Acknowledging a hole of $5.6bn in the finances of PrivatBank, Ukrainian authorities on December 19 began the process of nationalising the country’s biggest lender by assets, owned by oligarchs Ihor Kolomoisky and Hennady Boholyubov.

The decision puts an end to weeks of speculation over a crisis at the bank resulting from evidence of massive insider lending that was exposed by bne IntelliNews in November. The loan book of PrivatBank was leaked to bne and shows that Ukraine’s largest commercial bank has acted as a little more than a “vacuum cleaner” for the local population’s savings, hoovering up a growing amount and sending it on to obscure shell firms, many owned by related parties or unknown foreign entities.

Our investigation revealed that in fact almost all the bank’s largest loans are to such borrowers – some of which are currently being investigated by Ukrainian prosecutors for tax evasion and fraud.

The situation with PrivatBank threatened the country’s entire banking system, President Petro Poroshenko said hours after the news broke of the takeover. “A direct threat to both the bank itself and the entire banking system of Ukraine has emerged. It is obvious for us as well,” Poroshenko said.

PrivatBank accounts for more than one third of private deposits in the country and around 20% of total banking sector assets in the country. Over the past six months serious concern over this issue has been raised by Ukraine’s key financial partners, the International Monetary Fund (IMF), the World Bank, and the European bank for Reconstruction and development (EBRD), Poroshenko added. “Our decision is based on saving the bank and guaranteeing property rights to financial resources to everyone who put money in this institution.”

PrivatBank’s problems have been piling up “for years” and have “taken a turn for the worse in conditions of war and economic crisis”, according to the president, who blamed Kolomoisky and Boholyubov for the crisis.

In a statement released late on December 18, the cabinet said the finance ministry will become the owner of 100% of the bank’s shares and will guarantee “the smooth functioning of the bank and security of its clients’ assets”. PrivatBank’s private shareholders had turned to the government with the proposal that “the government, acting in the interests of the bank’s clients, become its absolute owner”, the statement said.

Earlier this year, PrivatBank signed off on a three-year road map with the National Bank of Ukraine (NBU) for boosting its capital and purifying its credit portfolio, but failed to fulfill its obligations, NBU governor Natalya Gontareva said.

Ukrainian authorities say they will contribute UAH116bn ($4.415bn) in state bonds to the bank’s equity, and plan to raise UAH32bn ($1.2bn) by converting related party loans and unsecured lending to the bank into its equity. At the initial stage, the government will increase the bank’s equity by UAH43bn ($1.64bn) via contribution of state bonds.

IMF applauds decision

The UAH148bn ($5.6bn) believed to now be lacking from the bank’s capital is almost equal to a third of the IMF’s $17.5bn support programme for Ukraine agreed in 2015.

In a first reaction, IMF head Christine Lagarde welcomed the decision to nationalise PrivatBank, saying in a statement that this would “ensure the smooth operations of the bank given its systemic role in Ukraine’s financial system”.

The government bailout of PrivatBank should now prompt authorities to clean up the bank’s management and appoint “an independent management team to restore the bank’s viability, minimising the cost to the state and taxpayers in line with existing legislation and international best practice”, Lagarde added.

The resolution of the PrivatBank issue was a key precondition for the IMF to continue cooperation with Ukraine under its aid programme, a high-level source in the NBU told bne.

In 2014-2015, the central bank provided PrivatBank with UAH30.5bn ($1.2bn) in refinancing loans with the aim to support its liquidity and cover its deposit outflow, which was caused by the economic and financial meltdown in Ukraine, Russia’s illegal annexation of Crimea, and the military conflict in the Donbas region.

PrivatBank’s deputy chairman Oleg Gorokhovsky said after the government statement was published that the bank has experienced at least seven “information attacks” over the past two years and a half that led to a panic among its clients and outflow of funds from individuals and corporate clients. The lender had seen increased withdrawals in recent days of UAH2bn ($76mn) daily against previous peaks of around UAH1.5bn ($57mn).

The decision on a voluntary and peaceful transfer of the bank to state ownership was made at a time when we realised that PrivatBank “could not survive” the latest information attack, Gorokhovsky wrote on his Facebook page.

Related party loans galore

In May, Finance Minister Oleksandr Danylyuk said the lender was dogged by “systemic problems”, which in turn triggered criticism of his comments by the NBU. PrivatBank went on to secure an agreement with the regulator to entirely repay its refinancing loans, valued at the hryvnia equivalent of almost $1.2bn, by August 2017.

In late November, Fitch Ratings affirmed PrivatBank’s long-term foreign currency Issuer Default Ratings (IDR) at ‘CCC’. According to the agency, related-party lending was reported in IFR accounting standards at a high 19% of loans at the end of the first half of 2016 (vs. 18% in late 2015). But in Fitch’s view “this may not fully capture all exposures to affiliated entities, given limitations on ownership transparency in Ukraine”.

Gontareva said that as of April 2015, more than 90% of the bank’s corporate loans were provided to related parties, according to the NBU’s stress tests. However, Oleksandr Dubilet, who headed PrivatBank prior to the decision on its nationalisation, called the central bank’s assessment of related parties loans in the lender’s portfolio of corporate loans exaggerated.

According to the loan book leaked to bne, there is only a handful of identifiable large-scale borrowers in the bank’s roughly €6bn loan business, with the rest being no-name Ukrainian shell firms or offshores vehicles.

Apart from some identifiable Privat Group structures, hardly any other borrower on the loan book leaked to bne is a recognisable corporate brand, easily identifiable with a real business. For example, only 11 of the around 1,000 borrowers over UAH10mn are joint stock companies, even though most large businesses in Ukraine are incorporated as joint stock firms as a legacy of the post-Soviet voucher privatisation.

Of the 100 largest borrowers, accounting for UAH94.5bn or 46% of PrivatBank’s gross loans, all but one are limited liability firms. Most are registered in Kharkiv and Dnipropetrovsk, excluding the offshores, although PrivatBank has a dense national branch network. Hardly a single company has a recognisable brand name. Some of these are owned by Ukrainian individuals, but most are owned by offshore structures. Another 8% of lending, some UAH18bn, goes directly to offshore vehicles.

Cleanup and fallout

The nationalisation of PrivatBank is part of a wider cleanup of Ukraine’s wobbly and murky banking system.

Over the past two and a half years, more than 80 lenders had their licences withdrawn by the central bank, many of them due to their involvement in money laundering or for a lack of transparent ownership structure. The number of operating banks has declined from 180 in early 2014 to just around 100.

But the size of PrivatBank means the situation there poses a new challenge to Ukraine’s financial stability. The country’s largest bank by assets has aggressively ratcheted up its share of Ukraine’s retail deposits past the 37% mark, with UAH148bn (€5.2bn) in individual deposits out of a total of UAH409bn in the system, according to central bank statistics released in July.