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The crowds at conferences this year have been fairly thin, but Ukraine's bankers turned out in force for the annual Ukrainian Banking summit organised by Adam Smith in November. Was it a sign that things in Eastern Europe's most battered state have finally turned the corner? Quite the opposite.

The financial sector in Kyiv is still reeling from the blow delivered by the global banking meltdown this time last year. The leading commercial banks and regulators that turned up to this event tried to put a brave face on things, but many of the participants had come to confront their regulator in person and there was more than a little venting of frustration in the questions from the floor.

Still, most banks are out of survival mode now, but that is after they took some pretty drastic action. One of the most striking presentations was from Delta Bank, a darling of consumer lending that came from nowhere in the last two years.

Delta's business is based on lending into the consumer boom and it made the prescient call of abandoning all its international borrowing in 2007, entirely replacing its funding needs with domestic deposits that should have insulated it from the abrupt closure of international capital markets and the heavy devaluation of the hryvnia that followed in the spring. But the presentation by the first deputy director of the bank, Vitaliy Masyura, painted a grim picture. "We blocked access to the revolving credit cards and slashed the number of products in our offering going all the way back to the most basic things," Masyura said in a deadpan delivery. "We also kept margins high that allowed us to offer higher rates on deposits, which meant we could keep the funding up."

This is the strategy that most have followed - and it has worked well for the stronger banks. Indeed, as central banks across the region continue to slash overnight rates, margins are increasing, steadily making it easier and easier for banks to make money. However, Masyura says that Delta has cut its number of points of sale from over 3,000 to 500 in a few months and let a large part of its staff go, undoing much of the advances the bank had made over the last couple of years.

And things are even tougher for the smaller banks that don't have large networks or strong brands to bank on. No one will be drawn on just how bad the problem of non-performing loans (NPLs) has got, but some estimates put the figure at a crushing 40% of the sector's total loan portfolio. Banks are desperate for cash to cover this bad debt. The trouble is that so is the government, which has been living hand to mouth on IMF handouts as it struggles to come up with hundreds of millions of dollars every month to pay its Russian gas bill.

Questions

The frustration felt by the delegates was clear to see on the floor of the hall. The Q&A session got quite heated when members of the audience from the banking community harangued the assembled regulators and government members on the panel. "How can we compete when bonds are at 30%?" asked one questioner. "The regulator is doing nothing to help us."

While the regulator tried to reassure the delegates and there was more talk about a "bad bank" that will take toxic debt off banks' balance sheets (still no sign of it), the buzz in the coffee break was entirely different. Walking through the crowd you'd hear snippets of conversations as bankers traded information on what was actually going on in the market. "I don't know what will happen next year," says the head of risk at the Bank of Cyprus. "The non-performing loans are much higher than they appear and the banks were simply irresponsible in lending money in dollars as the exchange rate has gone from UAH5 to UAH8 - now no one can pay."

To be fair to the banks, just because the exchange rate had been stuck at UAH5 to the dollar for nearly half a decade - one of the most stable currencies in the region - they felt comfortable with extending foreign-denominated loans and Ukrainians felt comfortable taking them.

The other potential bomb ticking away under the floorboards is the real estate loans. The devaluation of the hryvna has crushed the construction sector, but doubling the damage is the fact that many of the banks were speculating on the real estate market themselves and remain heavily exposed to the sector. Much of this debt has been "restructured," but the debt is still bad, it just isn't counted as an NPL any more. "How big is the banking sector's exposure of the real estate sector?" asked a member of the Austrian central bank who was on a recce to Kyiv. "No one is sure, but this debt will reappear to wound the banks sometime next year."

Despite the doom and gloom amongst the elite in the Premier Palace Hotel, the mood on the street is much lighter. The shops are open and full, bars and restaurants are humming as the holiday season approaches, and even a few of the construction cranes that tower over the skyline are twirling again.

The worst of the crisis is over and the economy has clearly stabilised. But the toxic assets that have been hidden away are still rotting and need to be dealt with.

The brokers are a lot more confident. Despite the almost total collapse of valuations on the PFTS, the stock market has bounced back strongly and those committed to Ukraine have made a bundle in the last six months. With cash in their accounts and an end to the political imbroglios on the visible horizon, they are more confident about next year. "The economy is like a ball being held under the water," says Tamas Fiala, CEO and co-founder of Dragon Capital. "No one wants to take their hand away until the elections are passed, but once they do, the ball will bounce out of the water."

A strong up-tick will almost certainly come in the first part of the year, but how high the ball bounces depends on external conditions and how long it will stay in the air depends on who wins the presidential elections slated for January. With early parliamentary elections being called immediately after the presidential ones, political stability may not return to Ukraine until next summer.

Anything is possible in the elections. Ukrainian President Viktor Yushchenko has even threatened to dissolve parliament first if it doesn't approve changes to the constitution. But currently two scenarios are most likely.

In the first scenario, Party of Regions Viktor Yanukovych wins in the presidency in a second round of voting at the end of January, leaving the president and prime minister in opposition and the government unworkable. While Yanukovych would be easier to work with than Yushchenko, because Tymoshenko wants to keep her Orange Revolution credentials burnished, she cannot be seen to cooperate too closely with him. In this case, Yanukovych would very likely call fresh general elections for sometime in 2010 in the hope of breaking Tymoshenko's hold on government.

If Tymoshenko wins a clear victory in the second round to become president, then she would have all her ducks in a row, controlling both the presidency and parliament. Investors would love this scenario and Ukraine would likely see a big pick-up in capital inflows simply because of the stability it promises after five years of chaos.