Over the past two and a half years, the Ukrainian banking sector has been changed dramatically by the country’s regulator, the National Bank of Ukraine (NBU). More than 80 lenders had their licences withdrawn by the central bank, many of them due to their involvement into money laundering or for a lack of transparent ownership structure. However, the country’s central bank expects even bigger challenges ahead.

The number of operating banks has declined from 180 in early 2014 to just over 100. “Most of the nearly 80 resolved banks had significant shortcomings with regard to liquidity, solvency, and excessive exposure to related parties,” the International Monetary Fund (IMF) wrote in its report published on October 3. ”The banking system is adjusting to the post-crisis environment.”

The NBU’s governor, Valeriya Gontareva, admitted recently that the fast and uncompromising actions of regulator were “a shock” to the sector. “However, none of these banks was withdrawn from the market unfairly. Many of them resembled more money-laundering machines rather than European financial institutions,” she told a research conference in Kyiv earlier this year. “Two years ago... 27% of the banking system was non-transparent; in many cases we did not even know who the main shareholder of a bank was in fact.”

The remaining Ukrainian banks have continued to make steady progress in their recapitalisation and restructuring efforts, the IMF underlined in the report. According to the central bank, the average capital adequacy ratio (CAR) had risen to 13.9% by the end of 2015, though there is a wide spectrum of capital strengths.

The IMF says the NBU has completed the first two rounds of bank diagnostics for the 39 largest banks (accounting for 95% of the system’s assets), focusing particularly on the sustainability of borrowers’ cash flows and the quality of loan collateral.

“In completing this review, the NBU exercised its new legal powers that inter alia allow it to shift the burden of proof to a bank to demonstrate that a borrower is not a related party. Results showed material capital shortages in 28 out of the largest 39 banks,” the document reads. ”Poor quality of collateral resulted in an increase of the estimated levels of non-performing loans (NPLs) and provisioning requirements, which underscored the need for banks to enhance their credit risk management and loan underwriting practices.”

Of the initial 20 largest banks, those that needed additional capital have since brought their capital to at least zero mainly by converting subordinated debt into equity, substantially enhancing loan collateral, and transferring assets to the banks’ balance sheets to settle loans, or have been closed. On the top of that, banks with related-party exposures in excess of prudential limits are now required to unwind them within the next three years, the IMF underlined.

The diagnostics of the next 19 largest banks was completed in July and indicated that 12 of these banks needed additional capital. Shareholders’ efforts to recapitalise these banks are now under way.

According to a new schedule agreed between the IMF and the NBU in September, the deadline for the recapitalisation of the first largest 20 banks to reach a CAR of 5% of risk-weighted assets was extended to end-September 2016. For the next 19 largest banks the deadline to reach 5% CAR is February 2017.

Related parties

The Ukrainian authorities have also formulated “a set of principles that would guide a possible resolution of systemic banks”, the IMF added, triggering a wave of speculations over the fate of battered PrivatBank, the country’s largest lender by assets owned by Ukrainian oligarchs Ihor Kolomoisky and Hennady Boholyubov.

According to the Kyiv-based brokerage Concorde Capital, this point is “an indirect reference” to the troubles facing PrivaBank, which is one of three banks qualified by the NBU as systemic, besides the two state banks – Oschadbank and Ukreximbank. “The nationalisation risk raises questions about what the government would do with the holders of PrivatBank’s Eurobonds,” Concorde wrote in a research note on October 5.

According to the IMF’s report, a decision on state participation in the recapitalisation of a problem systemic bank will be made on the basis of a technical report prepared by the NBU that assesses inter alia the bank’s capital needs and viability, with the aim to avoid losses to the state.

“Public funds will be injected only after shareholders have been completely diluted and non-deposit unsecured creditors and related deposits are bailed in,” the document reads. ”In case a bank is nationalised, the Ministry of Finance will hire a well-known international firm to run the bank with a commercial business perspective. Moreover, international best practice will be followed and all legal means pursued to ensure that the state secures from former owners the recovery of all the loans related to them in a timely manner.”

Previously, PrivatBank had since secured an agreement with the NBU to entirely repay its refinancing loans, now valued at the hryvnia equivalent of almost $1.2bn, by August 2017.

According to the agreement, PrivatBank is bound to the following requirements: to further increase its share capital; repossess collateral by April 1, 2016; gradually decrease the share of loans issued to related parties and insiders at the bank; obtain additional collateral for a significant part of loans by September 1, 2016; gradually repay overdue principal and interest on the NBU refinancing loans by August 2017; and provide additional collateral for the NBU’s refinancing loans in the form required by the regulator. In addition, oligarch Kolomoisky provided a personal guarantee confirming the lender’s ability to follow the restructuring plan.

PrivatBank’s CAR is 11%, just above the central bank’s threshold of 10%, but its related-party loans remain a source of concern. On October 5, the Wall Street Journal wrote that PrivatBank’s loans to related parties are believed to account for at least 40% of its total loan book, which could threaten the stability of the lender if those parties run into financial problems. 

However, PrivatBank said in a statement e-mailed to bne IntellinNews the same day that the ratio of maximum credit exposure to related parties compared with its regulatory capital reached 29.29% as of September 1, according to the NBU’s new methodology.

The new methodology for calculating the ratio of a maximum credit exposure to related parties was approved by the NBU board in June 2015. Due to changes in the methodology, the ratio increased to its peak of 63.72% in the Ukrainan banking sector as of December 1, 2015, but gradually fell thereafter.

Meanwhile, a Kyiv-based source with knowledge of the matter told bne IntelliNews that some of Ukraine’s Western backers insist on splitting off the bank with the aim to reduce PrivatBank’s dominant position in some banking segments. Specifically, PrivatBank accounts for around a third of Ukraine’s private deposits and more than half of the country’s payment cards.