James Marson in Kyiv -

Five months after the run on Prominvestbank, Ukraine's banking system is edging towards breaking point, with depositors hungry for their cash and borrowers struggling to service loans. Indeed, Fitch Ratings cited the "increased risk of a banking and currency crisis" when it downgraded Ukraine's sovereign debt in February.

The banking crisis first struck in October when a run on Prominvestbank and a rapid fall in the hryvnia's value led to a loss of confidence in the banks and mass withdrawals. Now a new wave is hitting, says Nick Piazza, CEO of Galt & Taggart Securities. "We're heading towards another downturn."

The banks' asset quality has already taken a major hit from the hryvnia's loss of over 50% of its value against the dollar in 2008, as borrowers have struggled to service foreign currency-denominated loans. Dragon Capital, a Kyiv-based investment bank, puts the number of foreign exchange loans at 73% and estimates that non-performing loans could reach 25%.

"We see key problems with the banking system in 2009 to be liquidity, asset quality and the need to obtain funds for recapitalization," says Andriy Parkhomenko, an economist at Concorde Capital.

The hryvnia has steadied at around UAH8 to the dollar in recent weeks, but further depreciation is predicted, with Dragon Capital estimating the average rate for 2009 at UAH9.5, with a figure of UAH8.5 at year-end. A further fall in the hryvnia would send people scurrying to the banks. Some 20% of hryvnia deposits and 17% of forex deposits were already drained from accounts from October to January. Liquidity shortages have in recent weeks prevented some banks from paying out deposits even when their term has matured. Six banks have been placed under administration by the central bank since the start of the crisis, with nine more reckoned to follow suit in the medium term.

Vitaliy Vavryshchuk, a banking analyst at Dragon Capital, predicts a continuation in deposit decline for two to three months, tapering off before an increase in the deposit base in the third or fourth quarter. "People are well aware which banks they can trust," he says. "We'll see a flight to quality."

Winners and losers

This could benefit banks with foreign parents. Concorde Capital estimates that the country's 182 banks could need to raise UAH80bn to UAH105bn in capital in 2009, and while foreign parent banks are expected to inject capital into their subsidiaries, many local banks may have to turn to the government for capital in return for a controlling stake, or hope to find a strategic investor. "Obviously, not all banks have the ability to raise such additional equity," Parkhomenko says. "We anticipate that every third or, in the worst case, every second Ukrainian bank will falter or be acquired in 2009."

The banks that will make it through the crisis are the largest banks and the smaller ones connected to large business groups. "It's the middle ones that will topple over," Galt & Taggart's Piazza believes. "The ones most at risk are those that expanded their credit portfolios and network of branches rapidly during the consumer credit boom of the last four years."

Dragon Capital estimates that five to seven of the top-20 banks will change majority shareholders by the end of 2010. This process has already started, with takeovers of Prominvestbank, Rodovid, Nadra and Ukrprombank already announced or under discussion.

Securing the next tranche of the $16.4bn standby loan from the International Monetary Fund (IMF) will be vital to stabilizing banks and the hryvnia. Worryingly, the IMF delegation left Kyiv after a visit in the first week of February without announcing disbursement of the second tranche, although talks are set to resume. "It's crucial that the government figures things out with the IMF," Piazza says.

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