On 27 November the
International Monetary Fund published a 96-page report entitled, “Ukraine
Context: Following the 2008/9 financial
crisis and deep recession, a cyclical recovery took hold in Ukraine, supported
by a stronger external environment. Efforts to consolidate public finances and
repair the banking system began strengthening Ukraine’s resilience to external
shocks. More recently, policies have not been sufficient to meet key
objectives, and the government has hesitated to undertake politically unpopular
reforms. The external environment has become less supportive, and the recovery
is losing momentum.
[...]
10.
Progress has been made on banking sector reforms, but bank balance sheets
remain weak, and private credit growth is subdued. (Table 7; Figure 6; Annex III).
Capital adequacy ratios are above the statutory minimum, thanks to two rounds
of capital injections in 2009–10. But bank profitability is near zero as banks
continue provisioning against bad loans. Nonperforming loans are around 15
percent of total loans (39 percent under broad definition of NPLs). Credit
growth to the economy was only 6 percent in March, y-o-y, and credit as a
percent of GDP has fallen from 79 percent in 2008 to 59 percent.
Notwithstanding some de-dollarization, bank balance sheets remain exposed to
currency movements due to regulatory distortions (the banking system has an overall
fx short position of about US$8 billion) and fx (mostly in US$) loans to
unhedged borrowers. External support for the banking system is shrinking. BIS
figures show a 26 percent drop in foreign bank exposure to Ukraine during 2011.
The loan-to-deposit ratio has fallen to a still high 160 percent, from a 2009
peak of 230 percent. Several important banking laws and reforms were completed
during the past 18 months that will strengthen transparency (Ultimate
Controllers law), banking supervision (Consolidated Supervision law; new
provisioning regulations; migration to IFRS) and the resolution framework
(Deposit Guarantee Fund law). Implementing regulations for these laws are being
finalized. Nadra Bank (intervened in 2009) was privatized and recapitalized
during 2011 with private funds, while resolution of the remaining
state-intervened banks continues.
[...]
Annex III. Financial Sector
Developments and Challenges
This annex looks at the emergence of
Ukraine’s banking crisis and the policy response and highlights some key
near-term challenges facing the sector and policymakers, including:
deleveraging, high nonperforming loans, currency mismatches, and withdrawal of
longer term liquidity support granted during the crisis. It concludes with an
assessment of banks’ relative financial soundness.
In the
years leading up to the 2008/9 financial crisis, bank lending in Ukraine grew
at a very rapid pace.
Credit growth peaked in 2005–07 at an average of 70 percent per annum and the
loan-to-GDP ratio surged to nearly 80 percent of GDP by end-2008.
The credit
boom exacerbated vulnerabilities, many of which were discussed in the context
of the 2008 FSAP (Box A1). Household and corporate sector debt grew rapidly, but banks’ risk
management and lending standards, and supervisory oversight did not keep pace.
Credit risks rose from real estate prices that surged well past levels in
countries with comparable income levels and from currency mismatches on
borrowers’ balance sheets from pervasive foreign-currency lending. Banks’
liquidity risk deepened as loan-to-deposit ratios approached 230 percent.
In late 2008, Ukraine was hit by a
banking crisis. Weakened
confidence in Ukraine’s policies and concerns about banks’ ability to roll over
existing credit lines set off a deposit run that quickly developed into a
full-blown banking crisis. As depositors fled (resulting in a 20 percent drop
in the depositor base) they also abandoned the hryvnia, triggering a currency
crisis. Bank lending froze (-2 percent nominal credit growth in 2009), NPLs
rose rapidly, and bank profitability plummeted as banks increased their capital
buffers and provisioned against loan losses.
The
initial focus was on containing the crisis. The Fund (backed by a CIDA technical assistance grant)
worked closely with the authorities and the World Bank, initially to stabilize
the system through anti-crisis measures, and then on rehabilitation and
strengthening banks and the institutional framework, and reducing
vulnerabilities (Box A2). Two rounds of recapitalization have raised capital
adequacy ratios to their current level of about 18 percent—well above the
statutory minimum of 10 percent (Table 7)—thus providing some buffer against
any further losses.
The focus has gradually shifted
towards strengthening the legal and regulatory framework, and the contingency
framework. Several
important laws have been passed to strengthen supervision (consolidated
supervision law), transparency (ultimate controllers law), and the resolution
framework—implementing regulations for all three will be finalized during
2012.Under the revised resolution framework, responsibility for administering
intervened banks has been shifted to the Deposit Guarantee Fund, which will
allow the NBU to focus more squarely on its core mandate. The NBU is reviewing
their emergency liquidity assistance and refinancing operation frameworks to
allow longer maturities in some circumstances (while retaining strong
collateral, solvency, and monitoring conditions, as needed). Given their
experience in during the 2008/9 banking crisis, Ukraine could quickly
re-activate other crisis response functions, if needed.
Despite
progress made, Ukraine’s financial soundness indicators, and credit growth,
remain comparatively weak. Ukraine is one of the more vulnerable countries with respect to NPL and
loan-to-deposit positions (and spreads), and real credit growth has been
negative.
Key challenges. There are a range of challenges inhibiting
banks from reviving lending and providing a more supportive role for growth, including:
risks of macroeconomic instability, a weak legal framework, lack of stable
long-term funding, and still-weakened bank balance sheets. The focus here is on
four specific near-term challenges: deleveraging, high NPLs, currency
mismatches, and unwinding longterm liquidity support (stabilization loans).
Deleveraging. The foreign banking presence in Ukraine is smaller
than in many peer countries (about 40 percent of Ukraine’s banking system is
foreign owned; about 22 percent by euro area banks). Nonetheless, the drop in
external funding has been significant, and has dampened banks’ capacity to lend
(despite some increase in deposits). External debt of banks fell 35 percent
between end-2008 to end-2011 to US$25 billion) and BIS figures indicate
significant reductions in foreign claims on Ukraine. Bank balance sheets
continue to grow (with loans to corporates increasing), but at a slower pace
than nominal GDP (banks are relying relatively more on local deposits to reduce
still-high loan-to-deposit ratios). Overall nominal credit growth is in single
digits (fx-denominated loans continue to fall, driven by the ban on fx loans to
unhedged borrowers, which has contributed to an overall drop in retail loans).
Deleveraging is expected to continue to weigh on bank balance sheets, with
foreign financing to Ukraine’s banking system is expected to continue to fall.
The NBU has expressed interest in participating in Vienna 2.0, which could
provide a platform for mitigating deleveraging pressures, and better cross-border
coordination.
Reducing
NPLs. The crisis pushed NPLs and loan loss
provisions (LLPs) into a steep upward trend. By end-April 2012, NPLs (doubtful
and loss items) appeared to have stabilized at around 15 percent of total loans
(or around 40 percent if including “substandard” loans). A comparison against
past crisis cases suggests Ukraine is lagging in terms of bringing down NPL
levels at this stage of the post-crisis cycle (though contemporaneously better
than some peers). NPLs are concentrated among enterprises, though household
mortgages have also contributed. These high levels of NPLs are weighing heavily
on bank balance sheets and profitability, and the lack of incentives to
write-off loans could be dampening full realization of the extent of bad loans (some
analysts have noted that current levels of LLPs may be insufficient). The NBU
and the Government have taken some measures to help cleanse NPLs from the
banks’ balance sheets by providing tax relief for loss provisions and
write-offs, the latter of which totaled to UAH 33 billion (about 4 percent of
loans) during the past 16 months. A new regulation bringing asset
classification and loan loss provisioning rules closer to international best
practices was approved, but further tax, legal, and regulatory measures are
needed. Where banks report high ratios of restructured loans (or other risk
factors), independent assessments may be useful. Other steps should include
further strengthening of creditors’ rights, and tax measures to facilitate
write-offs (e.g., clarify tax consequences of writing off fully provisioned
loans, establishing fair value of NPL sales for tax purposes, tax treatment of
accrued but unpaid (suspended) interest on overdue loans, and VAT on resale of
repossessed collateral).
Reducing currency mismatches. In early 2009, the NBU redefined (via ‘Resolution
109’) the coverage of banks’ net open fx positions by instructing banks to
exclude fx LLPs against fx loans from the calculation. This created a sudden
increase of long (or a decrease of short) fx positions that compelled the banks
to sell fx in the market against UAH. The overall short position of the banking
system (from an economic perspective) is currently estimated at about US$8
billion, or about 6 percent of system assets. This leaves banks exposed to
movements in the exchange rate, with implications for capital adequacy through
devaluation losses and possible increases in NPLs and provisioning (banks
remain exposed to exchange rate movements from fx lending to unhedged
borrowers). The NBU is moving forward with a pilot program for unwinding this
policy that has included the parallel sale of government fx-indexed bonds. The
impact on the exchange rate or fx reserves (and bank liquidity) from unwinding
this resolution is an important consideration, though the magnitude is
contingent on the mix of adjustment chosen by banks. Overall, stress tests
suggest that existing banking system capital buffers could absorb a modest
exchange rate depreciation, though some individual banks could require
additional capital.
Unwinding Longer Term Liquidity
Support (Stabilization Loans). The
stock of stabilization loans has fallen from a peak of about UAH85 billion
shortly after the onset of the crisis, to around UAH60 billion. These loans are
scheduled to be paid down in roughly equally distributed amounts over the next
four years, though some of these loans may be only partially recoverable (e.g.,
those to state-intervened banks). These repayments, combined with liquidity
needs from unwinding Resolution 109 (and deleveraging), present liquidity
management challenges for banks and the NBU. It is likely that the NBU will
need to provide liquidity support, to banks determined to be solvent, in the
context of unwinding these crisis era policies and as term external funding is
withdrawn. In this context, the authorities are reviewing their refinancing
window, with an eye towards extending maturities out towards 365 days, and are
considering some smoothing payments of stabilization loans under strengthened
collateral conditions.
Assessment
of Ukrainian Banks’ Financial Soundness. To assess the health of the banking system, staff
compiled a financial soundness indicators (FSI) index using bank-by-bank data.
The results suggest that while the large majority of banks currently have
adequate indicators, there is a need for close monitoring and assessment of
some banks. Such indicators (with established thresholds that could trigger
supervisory actions) provide useful ‘early warning indicators’ for bank
monitoring purposes.
Source: Ukraine:
Staff Report for the 2012 Article IV Consultation (2012-11-27)
Mark Pleas
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