The afTermaTh of The crisisan overhaul of ukraine’s banking sector

rafał sadowski

67

The afTermaTh of The crisisan overhaul of ukraine’s banking sector

rafał sadowski

nuMber 67WarsaWJuly 2017

© copyright by ośrodek studiów Wschodnichim. Marka karpia / centre for eastern studies

content editoradam eberhardt, Wojciech konończuk

editorhalina kowalczyk

co-oPerationkatarzyna kazimierska, anna Łabuszewska

translationMagdalena klimowicz

co-oPerationnicholas furnival

graPhic design Para-buch

PhotograPh on coveryevgeniy11, shutterstock.com

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chartsWojciech Mańkowski

Publisherośrodek studiów Wschodnich im. marka Karpia centre for eastern studiesul. koszykowa 6a, Warsaw, PolandPhone + 48 /22/ 525 80 00fax: + 48 /22/ 525 80 40osw.waw.pl

isbn 978-83-65827-07-4

Contents

Theses /5

I. ‘Bankopad’, or The Collapse of The Banks /7

II. oligarChiC Banking /12

III. sTaBilisaTion – real or feigned? /17

IV. “privaTBank is The guaranTor of The ConsTiTuTion” /19

V. The siTuaTion afTer The Crisis /23

VI. The sTaTe-owned Banks – The ConTesT for ConTrol of finanCial flows /24

VII. The russian Banks are Changing Their spoTs /27

VIII. The poliTiCal ConsequenCes of The Changes in The Banking seCTor /30

appendiX /32

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Theses

•In 2014-2016, Ukraine’s banking sector was affected by what has proventobethemostseriouscrisis inthecountry’smodernhistory.Overthesethree years, almost half of the banks, which hold 30% of the sector’s as-setsasawhole,wentbankrupt.TheirtotaloperatingdeficitamountedtoUS$11.8billion(withthevalueofassetsattheendof2016standingatUS$45.7billion)andthebanks’capitalinhryvniaswasreducedalmostbyhalf.

•Acrisisonthisscalewasnotonlytheresultoftheeconomiccollapseag-gravatedbythewarwithRussia(includingtheoccupationofCrimeaandthelossofcontrolofapartoftheDonbas)andthedomesticpoliticalcrisis(includingtheRevolutionofDignity),butwasmainlycausedbythedys-functionofthebankingsectorandbadpracticesconnectedwithso-calledoligarchicbanking,whichhadbeenpresentinthesectorformanyyears.Inmanycasesthebankswerenotinvolvedintypicalfinancialoperationsandinsteadweretreatedbytheirownersasinstrumentstoobtainfundsintendedfordoingbusinessinothersectorsoftheeconomy.Moreover,itturnedoutthatsomeofthebanksde facto operatedinpyramidschemes.

•Itcanbeestimatedthatin2014–2016thelossesincurredbythestateandbanking sector clients exceeded US$ 20billion (23% of Ukraine’s GDP in2016).Theselossesincludedclients’uninsuredlostdeposits,statepayoutstoinsureddepositsforinsureddeposits,unpaidcentralbankrefinancingloans, the costs of refinancing, and costs of recapitalisation from centralbankfundsandfromstatebudget.Aportionofthesefunds(itisnotpos-sibletodeterminetheexactsum)hasbeenillegallytransferredfromthebankingsystemtocompanieslinkedtothebanks’ownersorabroad.

•Ukraine’s leadership has managed to stabilise the situation in the bank-ingsectorandhaltthedownwardtrends,inlargepartduetoconsiderablesupport from and under major external pressure from the InternationalMonetaryFund,theEuropeanUnionandotherWesternstates.Significantamendmentswereintroducedtoregulatethefunctioningofthebankingsector, the sector itself was cleansed of insolvent entities, andthe finan-cialstandingofbanksoperatingonthemarketwasstrengthenedandim-provedbywayofrestructuringandrecapitalisation.

•Regardlessoftheachievedstabilisationofthesituationinthebankingsec-tor,itistooearlytodeterminewhetherthereformsbroughtsuccessandif

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theimprovementissustainable.Atpresent,continuedimplementationoflegalreformsisofparamountimportance,includingreformstoprotecttherightsoflenders(forexampleinvolvingtheimprovementofloansecurityrequirementsandcreditriskassessment).Asfarastheoperationofspe-cificbanksisconcerned,itisnecessaryforthemtoboosttheirlendingac-tivityandcontinuetheirrestructuringandcorporategovernancereform.Itisequallyimportanttofurtherstrengthenbankingsupervisionandtoincreasetheefficiencyofpublic-orderinstitutionsinpreventingfinancialcrime.

•Thecrisishasmadeitnecessaryformajorchangestobe implementedinthe functioning and structure of the banking sector. Examples of theseinclude:theconsolidationofthehithertorelativelyfragmentedsector(atpresentalmost90%ofassetsbelongto the20largestbanks); largestate-ownedandforeignbanksachievingadominantmarketposition;andama-jorreductioninthemarketshareofbankswithprivateUkrainiancapitalwhichpreviouslyhadafairlystrongposition.

•Thechanges inthebankingsectorhavemajorconsequencesnotonlyforthefunctioningoftheUkrainianeconomy,butalsoforUkraine’spoliticalsystem.Priortothecrisis, thebankshadbeenanimportant instrumenttheoligarchsusedtogeneraterent(notalwaysinalegalandtransparentmanner)andtobuildpoliticalinfluence.Recentchangesinhowthesectorfunctions have limited the opportunities to apply illegal practices in theformwhichhasbeenusedtodate.Asaresultofthechangesinthebanks’ownershipstructureitisnolongerwidelypossibletousethesebanksasinstruments for exerting political pressure. However, it should be notedthatpositivetrendshavenotyetbeensolidifiedand,giventhefactthatthesupervisionbodiesandthelegalsystemareweakandthatthereisomni-presentcorruption,anumberofirregularitiesdopersistinthefunctioningofthebankingsector.

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I. ‘Bankopad’, or the collapse of the Banks

ThedeepeconomiccrisiswhichcamehardontheheelsofthedramaticeventssurroundingtheRevolutionofDignityandRussia’saggressioninearly2014hasresultedinaseriousslumpintheUkrainianeconomyandasignificantdeterio-rationofmacroeconomicindicators.Itinvolved,forexample,arapiddeclineofGDP(-6.6%in2014and-9.9%in2015),amajorriseintherateofinflation(reach-ing43%attheendof2015),analmost70%devaluationofthehryvnia,andadropofaround15%inforeigntradeturnoverandinvestmentin2014-2015.

Chart 1. Ukraine’s economy during the crisis, the change in GDP, inflation and the value of export of goods and services, in %

2014 2015 201620132012

GDP

Inflation at the end of the period

Export of goods and services(year on year change)

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Source:InternationalMonetaryFund

Theeconomiccrisiswasoneofthefactorsthatcausedthecollapseinthebank-ingsector.Mostimportantly,therehasbeenaconsiderabledeteriorationofthebanks’profitabilityandcapitalflight.In2014and2015,UkrainianbanksrecordedanoperatingdeficitofUS$3.3billion(3.6%ofGDP)andUS$2.7billion(3.1%ofGDP)respectively.In2016,thesituationbegantograduallystabiliseandon1DecemberthedeficitstoodatUS$0.7billion.However,duetothestatetak-ingoverUkraine’slargestbank,PrivatBank,inDecember2016andtotheneedtorecapitaliseit,thebankingsector’soperatingdeficitincreasedtoUS$5.8bil-lion(or6.7%ofGDP)attheendof2016.Asaconsequence,overthesethreeyearstheaccumulateddeficitamountedtoUS$11.8billion.

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Chart 2. The banking sector’s operating indicators, in billion hryvnias

01.01.2012 01.01.2013 01.01.2014 01.01.2015 01.01.2016

01.12.2016

01.01.2017

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Profit Loss

Operating balance

[bn UAH]

Source:NationalBankofUkraine

Althoughthevalueofthebanks’assetsexpressedinUkraine’snationalcur-rencyremainedpracticallyunchangedandamountedto125-130billionhry-vnias,duetothehryvnia’sdevaluation,thevalueoftheseassetscalculatedinUSdollarsfellsharplyfromUS$159billionon1January2014toUS$46billionon1January2017.Inaddition,therehasbeenasignificantoutflowofbank-ingcapital–from192.6billionhryvnias(US$24.1billion)on1January2014to103.7billionhryvnias(US$4.3billion)on1January2016and123.8billionhry-vnias(US$4.5billion)on1January2017.Thisposedasignificantthreattothebanks’financial liquidity,especiallyin2014and2015.However,in2016thebanksgraduallybegantoimprovetheirliquidityduetorecapitalisationandrestructuring.

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Chart 3. The banks’ assets and the value of their capital

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Value of assets in UAH

Value of assets in US$

Capital in UAH

[bn UAH / bn US$] [bn UAH]

Source:Author’sowncalculationsbasedondatacompiledbytheNationalBankofUkraine

Arapidincreaseinthevalueoftheso-called‘non-performingloans’(NPL)wasamajorproblem.AccordingtotheNationalBankofUkraine(NBU),theirshareinthetotalvalueofextendedloansincreasedfrom7.7%on1January2014to30.5%on1January2017.However,inconnectionwiththestatetakingoverPri-vatBankandreassessingitsloanportfolio,theNBUestimatesthattheshareofnon-performingloansmayriseto46%in2017.AccordingtotheIMF,whichusesabroaderdefinitionofNPL,anincreaseintheshareoftheseloanswasrecorded,from26.1%inMarch2014to48.2%inJune2016.Thecapitalflightandthede-teriorationoffinancialliquiditycontributedtoadropinthevalueofextendedloanswhich,inturn,hadseriousconsequencesfortheeconomyandlimitedtheopportunitiesforlocalcompaniestodobusiness.Asidefromthedomesticsituationcausedbytheeconomiccrisis,theproblemsfacedbylocalcompaniesandthesiphoningoffoffundsonalargescale,thefactorsthatcausedamajorincreaseintheshareofnon-performingloansalsoincludedtheRussianoccupa-tionofCrimeaandthewarintheDonbas,sinceinterritorieswhichKyivhadlostcontrolofborrowerssimplyceasedtopayofftheirloanstothebanks.AttheendofMarch2014,thevalueofloansextendedbyUkrainianbanksinCrimeaandintheDonbasstoodat95billionhryvnias(aroundUS$6billionaccordingtotheexchangerateapplicableatthattime),ofwhich36billionhryvnias(US$1.5billionaccordingtotheexchangerateapplicableatthattime)wereloanstakenoutbyhouseholds.Theshareoftheeasternregionsintheloanportfolioofindividualbankswasbetween25%and33%,whereasCrimea’ssharewasaround3%.Over70%ofloanstakenoutintheseregionsarenotbeingserviced.AccordingtoestimatesbytheMinistryofFinance,lossesincurredbythebanks

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inconnectionwithunpaidloansinregionsoutsideKyiv’scontrolamounttoaround60billionhryvnias(approximatelyUS$2billionaccordingtotheMay2017exchangerate)1.

Chart 4. The value of extended loans in billion hryvnias and the proportion of unpaid loans in %

01.01.2012 01.01.2013 01.01.2014 01.01.2015 01.01.2016 01.01.2017

The value of extended loans Corporate client loans Retail client loans

The proportion of non-performing loans in % (right axis)

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25[bn UAH] [%]

Source:NationalBankofUkraine

Thedeclineofthesituationinthebankingsectorresultedinseveralbanksbe-cominginsolvent.ThesewerebanksthatwereunabletomeettherequirementsintroducedbytheNationalBankofUkraineregardingfinancialliquidity,thequalityofcapitalandtheassets.Thenumberofbanksoperatingonthemar-ketfellfrom180inJanuary2014,to93inJanuary2017.Thevalueofassetsoftheinsolventbanksaccountedforaround30%ofthetotalvalueofassetsinthebankingsectorasawhole.Theinsolventbankswerealmostexclusivelyprivately-ownedbankswithUkrainiancapital(orde factoUkrainianbanksregisteredinCyprusorothertaxhavens)andthereasonsbehindthembecom-inginsolventgenerallyincludedthelackofabilityorwillonthepartoftheirownerstorecapitalisethem.

The banks that managed to sustain their market position are either state-ownedbankswhichreceivedrecapitalisationfromthecentralbank,orforeignbankswhichcouldcountonsupportfromtheirinvestorsandwhichhadbeen

1 П. Харламов, Неподъемное бремя: как банки добиваются погашения по кредитамв Крыму и зоне АТО, RBK-Ukraina, 26August 2016; https://daily.rbc.ua/rus/show/nepo-demnoe-bremya-banki-dobivayutsya-pogasheniya-1472202911.html

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followingaverycautiouslendingpolicy.Asaconsequence,thestatusofbankswithforeigncapitalincreasedconsiderablyinthebankingsector.Theirshareintheregulatorycapitalofthesectorasawholeincreasedfrom34%inJanuary2014,to55.5%inDecember2016.

Chart 5. ‘Bankopad’ – the drop in the number of banks operating in Ukraine

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01.01.2012 01.01.2013 01.01.2014 01.01.2015 01.01.2016 01.12.2016 01.01.2017

Number of banks Number of banks with foreign capital

The share of foreign capital in the banks’ regulatory capital, in %(right axis)

[%]

Source:NationalBankofUkraine

Accordingtoestimates,in2014-2016thetotallossesincurredbythestateandtheclientsoftheUkrainianbankingsectoramountedtoaroundUS$14.5bil-lion,plusthecostsconnectedwithstateassistanceandnationalisingUkraine’slargestbank,PrivatBank,whichmaybeafurtherUS$6billion.Amajorportionoftheselosses(itisdifficulttodeterminepreciselyhowlarge)maybefundsillegally transferredfromthebankingsector.US$3billionarerefinancingloansunpaidtothecentralbankbytheinsolventbanks,US$8.5billionarenon-insuredclients’depositswhichhadbeenlost,andanotherUS$3billionarepaymentsmadebythestateasinsurancefordepositswhichclientshadmadeinbanksthatbecameinsolvent.Sofar,onlyaminorportionofthelostfundshasbeenrecovered–aroundUS$150million2.Accordingtoofficialinformation,asatthebeginningof2017,theDepositGuaranteeFundopened3,835criminalcaseswithatotalvalueof295.5billionhryvnias(US$10.8billion),ofwhich262caseswithavalueof62.56billionhryvnias(US$2.3billion)involvetheftandsiphoningofffundsfromthebanks.

2 I.Koshiw,Y.Romanyshyn,Ukraineindangerofneverrecoveringstolenbillions,Kyiv Post,23December2016.

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II. olIgarchIc BankIng

ThelargescaleofthecrisisinUkraine’sbankingsectorwasnotonlycausedbythepooreconomicsituation,butmainlybystructuralirregularitiesandpathologiesinthebankingsystemandinhowthebanksfunctionwhichhadbeenpresentformanyyears.ThissituationresultsfromthefactthatanoligarchicsystemexistsinUkraine.Thisischaracterisedbythemassiveandnon-trans-parentinfluenceonstateinstitutionswhichinformalpolitico-businessgroupshaveandbyahighlevelofcorruption.Thedysfunctionofthebankingsectorhasalsobeencausedbytheinefficiencyofthestateinstitutionsandthelackofpropersupervisionofthissectormainlyonthepartofthemarketregulatorandfinancialsupervisionbodiesandalsobythestateservicescombatingfinan-cialcrime.Thiswascombinedwithinsufficientlegalregulations(forexampletheinsufficientprotectionoflenders’rights,faultyregulationsregardingloansecurityevaluation)andthelarge-scalecorruptionandweaknessofprosecu-tionbodiesandthejudiciary.

The most frequent pathologies in the banking system can be illustrated bythreemaincategoriesofbanksthathavebecomeinsolvent.Thefirstcategoryincludestheso-called‘oligarchicbanks’involvedinobtainingfundsforcom-paniesownedbylocalbusinessmoguls.Thesecondcategoryaretheso-called‘zombiebanks’thatonlyhadliabilitiesandnocapital,andwereusedtosiphonofffundstooffshorelocations.Thethirdcategoryincludesbanksinvolvedinmoneylaunderingwhichhadneitherassetsnorliabilitiesandwereusedtohideand/ortransferillegalfundstooffshoreaccounts.Inaddition,thepracticeofsiphoningofffundsfromstate-ownedbanksshouldbementioned,forexampleusingpoliticalconnectionstoobtainattractiveloanswhichthenwerenotpaidoff.Thebankswerealsousedinothertypesofillegalpractices,forexamplein‘corporateraiding’i.e.illegalcompanytakeovers.

Intheoligarchicsystemthebankswereanimportanttooltomanagefinancialflows,obtainfundsandtofinancebusinessactivity.Practicallyeverymajoroligarchownedabank(orevenseveralbanks)orindirectlycontrolledabankviaanetworkofhisassociates.Theactivityofabankofthiskindfocusedmainlyonprovidingservicestocompaniesownedbythisoligarch.Onlylatercouldthisbankofferitsservicestootherclients.

Thefactthattheownerstreatedthesebanksexclusivelyastoolstofinancetheirprivatebusinesses,andnotascompaniesprovidingfinanceandbankingser-vicesavailabletoeveryone,wasoneofthemostfrequentirregularitiesinthe

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Ukrainianbankingsector3.Inpractice,thistypeofactivity(so-called‘captivebanking’)boileddowntoobtainingcapital–oftenfromthemarketbyofferinganexcessivelyhighinterestrateondepositsorintheformofrefinancingob-tainedfromthecentralbank–andthentransferringthefundstocompanieslinkedtothebank’sownerasloansfrequentlyextendedonveryfavourablecon-ditionsandwithinsufficientcollateral.Inmanycases,theseloanswereofferedtocompanieslinkedtothebank’sownersorshareholdersonanenormousscale.FormercentralbankgovernorValeriyaHontaryevaestimatesthatastaggering97-100%ofthecorporateloanportfolioofPrivatBank(Ukraine’slargestbankwhichuntiltheendofDecember2016hadbelongedtotwooligarchs,IhorKo-lomoyskyiandHenadiyBoholyubov)wasextendedtocompanieslinkedtotheowners4.Themostimportantproblemwasthattheseloanswerenotproperlysecured,whichde factofacilitatedthetransferofmajorfundsfromthemarket.Thelossesincurredinthiswayeitherturnedouttobeirreversibleorhadtobecompensatedforfromstatefunds(forexample,inthecaseofdeposits,thecom-pensationwaspaidoutfromtheDepositGuaranteeFund).Forexample,afterthestatetookoverPrivatBankitturnedoutthatthebank’scapitalshortfallamountedtoaroundUS$5.7billion(atthebeginningof2017thegovernmentadoptedaplantorecapitalisethebankwithapproximatelyUS$4.3billionandanadditionalUS$1.5billioninJune2017).

3 Thisapproachiswellillustratedbythewords:“You’renotabank,you’reacashdesk.Youshouldrememberit!”.ThesewordswereallegedlysaidinOctober2013byOleksandrDyn-nyk,thethendeputyheadoftheVETEKcompanyownedbySerhiyKurchenko,abusiness-manlinkedtoYanukovych,toIhorFrantskevych,thenpresidentofBrokbiznesbankthatalsobelongedtoKurchenko.Frantskevych,whowasabank-managerKurchenkohadhiredtorunhisbank,hadobjectedtothetransferofmajorfundsfromthebank.InDecember2013,FrantskevychwasreplacedbyDynnykasthebank’spresident.After:Ю.Сколотяный,Ограбление страны: "кейс Брокбизнесбанка" без ручки, Zerkalo Nedeli, 18December2015;http://gazeta.zn.ua/finances/ograblenie-strany-keys-brokbiznesbanka-bez-ruch-ki-_.html

4 TheformerprivateownersofPrivatBankwhichisnowstate-owneddenythisinformation.

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Chart 6. Captive banking in Ukraine

Companies linkedto the bank

or fictitious companies The bankClients

(deposits)

Refinancing loansfrom the NBU

Correspondent accountsin foreign banks

Offshore companiesand accounts linkedto the bank’s owners

Muchmoreseriousconsequencesinvolvethe‘oligarchicbanks’thathavebe-comeinsolvent.Forexample,thefollowingcasesofbanksbecominginsolventreceivedthemostmediaattention:

– NadraBankownedbyDmytroFirtash,anoligarchactivemainlyinthechemicalandgassector;in2008-2009thebankreceivedrecapitalisa-tionfromthecentralbankofaroundUS$1.5billion,ofwhichamereUS$13millionhasbeenrecovered;

– FinanceandCreditBankownedbyKostyantynZhevago,activemainlyin the metallurgical and machine-building sector; the bank’s clientslostUS$380millionandthestatelostUS$60millionofrecapitalisationwhichhasnotbeenreturned;

– VAB Bank owned by Oleh Bakhmatyuk who is doing business in theagriculturalandfoodprocessingsector;US$220millionofadditionalcapitalprovidedbythecentralbankhasbeenlostandthebankguar-anteefundhadtocompensatetheclientsforUS$395millionoflostde-posits;sofar,theinvestigatorshavedeterminedthatthetotalvalueofloansthebankhadextendedtocompanieslinkedtoBakhmatyukwasUS$125million;

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– bankscontrolledby individualsassociatedwith formerpresidentYa-nukovych, for example Brokbiznesbank owned by Serhiy Kurchenkoand several smaller banks: for example the WBR bank owned by Ya-nukovych’s son Oleksandr, Expobank controlled by Serhiy Arbuzov,ProfinbankcontrolledbyYuriyIvanyushchenkoandKyivskaRuscon-trolledbyYuriyBoykoandYevhenBakulin;

– 25% of its assets belonging to the city of Kyiv; the central bank esti-matesthat75%ofitsloanportfoliowasactuallyextendedtocompanieslinked to the bank’s private stakeholders, mainly the oligarch VasylKhmelnytsky;

– Forum Bank which belonged to Vadym Novinsky, a businessman ofRussianoriginactiveinthemetallurgical,machine-andship-buildingsector,andagriculture.

Irregularitieswerealsorecordedintheactivityoftheso-called‘zombiebanks’.Thesebankshadnoassetsandtheiroperationexclusivelyinvolvedtransfer-ringfundstooffshorelocations,mainlytoaccountsintaxhavens.Oneoftheoperatingschemes(theso-called‘Alpinebanks’scheme)involvedtransferringfundsviaforeignfinancialinstitutions—forexample:MeinlBankandWinterBank(registeredinAustria),East-WestUnitedBank(registeredinLuxem-bourg),BankFrick(registeredinLiechtenstein),andJuliusBaer(registeredinSwitzerland).Simplyput,theschemeinvolvedtheUkrainianbankopeningcorrespondentaccountsinforeignbanks.Next,thebank’sUkrainianshare-holderstookoutaloanfromtheforeignbankusingthefundstransferredtocorrespondentaccountsascollateral.Aportionofthisloanwasintendedasre-capitalisationfortheUkrainianbankandanotherportionwastransferredtooffshorelocations.Whentheloanwasnotpaidoff,thefundsaccumulatedoncorrespondentaccountswereseizedbyforeignlenders.AccordingtoUkrain-iancentralbankgovernorValeriyaHontaryeva,in2014aloneastaggeringUS$2billioncouldhavebeensiphonedoffinthismanner.Similarschemesfortransferringmoneytooffshorelocationswereusedbyboth‘zombiebanks’and‘oligarchicbanks’.

Finally,someofthebanksoperatedinade factopyramidscheme.Oneexam-pleinvolvestheMykhailivskiyBankwhichofferedhighinterestondeposits.Theobtainedfundsweresubsequentlyforwardedtoafoundationlinkedtothebank’sowners,makingthemexemptfrombankingsupervisionandfrominsur-anceofferedbythebankguaranteefund.Thefundswerethentransferredtootherlocationsbytheindividualswhoactuallycontrolledthebank.Asacon-sequence,theclientslosttheirdepositstotallingoverUS$38million.

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WhenthepoliticalandeconomiccrisisinUkraineworsenedatthebeginningof2014,numerousbankownersortheindividualswhoactuallycontrolledspecificbanks,aswellasotherindividualsinvolvedinbusinessactivity,begantotrans-ferfundsfromUkrainetooffshorelocationsviaUkrainianbanks.Thiscontin-uedonalargescaleuntilaround2016.Thereasonbehindthisstrategywastheomnipresentchaos(surroundingthepoliticalchanges,thewarwithRussia,theeconomiccrisis),corruption,weaknessofstateinstitutions,andmistakesmadebyfinancialsupervisionbodiesandsecurityinstitutions.Detailedinformationisscarceastotheexactamountoffundsthatcouldhavebeentransferredinthismanner.However,itcanbestatedthatthescaleofthisactivitymusthavebeenenormousconsideringthatthelossesincurredbythestateinconnectionwiththispracticeexceededUS$20billion.

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III. staBIlIsatIon – real or feIgned?

ThecrisisinthebankingsectorhasbecomeoneofthemostseriouschallengestheUkrainianleadershipfacedafter2014.AnimprovementofthesituationinthebankingsectorwasconsideredoneoftheprioritiesoftheUS$17.5billionsupportprogrammeimplementedbytheIMF5.ThekeyroleinimplementingthereformprogrammewasplayedbytheNBU(whichisthecentralbankandmarketregulator)incollaborationofthegovernmentandtheMinistryofFi-nanceandwithsupportfromthepresident,aswellassignificantsubstantiveandfinancialassistancefromtheIMFwithoutwhichnoimprovementwouldhavebeenpossible.

Thecounter-crisisactionscarriedoutin2014-2016mainlyinvolved:

– performingathoroughassessmentofthesituationinthesectorandofthebanks’financialstanding,

– cleansingthebankingsystemofinsolventbanksand/orthosethatop-eratedillegallyorwhichwerede factooperatinginpyramidscheme,

– improvingthefinancialsituationoftheotherbanksoperatingonthemarket,

– increasingtransparencyinhowthebankingsectorfunctions,– improving corporate governance and the functioning of state-owned

banks.

In2015-2016,thecentralbankperformedadiagnosticofthesituationofthelargestbanks.Thisinvolvedassessingtheirfinancialliquidity,loanportfolios,investorrelations(includingloansextendedtoindividualslinkedtotheowners).Theanalysiscomprisedtwoelements:anassessmentofthequalityofassetsandtheperformanceofstresstestsalongsideananalysisofthebanks’resiliencetomacroeconomicshocks.Itcoveredthe60largestbankswhichhold97%ofthesector’sassets.Thestresstestsrevealedthatthequalityoftheloanportfoliowasmuchworsethanthebankshaddeclared.Atthesametime,thetestsformedthebasisforaprogrammetobedevisedinvolvingthecentralbanksrecapitalis-ingthebanks.Moreover,intheinitialstageofthecrisis,regulationswereim-plementedtolimitthetransferoffundstooffshorelocations.Atpresent,theseregulationsarebeingcancelledduetoanimprovementoftheeconomicsituation.

5 InternationalMonetaryFund,Secondreviewundertheextendedfundfacilityandrequestsforwaiversofnon-observanceofperformancecriteria,rephasingofaccessandfinancingassurancesreview,IMFCountryReportNo.16/319,September2016.

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Thepresentsituationindicatesthattheauthoritieshavemanagedtostabilisethesituationinthebankingsectorandhaltthedownwardtrends.Thisiscon-firmedbyspecificindicatorsthatshowaslowincreaseinthebanks’assets,capi-talandrevenues,aswellasanincreaseinthevalueofloansofferedtoclients.Itisratherunlikelythatothermajorbankswillbecomeinsolventasalmostallin-solventandnon-transparentbankshavebeenremovedfromthemarket.WhenthestatetookoverUkraine’slargestbank,PrivatBank,attheendofDecember2016andlauncheditsreorganisationprogramme,itbecamepossibletoremovethefinalpotentialmajorthreattothestabilityofthebankingsystemposedbyPrivatBank’spotentialcollapse.TheNBUishopingthatin2017thebankswillmanagetoachieveapositivebalance.

Despitepositivetrendsinthebankingsectorandaslowimprovementofthemacroeconomicsituation,itistooearlytoconcludethattheupwardtrendsaresustainable.Usingvividlanguageonecansaythatthefirewasputoutandnowitisnecessarytorebuildwhathasbeendestroyed.In2017,themostimportantgoalsofthereformprogrammesupervisedbytheNBUinvolveresumingandin-creasingthebanks’lendingactivity,introducinglegalregulationstoprotecttherightsoflenders,includingnewrulesforloanriskassessmentandloansecurity,aswellasimplementingnewbankingsupervisionrulesandbanks’liquiditystandards.Theunstabledomesticpoliticalsituation,causedbystronginternalconflict,continuestobeamajorproblemthattranslatesintothepoorqualityandinefficiencyofparliamentarywork.Forexample,in2016theUkrainianparliamentdidnotmanagetoadoptanysignificantlegalactsofmajorsignifi-cancetothebankingsectorwhichcontributedtoanimprovementinhowitfunctions.Inaddition,attentionshouldbepaidtotheextremelylowlevelofefficiencyofstateinstitutionsinrecoveringfundssiphonedofffromthebank-ingsector.Atthesametime,duetotheweaknessoftheapplicablelawandofthejudiciary,theNBU’sdecisions,includingthosepertainingtotheclosingofbanks,arebeingrepealedinthecourts.EventheactivityoftheNationalBankofUkrainehascomeunderscrutinybyinvestigativebodies.InFebruary2017,theNationalAnti-CorruptionBureauofUkraine(NABU)launchedaninvestigationintothelegitimacyofNBUspendingfundstorefinancebanksin2015-2016.Sofar,nochargeshavebeenformulated.

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IV. “prIVatBank Is the guarantor of the constItutIon”6

Theverystrongpositionofonemarketparticipant,PrivatBank,wasandcon-tinuestobeauniquefeatureofUkraine’sbankingsystem.UntilDecember2016,ithadbelongedtotwooligarchs:IhorKolomoyskyiandHenadiyBoholyubov(whoowned49.98%and41.57%ofthesharesrespectively).On21December2016,100%ofthebank’sshareswastakenoverbythestaterepresentedbytheMin-istryofFinanceforthesymbolicpriceof1hryvnia.

PrivatBank,oneofUkraine’soldestbanks,builtitsstrongpositionafterthe2008-2009financialcrisis.Sincethen,itcontinuedtoincreaseitsassetsatamuchfasterpacethanotherbanksdid.BetweenQ12007andQ12016,thevalueofassetsofallUkrainianbanksroseby400%,whereasforPrivatBankthisfigurewas752%.Betweenthebeginningof2010untiltheautumnof2016,thebank’smarketsharerosefrom16%to36%intheretailclientssegmentandfrom11%to25%inthecorporateclientssegment.Whenitwastakenoverbythestate,thebankprovidedservicesto20.5millionretailclients(morethanhalfofUkraine’sadultpopulation),500,000one-personbusinesses(70%ofthetotal)and600,000largercompanies(56%ofthetotal)7.ThebankoweditsimpressivereachtothedevelopmentofthenetworkofofficesandATMsacrossthecountry,aswellastoitscreditcardservices,inparticularitshighqualityinnovativeITservices(includingthePrivat24systemdevelopedex-clusivelyforthisbank).Duetoitssize,thebankwasconsideredas‘asystembank’,i.e.oneofthebanksofkeysignificanceforUkraine’sbankingsystem(in 2016, aside from PrivatBank, two state-owned banks Oschadbank andUkreximbankwerealsoonthislist),whichisdefinedasaninstitutionwhichwouldposeathreattothestabilityofUkraine’sbankingsystemwereittobecomeinsolventoroperateinanimpropermanner.Thismeantthatthestateofferedspecialtreatmenttothisbank,includingspecialsupervision,andwasobligedtosupportit.

6 ThisisaquotationfromaskitbyUkrainiancomedygroupKvartal95.Intheskit,IhorKolo-moyskyitalkstoPresidentPoroshenko:“Poroshenko:Whatkindofjokeisthat?PrivatBankistheguarantoroftheconstitution?;Kolomoyskyi:Isn’titthecase?”after:https://youtu.be/Et-mM92HPxQ?t=434(from7:14till7:30min.)

7 Dataafter:ЕленаШкарпова,Хорошийбанк,плохойакционер,злойрегулятор,voxukraine.orgforUkrayinska Pravda,20January2017;www.pravda.com.ua/rus/articles/2017/01/20/7132961ЮлияСамаева,"Приват"—государство:заходдомата,Zerkalo Nedeli,9December2016;http://gazeta.zn.ua/macrolevel/privat-gosudarstvo-za-hod-do-mata-_.html

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However,underpreviousshareholdersPrivatBank’sactivitysparkedcontro-versymainlyduetonon-transparentfinancialoperations.BanksownedbyPri-vatBankinLatviaandCyprusincurredfinesfromlocalsupervisionbodiesformoneylaundering(in2015theCypriotregulatorimposeda€1.5millionpenaltyonasubsidiaryofPrivatBank).Thebankwasalsoinvolvedinsiphoningofffundsintheso-calledAlpinebanksscheme;accordingtoestimatesin2014-2016morethan€1.16billionmayhavebeensiphonedoffinthisway.Overthelastthreeyears,othermethodsforsiphoningofffundsincludedtheso-called‘back-to-backloans’8,accordingtoestimatestheamountsiphonedoffthiswaycouldbeatleast€700million.Seriousdoubtshavealsoemergedregardingtheloansofaround€2billionextendedin2014-2016whichhavede facto beeninjectedintocompanieslinkedtoIhorKolomoyskyi.Thepracticeboileddowntoextendingloanstovariousfictitiouscompanieswithminimumcapital(wortharound€36)registeredinKharkivandDnipropetrovsk9andmainlyinvolvedintheretailsaleoffuels(companiescontrolledbyKolomoyskyiincludedUkrnafta,themainplayeronUkraine’soilmarket),fromwherethemoneywastransferredtooff-shorelocations10.Thecapitalthathasbeensiphonedofffromthebanksincludedbothfundsobtainedonthemarket(forexampledeposits,loans)andrefinancingloansfromthestate.Consideringthescaleandthenatureofthebank’sactivity,itispossibletoconcludethatwhentheeconomiccrisisbrokeoutinUkraine,thebank’sownersdecidedtotakeadvantageofittosiphonoffasmanyfundsaspossibletosavetheirownrevenues.Indoingso,theyexploitedthefactthatduetothebank’ssignificancefortheeconomyasawholethegovernmentwasforcedtoofferassistancetoitregardlessofitsdeterioratingfinancialstanding(theassistanceofferedbythegovernmentincludedrefinancingloans,andthepostponementoftheimplementationofcertainadministrativeordersbythebank).Asaconsequence,accordingtoofficialinformationinDecember2016,thebank’sfundingshortfallamountedtoaround148billionhryvnias(aroundUS$5.7billion).Atthesametime,duetoitssizethebankwasbeingusedbyitspreviousownersasatooltoputpressureonthegovernmentandtoforceittotakepoliticaldecisionsthatwouldbefavourableforthisgroup.

8 ‘Back-to-backloan’isaloantwocompaniesfromdifferentcountriesmutuallygranteachother.Itisexpressedinthecurrencyofthelendingcompany’scountry(forexampleUkrain-iancompaniesextendaloanexpressedinhryvniastoacompanyregisteredintheEUandaEuropeancompanyoffersaUkrainiancompanyaloanexpressedineuros).Thepurposeofthistransactionistosecureoneselfagainstexchangeratefluctuation.

9 ThecityisnowcalledDnipro.10 GrahamStack,HowPrivatBank billionsvanished throughAlpine ‘transitbanks’,bneIn-

telliNews, 20December 2016; http://www.intellinews.com/how-privatbank-billions-van-ished-through-alpine-transit-banks-112551/?source=ukraine

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However, as the shortfall in the bank’s finances grew, the two sides foundthemselvesinadifficultsituation.KolomoyskyiandBoholyubovwerenotable,orratherwerenotwilling,torecapitalisethebank.Werethebanktobecomeinsolvent,though,theywouldsuffermajorfinanciallosses(forexample,theywouldberesponsibleforthelostdepositsandforactingtothedetrimentofthecompany,whichwouldexposethemtocriminalliability).Thestateauthorities(i.e.thepresident,thegovernment,thecentralbank),fortheirpart,wouldnotletPrivatBankbecomeinsolvent(orperhapsdidnotwantto)duetothesocialcostpotentiallyassociatedwiththisfailure(morethan20millionclients)andthethreatofthecollapseofthefinancialsystemasawhole.Inthissituation,andalsounderpressurefromtheinternationalcommunity(includingtheIMF),adecisionwasmadethatthestatewouldpurchase100%ofthebank’ssharesforthesymbolicpriceof1hryvnia.Inadditiontothis,thebank’scapitalisa-tionwasincreased(bythecentralbankviarefinancingloansandtheissueofinternalbonds)by116.8billionhryvnias(US$4.3billion),ofwhich107billionhryvniaswasprovidedimmediatelyafterthestatetookoverthebankbackinDecember2016.AnothertrancheofstatefinancialsupportworthUS$1.5billiontothebankwastransferredinJune2017.ItshouldbenotedthatthebankhadalreadyreceivedrefinancingloanstotallingUS$1.2billion.

Itwasagainstthisbackdropthatanotherconflictemergedoverhowthestatetookoverthebank.Thebank’spreviousprivateownersfiledalawsuitwithacourtinLondonagainstthepresentowner,i.e.thestate,concerningthepur-chaseofthebondspreviouslyissuedbythebankworthUS$600million.Thestate,foritspart,explainedthatthebank’snationalisationhadbeencarriedoutinlinewiththe‘bail-in’rescueprocedurewhichforcesthelendersoftherescuedbanktobearsomeofthecostsandthatthebondswereseizedtocoverthesecosts.Atthesametime,courttrialsareunderwayinwhichtheNBU’sde-cisionstorecognisesomeoftheborrowersaspersonslinkedtothebankand,assuch,forcedtobearthecostsofrescuingthebankunderthebail-inprocedure,havebeenappealedagainst (thisconcernsforexamplethecompaniesownedbyorlinkedtobrothersHryhoriyandIhorSurkis,businesspartnersofthebank’spreviousowners11).

Summingup,asawholethetransactioninvolvingthestatetakingoverthebankwasfavourableforKolomoyskyiandBoholyubov,whohavecastofftheir

11 Formoreonthissee:Ю.Самаева,НБУvs"Динамо".Ктозабьетвнашиворота?,Zerkalo Nedeli, 19May 2017; https://gazeta.zn.ua/macrolevel/nbu-vs-dinamo-kto-zabet-v-nashi-vo-rota-248847_.html

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problemsassociatedwithabankthatneededenormousrecapitalisation,hav-ingsiphonedoffmajorfundsfromit.Thestate,foritspart,wasplacedinadeadend,asontheonehanditassumedliabilityforconsiderablecostsofthebank’srestructuringandontheother,managedtoavoidtheinsolvencyofabankofstrategicimportance,thusmaintainingthecountry’sfinancialstabilityandavoidingmajorsocialcosts.

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V. the sItuatIon after the crIsIs

The2014-2016crisishasresultedinveryseriouschangesinhowUkraine’sbank-ingsectorisstructuredandfunctions.Thesector’sstructurebecamemorecon-centrated;atthebeginningof2017,the20largestbanksheld89.4%oftheassetspresentinthesystemasawhole,whereasinDecember2013theproportionhadbeen73%.ThebanksthathavebecomeinsolventalmostexclusivelybelongedtoUkrainianprivatecapital(excepttwosmallstate-ownedbanks–RodovidandBankKyiv).Asaconsequence,theroleandtheshareofstate-ownedbanksandbankswithforeigncapitalhaveincreasedsignificantly.TheUkrainianstateownssevenbanks(includingUkraine’slargestbank,PrivatBank)whichinto-talhold51.3%ofthesystem’sassets,whereasinDecember2013theproportionhadbeen18.1%.Theshareofassetscontrolledbybankswithforeigncapitalincreasedfrom25.9%inDecember2013to34.9%inDecember2016.Overthesameperiod,theshareofassetsheldbyprivatebanksfellfrom56.1%to13.8%.

TheperiodbetweenDecember2013andDecember2016alsosawamajorchangeinthedistributionofdepositsmadebyretailclients.Theshareofstate-ownedbanksrosefrom13.3%to59.6%,theshareofforeignbanksincreasedfrom22.2%to26.4%,andtheshareofUkrainianprivatebanksfellfrom64.6%to14%.Atpresent,onlytwooutofUkraine’s20largestbanksareprivately-owned(PUMB,ownedbyRinatAkhmetov,andPivdennyi,ownedbyagroupofbusinessmenfromOdessa),andthestateownsUkraine’sfourlargestbanks(PrivatBank,Oschadbank,Ukreximbank,Ukrgasbank).Theremainderarecontrolledbyforeigninvestors.

Chart 7. The structure of the banking sector, the share of net assets in %

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40

50

60

State-owned banks

Foreign banks

Privately owned banks

PrivatBank

[%]

01.01.2014 01.01.2015 01.01.2016 01.07.2016 01.10.2016 01.01.2017

Source:NationalBankofUkraine* In December 2016, PrivatBank was taken over by the state

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VI. the state-owned Banks – the contest for control of fInancIal flows

UntiltheRevolutionofDignityandtheeconomiccrisis,themainproblemofthestate-ownedbankshadinvolvedindividualsholdingpowerortheiraidesusingthesebanksastoolstoobtainlow-costfundingortosiphonofffundsbelongingtothestate.Indoingso,theseindividualsusedthefactthatthesebankswerestate-ownedbanksofstrategicsignificanceforthesystemasawhole,whichwaswhythestatewouldnotallowthemtobecomeinsolventandwasforcedtocontinuouslyprovidethemwithsupport.Itisdifficulttoassesshowmuchmoneyhasbeensiphonedofffromstate-ownedbanksasnopreciseestimatesareavailable.Thescaleofrecapitalisationofstate-ownedbanksmayindirectlybeindicativeofthecostsbornebythestatetreasury.Between2008and2016,thestate’sspendingonthispurposeamountedtoUS$8.7billion.Thisdoesnotmeanthattheentiresumhasbeensiphonedoff,itonlysuggeststhatthescaleofthispracticemayhavebeenenormous.

Thestate-ownedbanks’‘politically-motivated’lendingtocompaniescontrolledby politicians and individuals linked to them had been a common practicethroughouttheperiodofUkraine’sindependence,butitevidentlygainedmo-mentumduringViktorYanukovych’spresidencyin2010-2013.Awholerangeofmethodswasbeingusedtothisend.Onesuchmethodinvolvedextendinghugeloanswithoutproperlysecuringthem(orsecuringthemwithfictitiousassets).In2011,thecompanySCMownedbyRinatAkhmetov,usingthemediationofanassociatedcompanyESUlinkedtoit,tookouttwoloansfromUkreximbankandOschadbankworthUS$2billioneachforthepurchaseofastakeinthecompanyUkrtelecom(whichatthattimewasbeingprivatised).TheloansarenotbeingpaidoffandESUhasalreadyrestructureditsrelateddebttwice12.Anotherexampleofbanksofferingfundingtobusinessesrunbypoliticiansin-volvesOschadbankextendingaloanworthUS$600milliontotheActiveSolarcapitalgrouplinkedtoAndriyKlyuyev,aninfluentialpoliticianintheYanu-kovychera,whoinformallycontrolledthisbank.Itshouldbenotedthataloanofthissizeviolatedthestandardsregardingdebtconcentrationtoonecredi-tor.Oschadbankonlyrecentlymanagedtoobtaincourtdecisionsenablingittocollectthedebtinitsfullamount.Accordingtomediareports,aroundathird

12 WhatmakesthiscaseevenmorestrikingisthatAkhmetovnotonlyboughtthesharesinthestate-ownedcompanyatanattractiveprice(US$10billion)—healsousingmoneyfromloanstakenoutfromfromstate-ownedbanks(US$4billion)whichsofarhavenotbeenpaidoff(defactothismeansthatinsteadUS$10billionhepaidUS$6billionfromhisownfunds).

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ofUkreximbank’scorporateloanportfoliowasextendedtocompanieslinkedtoViktorPolishchuk,abusinessmanwhousedtobeparticularlyactiveintheYanukovychera.Otherillegalpracticesincludedoverestimatingthevalueofcollateralwhentakingoutaloan,understatingthecostofloansandextendingloansagainstthebank’slendingstrategy13.

Othermajorproblemsthestate-ownedbanksfaceincludemismanagementandwidespreadcorruption.Betweenthebeginningof2016andFebruary2017,thecourtsissued332verdictsincriminalcasesinvolvingOschadbankand114in-volvingUkreximbank.Inmostcasesthesebanksweretheaggrievedparty.

Controlofthestate-ownedbanksalsohasmajorpoliticalsignificance.Thecom-positionofthemanagementandsupervisoryboardsistheresultofpoliticalarrangementsmadewithintherulingcoalition.Thepresentgoverningbod-iesofthelargeststate-ownedbanksarelinkedeithertoPeople’sFrontanditsleader,formerprimeministerArseniyYatsenyuk(forexampleOschadbankandUkrgasbank)orPresidentPoroshenko(forexampleUkreximbank,butalsotheNBU).AsforPrivatBank,OleksandrShlapakhasbeenappointeditspresi-dent.HiscandidacyhasbeenagreedbywayofcompromisebetweenPresidentPoroshenkoandPrimeMinisterGroysmanbuthealsohasgoodrelationswithotherpoliticians(includingYatsenyuk).

Theprogrammeforreforminghowstate-ownedbanksaremanaged(whichisalsoanelementoftheIMFassistanceprogramme)announcedbythegovern-mentassumesanimprovementofthebanks’financialstandingandcorporategovernance,followedbytheprivatisationofaportionoftheirshares.Thegov-ernmentisplanningtosellaportion(i.e.20%)ofitsstakeinstate-ownedbanks.DuetothefactthatnootherinvestorsareinterestedinenteringtheUkrainianmarket,thegovernmentisprimarilyhopingthatinternationalfinancialinsti-tutionssuchastheEuropeanBankforReconstructionandDevelopmentwillbethenewshareholders.Thegovernmenthasrecentlyannouncedthatoverthenextfiveyearsitintendstoreducetheshareofstate-ownedbanksinUkraine’sbankingsectorfromthepresentlevelofmorethan50%downto30%.Accordingtothestrategyforreformingstate-ownedbankswhichthegovernmentadoptedin2015,theprivatisationofOschadbankandUkreximbankistobelaunchedinmid-2018,andtheprivatisationofUkrgasbankbytheendof2017.Taking

13 Д.Марчак,ЧтонетаксгосбанкамивУкраинеикакэтоисправить,Ekonomichna Pravda,1September2016;http://www.epravda.com.ua/cdn/cd1/2016/08/chto-ne-tak-s-gos-banka-mi/index.html

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accountofthesituationinthebankingsector,thelackofinterestonthepartofforeigninvestorsandthefiascooftheprivatisationprogrammewhichhasalreadybeencarriedoutinothersectorsoftheeconomy,itisratherunlikelythatthesedeadlineswillbekept.

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VII. the russIan Banks are changIng theIr spots

Thefinancialcrisisand–mostimportantly–thewarwithRussiahavesignifi-cantlyimpactedthepositionofbankswithRussiancapitalinUkraine’sbankingsector.Thechangeismainlyevidentinhowtheyfunction,notintheirshareinthesectorasawhose,asthishasde factoevenincreased.UntilRussia’saggres-sion,RussianbanksorbanksownedbyRussiancitizensbutregisteredinothercountrieshadoccupiedamajorplaceontheUkrainianmarketandtheirmarketsharewas11%,or11.53%includingbankswithRussianminoritycapital14.Overtwoyears,thisproportioncontinuedtoriseandon1October2016itstoodat15.64%forbankswithacontrollingstakeand15.84%forallbankswithRussiancapital(includingbanksownedbyRussiansbutregisteredinothercountries).

Chart 8. The share of banks with Russian capital in Ukraine’s banking sector in billion hryvnias*

Total assets of banks with Russian capital

The share of banks with Russian capital in the sector as a whole in % (right axis)

0

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10

15

20

25

10

15

20[bn UAH] [%]

01.01.2014 01.01.2015 01.01.2016 01.10.2016

Source:Author’sowncalculationsbasedondatacompiledbytheNationalBankofUkraine*The share of all banks with Russian capital has been taken into account, including those with a minority stake, and banks owned by Russian citizens but registered in other countries.

ThemainreasonbehindtheincreasedsignificanceofRussianbankshasbeenthecollapseofanumberofUkrainianprivatebanksandthecapitalflightfromthe Ukrainian market. In addition to this, during the crisis Russian banks

14 ThisfigurealsoincludesAlfaBankwhichbelongstoABHHoldings,acompanyregisteredinLuxembourg,whosemainshareholdersareRussiansholdingIsraeliandRussiancitizen-ship,MikhailFridmanandGermanKhan,RussiancitizensAlekseyKuzmichevandPyotrAven,andtheItalianbankUniCreditSpA.

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received considerable recapitalisation from their shareholders, which alsoenabledthemtostrengthentheirmarketposition(therecapitalisationwasnotprovidedintheformofpaymentsoffundsbutmainlybyconvertinginterbankloansandsubordinatedloansfromparentcompaniesintoregulatorycapital).ThetotalvalueofrecapitalisationprovidedtoRussianbanksstoodatUS$2bil-lionin2015andatmorethanUS$1.4billionin2016(thisaccountedforamajorportionofforeigndirectinvestmentinUkraineandmadeRussiaUkraine’sbig-gestforeigninvestor).

Russia’saggressionagainstUkrainehasplacedRussianbanksinaverydiffi-cultsituation.Thiswasmainlycausedbythefactthattheywereperceivedbytheclientsasinstitutionsstemmingfromtheaggressorcountryandassuchhadaverynegativeimage.InJanuaryandlaterinMarchandApril2017picketlineswereorganisedinfrontofthesebanks’headquartersandtheirofficeswereblockedinseveralcitiesinUkraine(includingKyivandKharkiv).Thisperceptionhascausednumerousclientstowithdrawfromthesebanks’ser-vices.BetweenJanuary2014andApril2016,thevalueofdepositsmadebyretailclientsinRussianbanksfellfrom9.3%to5.8%ofthetotalvalueofretailclientdepositsinthebankingsystem;forcorporateclientstheproportionfellfrom8.3%to3.3%ofthetotalvalueofdeposits15.FrequentcasesofloansnotbeinghonouredhadequallypainfulconsequencesandsignificantlyworsenedtheRussianbanks’loanportfolio.Attheendof2015,unpaidloansaccountedfor67%oftheloanportfolioofSberbank,85%ofProminvestbank’sandastaggering95%ofVTB’s.Inaddition,theRussianbankshavelostaccesstorefinancingfromtheNBUandcouldonlycountonsupportfromtheirshareholders.Asacon-sequence,theRussianbanks’indicatorshavesignificantlydeteriorated.Forexample,on1October2016theirassetprofitabilitywasthesector’slowestandstoodat-32.3%forVTBBank,-19.35%forBMBank,-14.10%forProminvestbank,withtheaverageratioforUkraine’sbankingsectorasawholebeing -5.46%.ThishasledtoasituationinwhichRussianbanksbeganforallintentsandpurposestovegetatewhiletryingtosurvivehardtimes.AportionofthemaremakingattemptstowithdrawfromtheUkrainianmarketandselltheirshares.Rep-resentativesofProminvestbankandVnesheconombankandotherbankshaveannouncedtheirintentiontoselltheirsharesinbanksinUkraine.However,abuyerisyettobefound.InMay2017,twopotentialbuyersannouncedtheirintentiontobuysharesinProminvestbank:UkrainianoligarchOleksandrYa-roslavsky(owneroftheDCHgroup)andaconsortiumcreatedbyPavelFuks

15 DataforbankswhoseinvestorsareregisteredinRussia.

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(aRussianinvestorinthepropertydevelopmentsector)andMaksymMykytas(aUkrainianMP).PotentialinvestorsarescaredoffbyUkraine’spersistentlydifficulteconomicsituationandthepoorfinancialstandingofRussianbanks,whichrequiremajorfundsforinvestment.Russianshareholders,ontheirpart,arenotwillingtoexcessivelyinvestintheirUkrainiancompaniesduetotheriskoflosingmajoroutlays(theywillrecapitalisetheirbankssothatthesecansurviveonthemarket,butwillavoiddevelopment-orientedinvestment).Be-sidesthis,itisunfavourableforthemtoselltheirassetsatanexcessivelylowpriceandtowithdrawfromthemarketwithmajorlosses.

AlfaBankhasadoptedauniquemannerofoperatingontheUkrainianmarket.ItpositionsitselfasaEuropeanbankandtheNBUdoesnotconsiderittobeaRussianbank.Ithasevenmanagedtodevelopitsbusiness–inOctober2016ittookover100%ofsharesinUkrsotsbank(Ukraine’ssixthlargestbank)ownedbytheItalianbankUniCredit16.InMarch2017,100%ofsharesinSberbank-Ukraina(theseventhlargestbank)wassoldtoaconsortiumledbySaidGuts-eriyev,sonoftheRussianoligarchMikhailGutseriyev.TheconsortiumincludedanundisclosedcompanyregisteredinBelarusandcontrolledbyGutseriyevandtheLatvianbankNorvikBanka(ownedbyGrigoriyGuselnikovwhoholdsdualRussianandBritishcitizenship).ThistransactionalsoillustratesacertainmannerofoperationappliedbyRussianinvestorswhichinvolvestransferringownershipofbankstocompaniesregisteredinEUcountriesinsteadofRussiancompaniesgivingupcontrolofthesebanks.ThisisintendedtohelpthembuildupapositiveimageforthesebanksasEuropeanbanks.ItisalsomeanttoenablethebankstoescapepotentialrestrictionsandsanctionsthattheUkrainiangov-ernmentmayimposeonRussiancompanies.Forexample,inMarch2017KyivbannedthetransfertoRussiaoffundsfromRussianbanksoperatinginUkraineinreactiontoRussiarecognisingdocumentsissuedbytheDonetskandLuhanskseparatistrepublics.

16 Thetransactioninvolvedanassetswap.TheownerofAlfaBank,ABHHoldings,tookover100%ofsharesinUkrsotsbankinexchangefortransferring9.9%ofitssharestoUniCredit.

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VIII. the polItIcal consequences of the changes In the BankIng sector

ThechangesinthebankingsectorhaveimportantconsequencesforthepoliticalsysteminUkraine.Thisisparticularlyevidentintwoareas:1)thepositionofoligarchicgroupsinthesystem(theoligarchicbankingdiscussedaboveformedanimportanttoolforthemtogenerateprofitandbuildinfluence);2)thepoten-tialattemptsbyoligarchstoinfluencepoliticiansholdingpowerbyusingtheinstrumentofcontrolofthebankingsystem.

ThecollapseofbankswithprivateUkrainiancapital,thatbelongedtomajorandminoroligarchs,haslimitedthearrayoftoolstheseoligarchscanusetobuildtheirbusinesspositioninspecificsectorsoftheeconomyandtheoppor-tunitiestoapplycertainfundtransferringschemes.Thishasweakenedtheoligarchs’influenceonthebankingsectorand,moregenerally,ontheeconomyasawhole.Forexample,atpresentitismoredifficultforthemtoobtainfundsfromthemarketandtotakeoutloansusingoligarchicbankingschemes(orso-called‘captivebanking’).Theremainingbanksoperatingonthemarketthatareforeign-ownedandprofit-orientedapplyaverycautiouslendingstrategyandrequireloanstobeproperlysecured,whichmakessiphoningofffundsviathesebanksincreasinglydifficult.Duetostepped-upcontrolonthepartoftheregulator,increasedtransparencyofoperationsandownershipstructurecon-nections,aswellaslegalchangesintroducedbythegovernmentincollabora-tionwithandunderstrongpressurefromWesternpartners(theIMF,theEU,theUSA),thefunctioningoftheformeroligarchicbankingmodelwithallitspathologieswillnolongerbepossible.RinatAkhmetov’sPUMBistheonlymajorbankownedbyanoligarchthathassurvived.Ithasdonesobecauseitadjusteditscorporategovernanceandoperatingmodeltomarketstandards.Thelegalchangesandtheincreasedsupervisionoffinancialflowsinthecontextofmoneylaunderingwillbeofparticularimportance,especiallyforcombatingcorrup-tion,evenifitislikelytotakeseveralyearstoimplementtheminfull.

Thesechangesmayresultinlimitingspecificoligarchs’capabilitytoinfluencethepoliticalsystemviathebankingsectorinitscurrentform.Theoretically,theweakeningoftheformerlyverystrongstatusofoligarchsinthebankingsectormayenablethegovernmenttostrengthenthestate’spositiontowardstheoligarchs.OneexamplemaybethenationalisationofPrivatBankthatusedtobelongtothehighlyinfluentialIhorKolomoyskyi(andhisbusinesspartnerHenadiyBoholyubov).KolomoyskyitookadvantageofhiscontrolofUkraine’slargestbank–abankofsignificanceforthecountry’sbankingsystemasawhole

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–toputpressureonthegovernmentandtoobtainpoliticaldecisionshefoundfavourable.Thefunctioningofabankofthissizehasasignificantimpactnotonlyonthebankingsystembutalsoonthecountry’seconomyasawhole,andthegovernmentwasforcedtotakethisintoaccount.Whenotherbanksbecameinsolvent,theinfluenceotheroligarchshadonthebankingsectorweakened.ThisconcernsmainlyoligarchslinkedtoformerpresidentYanukovych(in-cludingOleksandrYanukovych,Kurchenko,Ivanyushchenko,Arbuzov),butalsoDmytroFirtash,VadymNovinsky,VasylKhmelnytsky,OlehBakhmatyuk,KostyantynZhevago,ViktorPinchukandothers.

Thisdoesnotmeanthattheoligarchsarelosingtheirinstrumentstoexertin-fluenceonthepoliticalsystem.However,itdoesmeanthattheformerschemesforinfluencingthepoliticalsystemviathebankingsectorarelikelytochange.Theoligarchs’influencepersistsbothinthebankingsystemandinthepoliticalsystemasawhole.However,thechangesthathappenedinthebankingsectorandtheimplementedreformsinspireachangeintheformandthemannerofbuildingtoolstoexertpoliticalinfluenceandtheuseofbanksandthebankingsectortopursuethispractice.

Rafał SadowSkiWork on this paper was completed in May 2017

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appendIX

Ukraine’s20largestbanksason1January2017

no. name owners, proportion of shares, in %

1 PrivatBankthe state, represented by the Ministry of Finance of Ukraine 100%

2 Oschadbank the state, represented by the Council of Ministers 100%

3 Ukreximbank the state, represented by the Council of Ministers 100%

4 Ukrgasbankthe state, represented by the Ministry of Finance of Ukraine 100%

5 Raiffeisen AvalRaiffeisen Bank International AG 68% (Austria); European Bank for Reconstruction and Development 30%

6 Ukrsotsbank ABH Holdings 99%

7 Sberbank100% of shares belonged to Sberbank of Russia; in March 2017 they were sold to a consortium belonging to Norvik Banka (Latvia) and an undisclosed company registered in Belarus

8 UkrSibbankBNP Paribas S.A. 59% (France); Société Fédérale de Participation et d’lnvestissement 10% (Belgium); European Bank for Reconstruction and Development 40%

9 PUMB Rinat Akhmetov 99%

10 Alfa Bank ABH Holdings 100%

11 Prominvestbank Vnesheconombank (VEB) 99% (Russia)

12 Crédit Agricole Crédit Agricole S.A. 99.9% (France)

13 OTP Bank OTP Bank 100% (Hungary)

14 VTB Bank VTB Bank 99.99% (Russia)

15 Pivdennyi Banka group of businessmen from Odessa: Yuri Rodin 18%; Mark Bekker 19%; Alla Vanetsyants 11% and others.

16 Citibank Citigroup Inc 100% (United States)

17 ING Bank Ukraina

ING Group N.V. 100% (Netherlands)

18 ProCredit BankProCredit Holding AG&Co. KGaA (Germany, Belgium, Nether-lands, USA) 72%; KfW Group (Germany) 27.8%

19 Kredobank PKO BP 99.5% (Poland)

20 Megabank

European Bank for Reconstruction and Development 15%; KfW (Germany) 15%; the government of Germany (15%); International Finance Corporation (USA, World Bank) 6%, Viktor Subbotin (a businessman from Kharkiv) 5%