Banking Sector Reform 2014-2018: Main Trends and Risks

Since the beginning of 2014, the banking system of Ukraine has experienced one of the strongest crises in its history. The crisis in the banking system started almost during Euromaidan. It was through the banking sector that the flywheel began to unfasten the economic crisis in early 2014. The political situation in the country provoked the withdrawal of tens of billions of dollars from Ukraine – the flight of capital connected with the government of Viktor Yanukovych. The devaluation of the hryvnia began, banks have lost liquidity. Although the National Bank of Ukraine introduced currency restrictions in the beginning of the winter of 2014 to stop the hryvnia falling, the situation did not save. The annexation of the Crimea and the beginning of an antiterrorist operation in the Donbas, where large industrial assets and a large part of the business of some of the largest banks were concentrated, exacerbated the situation. Following the Revolution, the new leadership of the National Bank of Ukraine began the process of reforming the banking system. One of the key elements of the reform was clearing the market from fake and poor-quality banks. The banks of most Ukrainian oligarchs came under the purge process: before the beginning of 2018, the interim administration was introduced in 94 banks that were unable to pre-capitalize, turned out to be insolvent, or were active participants in the informal economy.

 

In 2014, banking assets as a percentage of GDP, the banking sector of Ukraine had similar proportions to Poland and Russia. However, by 2016, closing down banks and reducing lending led to a sharp reduction in the role of banks in the economy. Ukraine is now significantly behind Russia and Poland, and Belarus has overtaken it. It should be borne in mind that the assets of Ukrainian banks in 2014 were overstated due to hiding loans to related parties. External factors such as depreciation of the hryvnia prevented the further decline of bank assets relative to GDP. Thus, in four years there has been a sharp decrease in the role of banks in the economy – now significantly less than in neighboring countries

The number of banks in Ukraine has sharply decreased, although the pace of decline has recently slowed. Of the 180 banks operating in early 2014, 94 banks were found to be insolvent or liquidated by the NBU. Five banks were liquidated or reorganized voluntarily. From Temporary Administration, 1 bank was sold, 2 transition banks were created and PrivatBank was bought by the state.

Consequently, more than 50% of banks stopped their work in 2014-2017. As at the end of April 2018, there remain 82 active banks. Of these, 39 banks (47.6%) have foreign capital.

The closure of banks and the growth of assets of state-owned banks have led to an increase in the market share of the 5 largest banks from 40% in 2013 to 61% in 2017. Only 3 of the 15 largest banks (in 2013) stopped working. However, 11 out of the following 15 banks closed. Privatbank was declared insolvent in December 2016, but it received state aid. The growth of the share of the largest banks by 21 percentage point over 4 years is significantly higher than in previous years

Structure of assets of commercial banks (as of the beginning of 2018) (ДИЗАЙНЕРУ: потрібна секторальна діаграма)

 

Bank Share in Ukraine’s banking sector
Privatbank 20%
Oschadbank 17%
Ukreximbank 13%
Ukrgasbank 6%
Raiffeisen Bank Aval 5%
First Ukrainian International Bank 4%
UkrSibbank 3%
Alfa Bank Ukraine 3%
Sberbank 3%
Ukrsotsbank 3%
Other 23%

 

The situation with Privatbank

One of the most implemented risks of the banking system was the privatization of Privatbank. Privatbank was nationalized at the end of 2016, eliminating the potential threat to the entire financial system. Due to huge losses (165 billion UAH in 2016), the state recapitalized the bank in several steps, and obligations to certain bank lenders were written off. So far, the state’s contribution to the bank has reached 140 billion UAH.

Key changes to PrivatBank after nationalization:

  • Obligations against creditors are written off for UAH 29 bln (appealed in courts)
  • Changes to corporate governance
  • New Supervisory Board with international participation
  • Developing a new strategy for the bank
  • Until now, the restructuring of loans issued to related parties has not advanced, requiring the necessary effective transition to the collection of bad debts

 

Inactive loans.

Unemployment loans skyrocketed during the crisis to 56.4% of gross loans. The NBU has strengthened the requirements for the classification of loans, which led to a sharp increase in non-performing loans in the first half of 2017.

The share of non-performing loans in neighboring countries (as end of 2017):

  • Belarus 13.7%
  • Poland 4.1%
  • Russia 9.7%

There is also a tangible difference in the level of non-working loans depending on the type:

  • Credits to individuals in foreign currency issued to their bans almost completely do not work (95%)
  • The share of non-working loans to legal entities is similar in both hryvnia and foreign currency (about 56-59%)
  • The lowest share of non-working loans to individuals in hryvnias

 

Loss of the economy from the banking crisis

The banking crisis has caused losses for a number of stakeholders, for example:

  • Contributors for unsecured deposits
  • Taxpayers through state recapitalization of banks, payment of guaranteed deposits, and so on.

By the end of 2017, cumulative losses from 2014 are estimated at the following level:

  • Fiscal: 15% of GDP
  • Other: 23.5% of GDP
  • Total: 38.5% of GDP

Fiscal losses are significantly higher than in the banking crisis of 2008 (4.5% of GDP), but still less than in widely known cases of Iceland, Ireland, Turkey and Greece (27-44% of GDP)

 

Key components of the banking sector reform:

Beginning in 2014, within the framework of the banking sector, positive changes are being made in different directions. Implementation of most of the projects will last 4-6 years. In 2017-2018, the NBU identified the main priority areas for the implementation of the Comprehensive Program for Bank Sector Reform. For its main components it is expedient to include the following:

  • Banking Supervision
  • Unification and simplification of reporting
  • Coordinating regulators
  • Simplification of the merger mechanism of banks
  • Redistribution of controller functions (SPLIT)
  • AML
  • Connected people
  • Macro-prudential supervision
  • Strategy of state banks
  • Basel Core Principles Implementation
  • IFRS + IFRS 9
  • Credit Register of the NBU
  • New Supervision / Risk Based Supervision
  • Restart lending

 

  • Technology and Innovation. The NBU is working on increasing the share of cashless settlements in the economy and introducing the latest technologies and innovations in accordance with best international experience.
  •  Internal transformation.

At present, the NBU focuses on reengineering, optimization and automation of internal processes.

  • Functional organizational structure
  • Communication of regulators with consumers and stakeholders
  • Reforming the regulatory function of the NBU
  • The only NBU service center for market participants
  • (Customer Service)
  • Centralization of functions and TU reform
  • Electronic document circulation
  • Reforming the decision-making system at the level
  • committees and commissions
  • Development of project management in the NBU
  • Implementation of process management. Reengineering and
  • optimization of processes
  • New website and rebranding of the NBU
  • Output of non-key functions

 

Capital Markets

  • Liberalization of currency regulation
  • Opposition to BEPS
  • Consolidation and development of capital markets infrastructure

Reform of state banks

State banks occupy a dominant position (market share of 56%), even more share of deposits of individuals (62%). At the same time, these banks have a high share of problem loans

Short-term calls:

  • How to manage them commercially without external intervention?
  • Possible impact on competition?

Medium-Term Challenges:

  • Preparation for possible privatization
  • Appoint supervisory boards with the majority of independent members

The Cabinet of Ministers of Ukraine in early 2018 updated the basics of strategic reform of the state banking sector.

The updated strategic principles of the state banking sector are based on four main priorities:

  • Implementing strategies for individual banks to restore their business as a stable, profitable institution that operates on a commercial basis.
  • Improving the efficiency of the governance model of public sector banks by improving discipline and strategy implementation, as well as creating more value for the state before withdrawing from banks.
  • Development and implementation of approaches to working with non-performing loans in order to reduce the pressure on the balance sheets of the state sector banks, maximizing their residual value.
  • Implementation of the plans of the state to withdraw from the capital of banks to increase their value.

It is assumed that after the reform, “Ukrgasbank” and “PrivatBank” will be fully privatized in the period up to 2020 and 2022, respectively. At the same time, over the next five years, the state will retain a controlling stake in Oshchadbank and Ukreximbank but will begin the process of reducing its share in their capital. It is planned that the state by 2022 will reduce its share in total assets in state-owned banks from 55% to 24%.

NBU actions that had a negative impact

  • Delay with the introduction of free hryvnia swimming.
  • Delay with the introduction of control over the movement of capital
  • Unreasonable refinancing of banks
  • Opacity in decision-making related to the purification of the banking system
  • Weak communication support for reform

 

Number of Banks Banks with foreign capital
01.01.2008 175 47 26.9%
01.01.2009 184 53 28.8%
01.01.2010 182 51 28.0%
01.01.2011 176 55 31.3%
01.01.2012 176 53 30.1%
01.01.2013 176 53 30.1%
01.01.2014 180 49 27.2%
01.01.2015 163 51 31.3%
01.01.2016 117 41 35.0%
01.01.2016 117 41 35.0%
01.01.2017 96 38 39.6%
01.12.2017 86 38 44.2%
01.04.2018 82 39 47.6%