Ukrainian bank sector makes remarkable progress but is still far from healthy

Ukrainian bank sector makes remarkable progress but is still far from healthy
Entrance plaque and gargoyle at the National Bank of Ukraine premises in Kyiv.
By Ben Aris in Berlin February 10, 2017

Ukraine has been struggling to put in place the deep structural reforms demanded by its Western donors, but the one place where progress has been almost revolutionary is in the banking sector. The threat of a full-scale financial meltdown is receeding, but the sector still has major problems and is far from healthy. Even so, accelerating economic growth this year will make the clean-up easier. 

The National Bank of Ukraine (NBU), under the stewardship of governor Valeriya Gontareva, has closed down nearly 100 banks – mostly money-laundering fronts or simply scams to steal depositors’ money. The number of banks is down from a peak of 184 in 2009 to 98 as of December. At the same time, the regulator has been slimmed down and staffed with professionals, while swathes of new supervision regulation were introduced and actually enforced.


The most dramatic action the NBU has taken was to lock horns with the country’s richest man and most powerful oligarch, Ihor Kolomoisky, when on December 19 it nationalised his PrivatBank, the biggest commercial lender in the country that holds about a third of the entire retail deposit base. That was a shocker, but the fight is not over; Gontareva has threatened Kolomoisky with criminal charges if he doesn’t come up with collateral in the next six months to cover the $5.6bn hole in the bank’s asset sheet due to the fact that the vast majority of PrivatBank’s loans were made to related parties.

More recently on February 7, the NBU quintupled banks’ limits on foreign exchange trading, as the regulator moves cautiously towards removing all the capital controls it imposed during the worst of the crisis over the last two years. “The move is another move towards the easing of the rules of the foreign exchange regime,” ICU, a leading investment bank in Kyiv, tweeted.

Ukraine’s economy effectively collapsed in 2015 when GDP contracted by a stunning 15.5% in a year and the hryvnia devalued by three-quarters. In that environment it is amazing Ukraine managed to avoid a serious financial meltdown. When Russia’s ruble devalued by a similar amount in August 1998, the ensuing bank crisis wiped out the entire top tier of the banking sector.

The hope is that with an economic recovery underway since the end of the third quarter of last year, banks can grow their way out of trouble and clearly the pressure is coming off. But the country’s financial sector is not out of the woods yet.

The main problem is with the high levels of non-performing loans (NLPs). According to third-quarter 2016 banking statistics of the NBU – the most recent figures available – bank loans are divided into five levels of distress and the fourth and fifth categories are used to define NPLs.

However, the picture is very mixed. The sector can be usefully divided into four main types of banks in Ukraine: domestic state owned, domestic commercial, western owned and Russian owned.

NPLs a problem

Ukraine has a significant number of foreign owned banks – far more than its peers in Russia and Belarus. Western banks rushed in during the boom years and started a frenzy of acquisitions when it seemed that Ukraine was (finally) going to take off after nearly two years of reform neglect. Prices for banks soared to ridiculous levels, with some foreigners pay over five-times book value (one-times book is more normal) for small banks, since that was the easiest way to get hold of a Ukrainian bank licence.

At the same time the share of foreign capital has risen steadily from 35% of total bank assets in 2008 to a peak of 56% in October 2016, but fell only slightly in the last months of last year to 55.5% with 39 foreign owned banks still operating. Almost all the pain of the crisis and license withdrawals have fallen on domestic banks.

The fact that the share of foreign capital has risen continuously to the present day is slightly misleading, as many Western banks closed shop when the 2008 crisis hit, but they were replaced by Russian banks, as the Great Recession didn’t really make itself felt in Russia until much later, starting in about 2014.

On the whole the Western banks that remained have weathered the storm well. Overall, NPLs for the entire sector were about 30% of total loans as of the third quarter of 2016. That is extremely high: Russia’s bank sector has also been under enormous pressure in the last two years, but its banking sector ended 2016 with an aggregate NPL ratio of only 7.1%, which is considered manageable. But the Western banks are by and large healthier. Citibank, SEB and Deutsche Bank all have branches in Kyiv and none has any loans in the NBU’s fourth and fifth distressed categories at all. But being foreign is not an assurance of prudence, as Raiffeisen Bank International and ING both have worse than the sector average, probably because their businesses are much larger and they have a bigger exposure to corporate loans.

The NPLs amongst the leading Ukrainian banks is also a mixed bag. Ukrsibbank has one of the lowest NPL ratios from the domestic banks at 20%, but the other leaders are worse than the sector average, which has clearly been dragged upwards by foreign banks’ low levels of bad debt. The quirk in the data is that PrivatBank, which was nationalised in December, only had 20% of NPLs in the October official numbers, one of the lowest NPL ratios in the sector. A mere two months later the NBU changed its mind and now almost the entire loan book has been written off as NPLs, which testifies to a dramatic breakdown in the regulators’ supervisory abilities.

The NBU has since accused PricewaterhouseCoopers, PrivatBank’s auditor, of providing an inadequate evaluation of collateral on the bank’s loans. In its official audit of PrivatBank, PwC identified only about 20% of loans as being made to related parties, whereas a bne IntelliNews investigation in November estimated the level at well over 50%. According to the NBU, PwC had no right to conduct an evaluation of the assets that the bank took as collateral. The regulator is considering holding the auditor accountable for misconduct, which may include criminal or civil prosecution.

While the temperature in the hospital is improving, the temperature in some of the rooms is very different, goes a popular saying in Eastern Europe’s financial community. And the state-owned banks are especially vulnerable. According to Deputy Finance Minister Yuriy Butsa, the banking sector remains at risk of a systemic crisis and several of the state-owned banks may need further recapitalisation this year. The government’s trade bank UkrExImbank and state-owned savings bank Oshadny Bank have already received state money and might need more in 2017.

According to Ukraine’s memorandum on economic and financial policy agreed with the International Monetary Fund (IMF), the recapitalisation of banks or individuals’ deposits under government guarantees totalled UAH151.7bn ($5.9bn) in the second half of 2016, and UAH42bn ($1.64bn) in 2017.

Russian banks headed for the exit

Many Ukrainian banks are walking wounded, but none of them are in such dire trouble as the Russian banks working in Ukraine. “Russian banks have no future in Ukraine,” the deputy chairman of the NBU, Kateryna Rozhkova, said ominously on January 7.

There are a total of five Russian state-owned banks operating in Ukraine, including three in the top 20, that have a combined market share of about 9%.

The fate of Russia’s banking household names is becoming increasingly bleak as Ukrainians avoid doing business with the Ukrainian branches of Russian banks or renege on their debts to the banks as much for of patriotic reasons as economic ones.

The NLPs at the leading names have soared in the last year, rising to 50% for the Kyiv-based branch of Sberbank and are already over 80% for the Ukrainian affiliate of its sister bank VTB.



Russia’s biggest banks rapidly ramped up their Ukrainian business following the 2008 crisis when many of the Western banks fled. Amongst the biggest banks left operating on the market and working in more innocent times, these banks rapidly increased their loan portfolios, but things went sour following the 2014 annexation of Crimea by Russia.

Sberbank’s NPL ratio is already at 55% compared with the sector average of just under 30%, and its sister state-owned VTB has NPLs just shy of 90% – one of the worst ratios in the sector – thanks its extensive exposure to loans in the industry-rich Donbas region that is now at the heart of the separatist conflict zone.

Now with fighting flaring once again in the east of the country the situation has gone from bad to worse. Russian banks in Ukraine are in the crosshairs of the regulator and now have only two options: “Find a new owner or gradually reduce the presence on the Ukrainian banking market,” Rozhkova said at a press conference, Vedomosti reported.

In 2016 Ukrainian deposits in Russian banks decreased by almost UAH2bn ($72mn). “But [the Russian banks still hold] UAH22bn ($790mn) of assets, of which UAH16bn ($576mn) belongs to legal entities, ie. a total of about UAH37bn-38bn of citizens and company money,” added Rozhkova. The credit portfolio of Russian banks is estimated at UAH134bn ($4.82bn).

Earnings and capital adequacy

The banking sector problems have largely stabilised, but with weak earnings many of them need to be recapitalized. The NBU set a deadline of January 1 for banks owners to inject enough capital to bring them up to the mandatory minimum requirements and most banks managed it.

But the ongoing problems remain visible in the sector’s capital adequacy ratio (CAR) – the amount of cash a bank has to hold to ensure it can absorb a reasonable amount of loss and complies with statutory capital requirements. Having too little cash on hand is the main cause for banks to go bust, even if they are profitable.

The sector CAR in Ukraine has fallen to worrying low levels. Banks are obliged to keep at least 10% of the volume of their total loans as cash, but as transition economies are so volatile in the boom years most banks in the entire region tended to keep at least 20% as reserves. CARs have fallen steadily in recent years and scarily dipped below the 10% threshold in February 2016, exposing the whole sector to a bank run.

Since then the CARs have recovered somewhat and ended 2016 at just under 14%, but again this is only the aggregate number and many banks are in trouble. Cut off from normal sources of credit like a functioning interbank market or state loans, banks have to dip into their capital to finance lending and make the profits they need to replenish their capital. If the business climate sours, banks could find themselves in a death spiral of falling capital thanks to inadequate returns.

Even if they are functioning, many banks are yet to regain profitability. The total losses of Ukrainian operating banks shrank 4.3-times on year to UAH12.6bn ($483.7mn) in January-October, the NBU said in a statement published on December 2. And according to NBU data, 35 out of 100 operating banks in Ukraine were unprofitable in January-September.

The result was mostly attributed to a 60.4% reduction in allocations to loan loss provisions. “However, over the first ten months of 2016, loan loss provisions amounted to UAH39.6bn ($1.52bn), and remains the most significant factor behind the negative financial performance of the banking system as a whole,” the regulator underlined.



Mismatched assets and liabilities

The pressure should come off as the year wears on. On February 9 the government announced that economic growth accelerated to between 4.5% and 4.8% in the last quarter of 2016, making it easier for banks to make money as the momentum builds. “The economy is visibly gearing up. Upward momentum is visible, and authorities will be keen to sustain it. The IMF programme is on track, as fiscal policy is targeting small, but still meaningful, primary surpluses. A credit revival should revitalise the banking sector this year,” Ukrainian investment bank ICU said in its latest quarterly report.

But here the banks have another problem: a mismatch between their assets and liabilities. As the two charts of deposit and loan growth in 2016 shows, banks are collecting far more money from retail client deposits than corporates, but at the same time the corporate loans are far in excess of retail loans. This is bad practice in the banking world, as in general you are supposed to match your assets with your liabilities. However, provided there is no external shock to rock the boat you can get away with practices like this – as long as no one goes bust or people ask for their money back.



If something does go wrong, then it will be the state that is on the hook because on December 20 the Rada passed a bill that fully guarantees all individual deposits at all state banks. Before that, only the state-owned Oschadbank offered a 100% state guarantee on deposits, while depositors of other banks had to make do with a limited guarantee from the State Deposit Guarantee Fund that only covers the first UAH200,000 ($7,400) of deposits. This is a very generous deal by the government, but exposes it to a big bill; indeed, it has been down that road before in the 1990s when the deposit insurance scheme fund was exhausted by another bank crisis.

President Petro Poroshenko, who initiated the bill, deemed it necessary to cut short any panic related to the nationalization of PrivatBank and prevent a run on the bank’s deposits, which could have easily spread and brought the whole system down. While the guarantee is a big risk for the state budget, as long as things remain calm it has no impact on public finances for the meantime.

“The fallout from this bill could be on Oschadbank, which lost its exclusivity in offering a full guarantee on deposits (which it considered to be an advantage),” say analysts with Concorde Capital. Analysts now expect some outflow of deposits from Oschadbank to PrivatBank, which is now de facto a state bank (and so deposits are also 100% guaranteed) but is much more customer-friendly.

The explicit state guarantee will also create non-competitive advantages for state banks over private institutions, which doesn’t help Ukraine’s crippled banking system, as commercial banks are going to rely on profits to recapitalise. The share of state banks (including PrivatBank) in total individual deposits in Ukraine was 59% as of end-September, and there is a risk that it will growth further in the mid-term – particularly if the Russian banks are kicked out of the country.

ED: much of this information was taken from bne IntelliNews's monthly country report on Ukraine. For a sample copy or more information go to or send an email to to organise a trial.