The European Bank for Reconstruction and Development (EBRD) is set to take a 35% stake in Raiffeisen Bank International's troubled Ukraine subsidiary Raiffeisen Aval bank via a capital increase, according to Interfax news agency.

The move demonstrates RBI's severe problems in Ukraine and represents another example of how the EBRD is stepping up its equity investments in the banking sector in Central and Eastern Europe because of the region's continuing problems since the global financial crisis.

The EBRD will purchase an upcoming Raiffeisen Aval share issue in mid-October, Interfax reported. Kyiv investment boutique ICU estimated the value of the stake at $50mn in a recent analysis.

An EBRD spokesman denied to bne IntelliNews that an agreement had already been reached, and said any estimates of the value or the size of the stake were "pure speculation". The bank did confirm, however, that the deal was expected to go for approval before the EBRD board around the end of September.

RBI and the EBRD told bne IntelliNews in May that they were in negotiations on a deal.  "The proposed project along with the planned contribution to the capital of parent Raiffeisen Bank International (RBI, Austria) will support the development strategy of [Aval], give a strong positive signal to the market during the difficult political and economic crisis in Ukraine," the EBRD confirmed in July. 

The move is part of a concerted drive by the EBRD to strengthen its role as crisis manager in troubled East European markets. The EBRD  has acquired a 20% stake in nationalised Austrian bank Hypo Alpe Adria’s operations in the Balkans alongside private equity firm Advent International, and 20% in NKBM in Slovenia alongside Apollo Global Management.  It is also in negotiations to take a 15% stake in Erste’s loss-making Hungarian unit alongside the Hungarian government, while in Moldova it is trying to extend its 15% stake in the second largest bankVictoriabank to a majority, but appears to have been thwarted by local oligarchs. 

In Ukraine, the March 2014 annexation of Crimea by Russia forced Raiffeisen Aval to sell its branches there and shutter those in the east where the conflict is raging, which was a major factor in 52% of its loans in the country becoming non-performing.

Austria's Raiffeisen is the second major European banking holding to scale back exposure to Ukraine. In August, Italian giant Unicredit agreed to offload its Ukrainian subsidiary, Ukrsotsbank, another top five bank, to the Russian banking group Alfa - a development regarded with concern in Ukraine, which is in a quasi-war situation with Russia.

News that the EBRD will prop up Raiffeisen Aval will come as a relief to Ukraine's embattled government, who would have looked askance on any further Russian banking expansion. Prime Minister Arseny Yatsenyuk headed the Aval legal department before the bank's acquisition by Raiffeisen.

Raiffeisen symbolically acquired the bank in the immediate aftermath of the pro-European Orange Revolution of 2005, paying $1bn to become the first major European banking group to acquire a local subsidiary.

But its operations in Ukraine never recovered after the 2008-2009 financial crisis, when the bank was badly hit by politically connected borrowers reneging on debts, according to leaked US diplomatic cables.

"Second-tier oligarchs and members of the Ukrainian parliament are extorting from the country's banks and threatening bankers," a representative of Raiffeisen Aval told US diplomats, according to the cable dated 2010.

"The powerful borrowers act with impunity, having paid off the court system to evade their debt obligations," the cable continued, with the Raiffeisen representative estimating that one-third of Raiffeisen's non-performing loans comprises "deliberate non-payment", by politically connected businessmen.  

But the Raiffeisen retreat is also part of a broader story of Raiffeisen overexpansion in Eastern Europe. High levels of problem loans in other key markets such as Croatia, Romania and Hungary, together with adverse currency movements in Russia and Ukraine, plus bank levies and forced conversion of Swiss franc loans in Hungary, have all led to losses that the rest of the network could not counter-balance.

The sheer diversity of the bank's operations has become a weakness, something that the disposal programme starts to address. "A bank of our size should be more focussed," Karl Sevelda, RBI’s chief executive since June 2013, told bne IntelliNews recently, while adding "what we want is a more balanced structure".

RBI claims that its diversity helped it stay profitable in the past, notably during the global financial crisis, as not all its markets turned down at the same time or pace. But today RBI is exposed to several of the most problematic markets in the region at the same time, putting severe pressure on management resources. Jiri Stanik, founder of consultants Helgi Analytics, argues that RBI is spread too thinly. "Right now that looks a potential problem," he says.