via injecting liquidity into the system have failed, since Ukrainian banks are holding back, frightened by the serious economic and political risks on the local market. Instead, the extra liquidity has been used for currency speculation, which angered the NBU and caused the regulator to curtail liquidity by increasing reserve requirements and shrinking the monetary base.
According to official statistics, the net assets of Ukrainian banks declined by a nominal 3.6% in January-September; however, these statistics do not factor in the changes of the NBU's official exchange rate for the US dollar, which banks are using for reporting purposes. Therefore, factoring in the 5.2% decline of the official exchange rate, the contraction of banking assets should total around 7% year to date. Over the same period, the bottom lines of Ukrainian banks sank into the red, with nine-month losses totalling UAH21bn, against a profit of UAH7bn a year ago. The major contributor to the losses has been the allocation of funds to the loan-loss reserves, which right now is the largest expense item on banks' income statements.
With the weak internal stimulus, Ukraine's economic recovery is heavily dependent on the global economic landscape, the improvement of which should spur demand for Ukraine's major exports and unlock access to foreign liquidity markets. This in turn should positively affect the local job market, return stability to the national currency, stimulate foreign investment, and allow refinancing of rolled-over debts. We estimate that these expectations will start to materialize no earlier than in the second quarter of 2010, which together with renewed stability in the political arena, should give the Ukrainian banking system some momentum.
Agshin Mirzazade is Head of research at Foyil Securities
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