Profits in Ukraine’s banking sector tripled in 2019 to hit UAH59.6bn ($2.5bn) as of December as the sector stepped onto square two of its recovery path and a full recovery of the sector is now well underway.
At the same time non-performing loans (NPLs) have begun to fall which remains the biggest challenge the banking sector is facing.
Rising incomes, economic growth and improving confidence are all supporting the recovery of the banking sector. The sector’s profits were a new record high, Kateryna Rozhkova, first deputy governor of the National Bank of Ukraine (NBU) said on Facebook. “I will disappoint critics [by saying] that these are not super-profits of state-owned banks from government bonds. This is the real profit of the banking sector. If you look at the interest income of state-owned banks, the government bonds invested are only 12%.”
And the banking business is becoming more diversified. In December banks earned a total of UAH244.4bn over the course of the year, up from UAH204.5bn a year earlier. However, 63.1% of this was earned from the traditional business of charging interest on loans, down from 68.8% a year earlier. That means a third of banks' income is earned from other sources, with commission fees being the most important. (Banks earned UAH63.1bn from commissions in 2019.)
The share of non-interest income has been falling steadily over the last few years as banks begin to perform their traditional function of financial mediation again. In January 2016 interest income accounted for 92.5% of banking income, but had fallen to 71.2% by the end of that year and has been falling slowly ever since.
The rescue and restructuring of PrivatBank has also gone well. The bank was nationalised by the state in December 2016 when it was found to have a $7.2bn hole in its balance sheet after its former owner oligarch Ihor Kolomoisky stripped the bank of its assets using a scam consisting of making loans to shell companies he controlled.
PrivatBank is now state-owned and under new management, who made it the most profitable bank in the country in 2019, earning a handsome $1.3bn in profits. A distant second most profitable bank was Austrian-owned Raiffeisen Bank Aval that earned $195mn.
The runners up included First Ukrainian International Bank (FUIB) with $107mn; Ukrsibbank with $106mn; and, Hungarian-owned bank OTP Bank with $104mn. Of Ukraine’s 75 operating banks, 69 were profitable in 2019, according to the NBU.
The cumulative profits for the year are easy to see from the chart after a lacklustre year in 2018 and difficult year in 2017.
However, the improvement is more dramatic when drilling into the month-on-month numbers. Ukrainian banks earned an average of UAH4.9bn a month in 2019 – almost triple the UAH1.9bn they earned in 2018, whereas banks lost an average of UAH2.2bn a month in 2017, although the bulk of that was concentrated in one month alone: in December 2017 Ukraine’s banks lost a total of UAH28.3bn as well as big losses in June that year.
Rising profitability is allowing banks to write down bad debts and invest into their regulatory capital to improve their health. Regulatory capital of the sector has increased from UAH126,8bn in January 2016 to UAH150.3bn as of this January.
However, the even more important capital adequacy ratio (CAR) – the share of cash a bank keeps on deposit to meeting withdrawal demands – has risen from 12.3% to almost 20% over the same period.
The CAR ratio is one of the most important banking numbers. Internationally banks have to keep a minimum of 8% of their assets in cash and the mandatory minimum in Ukraine is 10%. However, across emerging markets banks usually keep some 20% of their assets in cash in good times, as these markets are prone to shocks so banks only feel comfortable with a large cash cushion. A falling CAR ratio is usually a clear sign of a brewing crisis or economic stagnation. The fact Ukraine’s CAR is already almost back to 20% is a very positive sign.
And the highly successful clean-up of the sector started under former NBU governor Valeriya Gontareva will continue in 2020. This year, the central bank plans to conduct stress tests on 16 banks, down from 29 in 2019. The banks to be tested are: Savings Bank, Alfa Bank, Ukreximbank, FUIB, Universal Bank, Southern Bank, Tascombank, Megabank, A-Bank, Sberbank, Credit Bank Dnipro, Bank Vostok, MTB Bank, Investment Bank, Pravex Bank and Forward Bank.
Loans and deposits recovering
Another positive sign of the recovery of the financial sector is the rise of both deposits and loans. As the chart shows, deposits have been rising. Deposits remain the main source of bank funding to make loans, and run well ahead of credits. Indeed as the economy and incomes continued to improve in the last quarter of 2019 deposits picked up noticeably in December.
Overall, retail lending has been growing over the last two years and was up 30% in 2019, according to the NBU, but its volume remains about a quarter of the size of corporate lending which has been doing less well.
Consumer loans can help finance an economic boom and played a key role in this respect during Russia’s boom years in the noughties. However, in Ukraine the volume of consumer loans has not reached the critical mass needed to start the virtuous circle of spending-profits-investment-pay rises turning.
While corporate lending recovered between the middle of 2016 and 2018, since November 2018 it has fallen off again, pulling the overall volume of new loans made in 2019 down to a mild contraction from UAH847bn in January 2019 to UAH822bn as of this January.
With the overnight central bank rate of 11% (and a real interest rate of a punishingly high c.9%) the cost of capital in Ukraine is still too high for bank credits to be a viable source of investment capital. The NBU has made a series of very deep rate cuts in the last few months and is almost certain to continue this policy in 2020 so corporate loans may improve as the year wears on.
Having said that the government has been trying to support credits, especially to small and medium-sized enterprises (SMEs), as a way of boosting economic growth. Almost 17,000 small and medium-sized businesses signed up for the government's new Credits 5-7-9% before the programme was launched at the start of February. Prime Minister Honcharuk wrote on Facebook: “No exaggeration: Ukrainian small businesses were waiting for this programme. Already before the official launch we received almost 17 thousand preliminary applications.”
Part of the reason for the low level of corporate loans is the bankers themselves are also reluctant to lend to companies and complain there are not enough high quality borrowers to lend to and build up their credit portfolios.
Bankers are still shy of dealing with large corporate loans as they are still holding a huge amount of NPLs on their books from the crisis years. Part of the reason that net interest income has been doing well in the last year is that slowly the recoverable of these NPLs are being paid off and that is the main credit business rather than the extending of new loans.
During the crisis years typically rather than write off the loans and book the loss, bankers simply restructured the loans, extending the terms indefinitely until such time as a client was able to re-start making the payments. It seems that Ukraine has reached that point now as NPLs fell to below 50% of all outstanding loans for the first time in years by the end of 2019. NPLs were 48.4% as of January 1, a reduction of 4.5 percentage points compared January a year earlier.
Loan portfolio quality improved across all bank groups, except banks with Russian capital, which have been sanctioned by the NBU and are essentially unable to operate in Ukraine now.
The new retail lending seen in 2019 has also helped to improve the quality of loan books as banks are being more careful about who they lend to: in 2019 the share of non-performing retail loans fell by 11.9 pp to 34.1%. At the same time the two major state-owned banks restructured more than UAH30bn ($1.2bn) of laons via the mechanism of voluntary financial restructuring which also improved the quality of the loan book. "Considering these actions, the state-owned banks (save for PrivatBank) reduced the share of NPLs from 55% to 49%," the NBU said in a statement in January. PrivatBank’s NPLs remained the highest in the sector at over 80% as of the end of last year.
Among other factors that improved the credit quality of the sector was efforts by banks with foreign capital to clean up their balance sheets by selling or writing down NPLs on the account of loss allowance. The share of NPLs in foreign group banks (except Russian banks) fell from 23.1% to 16% in 2019.
Finally the strong appreciation of the domestic currency in 2019, which was up some 14%, also helped by reducing the hryvnia equivalent in NPLs denominated in foreign currency, which also remains significant.
This article is from bne IntelliNews Ukraine monthly country report. Sign up to receive the report to your inbox each month, covering the slow moving macro- and micro-economic trends, the major political news and a round-up of the main sectors and corporate news. The first month is free and you can unsubscribe at any time.
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