Ukraine’s banks are back in profit but they remain hobbled by the crushing weight of their non-performing loans (NLPs) and steep interest rates left over from the country's economic collapse in 2015.

The Ukrainian banking sector reported UAH21.7bn ($80mn) of net profit in 2018 following a net loss of UAH26.5bn a year ago, the National Bank of Ukraine (NBU) said in a statement published on February 7, returning to profitability for the first time since 2013.

The net interest and commission fee income of the banking system increased by an average of 38% in 2018, the largest part (46%) earned from corporate loans. Investment in securities provided another 27% of interest income, and retail loans 26%.

Banking reform under the former NBU governor Valeriya Gontareva has been one of Ukraine's outstanding reform successes and her successor Yakiv Smolii is turning out to be equally competent.

The NBU has withdrawn the licences of around 100 lenders, many of them due to their involvement in money laundering, stealing depositors’ money or for having a non-transparent ownership structure, leaving 77 banks active.

However, despite this good news the amount of bad debt in the sector remains huge. Half of the loans in banks have gone bad (53.19% as of February) and over the last two years that percentage has hardly changed.

Moreover, the state banks, including Oschadnybank and Ukreximbank, are even worse off than the rest of the sector, where NPLs make up two thirds (67.7%) of their loan book.

But the real elephant in the room is PrivatBank that was nationalised at the end of 2017 after bne IntelliNews exposed in a cover story “Privat investigations” the fact that a large part of its loan book had been stolen by its former owners, oligarch Ihor Kolomoisky and his partners, using fake loans to related party shell companies. Since then the bad loans accounting for 83% of the loan book has not changed. Despite regular calls by the authorities to Kolomoisky to return the money drained out of the bank, clearly almost nothing has been recovered.

The situation with “foreign owned” banks is a bit better, where NPLs have fallen to around 40% from 50%, but these are mostly Russian banks that have been sanctioned by the NBU and are barely functioning. Best off are the private banks where a quarter of their loan book has gone bad, but that is a manageable, although still big, share of loans.

NPLs % of loan book	01/02/17	01/02/19
ratio of non-performing loans, %	53.99	53.19
incl. banks:
with state participation, of which:	77.23	67.69
CB "PRIVATBANK" PJSC	83.00	83.01
other than CB "PRIVATBANK" PJSC	29.37	54.54
belonging to foreign banking groups	49.66	39.80
private	23.75	23.35
insolvent	36.82	52.07
Source: NBU

While banks are struggling to shed their bad debt, where they are making progress is in restructuring this debt and reducing the amount of capital they have to put aside to cover it. In 2018, the amount of payments to reserves more than halved, to UAH 23.7bn in 2018 from UAH49.2bn in 2017.

However, the wobbly nature of the banks' balance sheets is holding back the business. In the last two years deposits have remained largely flat as have bank loans.

Companies make up the bulk of loans and increasing the resources for companies to borrow would feed economic growth. But in the wake of the economic crash the NBU had to hike rates and at its meeting on March 14 kept them at a punishing 18% as the fight against double-digit inflation is still taking priority. At this level the cost of borrowing is so high that projects are not economically viable if the investment capital has to be borrowed.

Retail lending remains very depressed for much the same reasons. In Russia’s boom years the consumption led boom was fuelled by soaring consumer credits, which in turn were fuelled by steadily falling borrowing costs.

Ukraine has a consumer borrowing fuelled boom to look forward to, but clearly it is still too early for this to start and interest rates need to come down a lot more before this particular virtuous circle of borrowing-spending-investment-profits-wage hikes starts turning.