Bank Industry Risk Analysis: Ukrainian Banks Operating With High Risks And Vulnerability To Tough Macroeconomic Landscape
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September 8, 2008 Bank Industry Risk Analysis: Ukrainian Banks Operating With High Risks And Vulnerability To Tough Macroeconomic Landscape Primary Credit Analyst: Ekaterina Trofimova, Paris (33) 1-4420-6786; ekaterina_trofimova@standardandpoors.com Secondary Credit Analysts: Annette Ess, CFA, Frankfurt (49) 69-33-999-157; annette_ess@standardandpoors.com Elena Romanova, Moscow (7) 495-783-40-91; elena_romanova@standardandpoors.com Table Of Contents Major Rating Factors 1. Executive summary 2. Economic Risk 3. Industry Risk A. Business Dynamics B. Regulatory Environment C. Accounting Policies Appendix 1: Basic Data On The Ukrainian Banking System Appendix 2: Ukraine Sovereign Ratings www.standardandpoors.com/ratingsdirect 1 Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of 670002 | 300722294 Use/Disclaimer on the last page.
Bank Industry Risk Analysis: Ukrainian Banks Operating With High Risks And Vulnerability To Tough Macroeconomic Landscape Major Rating Factors Strengths: • Good macroeconomic growth potential and positive wealth dynamics in the medium term • Banks' growing business diversification and strengthening franchises • Sustained adequate financial and commercial performances of banks, albeit vulnerable to shocks • Benefits from increased foreign ownership by strategic Western investors Weaknesses: • Challenging macroeconomic and political backdrop • Rapid loan growth untested by an economic downturn • Fragmented banking system with many pocket banks under obscure ownership • Regulatory and supervisory enhancements slow to tackle mounting structural problems • Substantial single-party lending and funding concentrations 1. Executive summary In a global context, Standard & Poor's Ratings Services considers the banking sector in Ukraine (foreign currency B+/Stable/B, local currency BB-/Stable/B, Ukraine national scale uaAA/--/--) to be high risk. We place the system in Group 10, the weakest in our Banking Industry Country Risk Assessment (BICRA) rankings, which reflect the strengths and weaknesses of a country's banking system relative to those of other countries. (For our latest BICRA rankings, see "Banking Industry Country Risk Assessment On Russia Revised To Group 7 From Group 8," published Aug. 6, 2008, on Ratings Direct.) Similarly ranked banking systems include Venezuela, Jamaica, and Bolivia. The low ranking on the Ukrainian banking system reflects its high vulnerability to potential shocks due to rapid, untested loan growth in the past few years, an unstable economic and political environment, substantial (albeit reducing) single-name and industry concentrations, significant dollarization of operations, uncertain enforcement of credit rights, insufficiently robust underwriting practices and risk management, as well as regulatory and supervisory responses lagging behind market developments. Despite political turbulence and inflationary pressures, macroeconomic growth has so far been strong, supporting the banking sector's development and credit standing and partly mitigating still-high business and credit risks for domestic banks. The gradual strengthening and increasing transparency of domestic companies, alongside growing personal wealth and banks' ongoing business diversification, has fueled the system's positive expansion. Still, the Ukrainian economic outlook remains highly uncertain. Galloping inflation in late 2007 and the first half of 2008 has weighed on disposable incomes and household budgets, while the widening current account deficit poses a risk to exchange rate stability. The wealth effect created by exponential gains from export prices could unwind if they Standard & Poor’s RatingsDirect | September 8, 2008 2 Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of Use/Disclaimer on the last page. 670002 | 300722294
Bank Industry Risk Analysis: Ukrainian Banks Operating With High Risks And Vulnerability To Tough
Macroeconomic Landscape
decline--particularly for metals.
The financial system's rapid loan growth and sharply increasing debt leverage in a still unstable credit environment
with questionable risk management practices could be piling up problems for the future and make the system
vulnerable to a potentially severe market correction, especially in real estate and construction. Deposit growth has
risen briskly in the past few years but has not kept pace with credit growth; banks are consequently increasingly
refinancing themselves abroad. Although fragmented, foreign capital and debt have continued flowing in, namely
benefiting from increased foreign bank ownership (43% of banking sector assets at midyear 2008 compared with
less than 20% in the early 2000s). Although strategic foreign investors cannot fully eliminate still-high credit risks
and potential market downturns, they are expected to take the lead in avoiding a hard landing. Their growing role is
particularly important in the context of a still fragile regulatory framework in Ukraine, despite some recent inroads
and demonstrated resilience.
The banking sector has greatly profited from strong credit demand, supporting growing earnings and so far good
credit quality, which nevertheless remain vulnerable to external shocks and a potential sharp slowdown in lending
growth. The government's anti-inflationary measures to limit money supply squeezed interbank liquidity in the
second quarter of 2008, with some precarious stabilization since early July.
In terms of potential extraordinary state support to private-sector banks, Standard & Poor's classifies Ukraine as
"supportive" (see "Criteria: External Support Key In Rating Private Sector Banks Worldwide," published Feb. 27,
2007), providing no rating uplift for private-sector banks. In a time of crisis, the authorities are likely to increase
supervision and regulation of troubled entities, but in our opinion they would provide only limited financial support
for domestically owned banks--even for those with large market shares--and only as a last resort.
2. Economic Risk
Business cycle: Economic growth sustained despite political instability and inflationary pressure
Due to high government expenditures and increasing domestic demand for goods and services amid extremely
favorable trade terms, GDP growth surged to 7.9% in 2007 from 2.6% in 2005 (see table 1). Although expected to
slow to 2.5% in 2009, as overheating takes its toll on both competitiveness and real incomes, long-term growth
potential remains among the best in Eastern Europe. The banking sector's creditworthiness would benefit from
renewed positive momentum in financial markets and the economy.
Table 1
Ukraine Macroeconomic Indicators
2009f 2008e 2007 2006 2005 2004 2003 2002 2001 2000
GDP (bil. $) 227.0 202.0 139.2 105.5 83.0 64.9 50.2 42.4 38.0 31.3
Real GDP growth (%) 2.5 6.5 7.9 7.4 2.6 12.1 9.5 15.7 9.2 265.8
GDP per capita ($) 4,965 4,383 2,995 2,258 1,761 1,367 1,049 878 781 636
Real GDP per capita (% change) 3.3 7.4 8.6 8.2 3.3 13.0 10.5 16.7 10.2 269.0
CPI (% change) 21.0 27.0 12.8 9.1 13.5 9.0 5.2 0.8 12.0 28.2
Population (mil.) 45.7 46.1 46.5 46.8 47.1 47.4 47.8 48.2 48.7 49.1
Unemployment rate (%) 7.2 6.5 6.9 7.4 7.8 9.2 9.7 10.3 11.7 12.4
Exchange rate, year end, UAH/$ 5.6 4.6 5.1 5.1 5.1 5.3 5.3 5.3 5.3 5.4
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Macroeconomic Landscape
Table 1
Ukraine Macroeconomic Indicators(cont.)
Domestic credit to private sector (bil. UAH) 875 729 419 241 142 87 66 40 27 19
Dom. credit to private & NFPEs (bil. UAH) 904.0 753.3 433.0 250.6 149.4 93.3 71.6 43.7 29.6 20.9
Financial sector liabilities (mil. $) 60,000 52,000 30,971 14,089 6,112 2,662 1,746 913 576 390
Net financial sector external debt (mil. $) 52,000 44,000 24,971 10,042 3,284 358 389 66 (162) (501)
Net banking sector external assets/GDP (%) (22.9) (21.8) (17.9) (9.5) (4.0) (0.6) (0.8) (0.2) 0.4 1.6
Domestic credit private & NFPEs/GDP (%) 78.0 77.2 61.6 47.0 35.2 27.0 26.8 19.4 14.5 12.3
Source: Standard & Poor's. e--Estimate. f-Forecast. UAH--Ukrainian hryvnia. NFPEs--Nonfinancial public enterprises.
The relatively undiversified nature of the Ukrainian economy, which mainly focuses on metallurgy and machine
production, may lead to some inherent cyclicality, however. Metallurgy, machine-building, and chemical production
dominate the Ukrainian economy, together accounting for over 40% of GDP. A sharp correction in global steel
prices or a reversal in the global credit cycle could significantly curb medium-term growth performance. The
country's assets are divided among a large number of larger and smaller players, with very few material
concentrations in single hands (namely those in the metallurgy sector), unlike most other Commonwealth of
Independent States (CIS) countries. Delayed structural reforms due to continued political turbulence may also
overshadow the country's medium-term economic prospects. Other major drags on growth include uncertain
property rights, unbridled corruption, and the Ukraine's entrenched bureaucracy, with the grey economy estimated
at about one-third of GDP.
Monetary and investment environment: Inflationary economy constraining savings development; foreign
capital inflows sustained, but fragmented; domestic liquidity fragile
Ukraine's economy has developed an addiction to foreign capital inflows, although the National Bank of Ukraine
(NBU) is taking action to constrain this. The domestic debt market is developing quickly but remains illiquid.
Despite a rapid rise, overall deposits have not kept pace with credit growth and banks are increasingly refinancing
themselves abroad. On June 30, 2008, growing foreign debt of Ukrainian banks made up $35.7 billion or almost
30% of their total liabilities. This ratio is comparable with Russia's and Romania's, but still below levels in
Kazakhstan, Latvia, and Estonia (see chart 1). Positively, more sustainable parent funding represents over 25% of
Ukrainian banks' foreign debt, reducing their refinancing risk and providing an extra layer of stability to system
liquidity under a stress scenario. As of June 30, 2008, Ukrainian banks foreign debt maturing till midyear 2009
exceeded $15 billion (over 12% of the banking system's assets), but these repayments should be manageable. Most
Ukrainian banks are reporting negative short-term liquidity gaps and are highly dependent on customer deposit
rollovers. Liquid assets represent only about 12% of Ukrainian banks' assets, covering only about 40% of their
short-term liabilities (please refer to "Liquidity Tension At Kazakh, Russian, And Ukrainian Banks Looks
Manageable, But Highlights Inherent Structural Vulnerabilities," published April 9, 2008).
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Macroeconomic Landscape
Chart 1
Inflation in Ukraine was running at 26.8% year-on-year in July 2008, which is sufficient to change consumer
behavior because of the disruption in the real value of private savings and fixed investments. The savings rate is still
rather low, averaging 5% of the population's disposable income over the last five years. Although slightly down
from about 30% in spring 2008, inflation is unlikely to dip significantly below 20% during the rest of 2008. With
an average return on equity (ROE) of around 11% expected in the banking sector throughout 2008, high inflation is
cumbersome for economic capital and profitability of banks. Following a bumpy performance in the late 1990s,
profitability of Ukrainian banks has strengthened. But it is weighed down by intensive pricing competition, high
operational costs, and limited pricing power and earnings diversification, keeping it below levels at many emerging
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market peers (see chart 2).
Chart 2
Despite the global credit crunch, Ukrainian domestic liquidity remained relatively comfortable until mid-February
2008. Capital inflows appeared quite strong in Ukraine as both external borrowings and foreign direct investment
(FDI), albeit fragmented, offered resilience against the country's habitual political uncertainty. However, monetary
tightening since first-quarter 2008 has been pressuring liquidity. Following a gradual decrease since early February,
banks' correspondent and term deposits at the NBU dropped by 45% as of the second half of May though picking
up again in early July. Although still volatile and fragile, the Ukrainian hryvnia (UAH) interbank liquidity situation
stabilized in the beginning of July, with overnight rates down to 7%-17% versus peaks of 50%-60% during the
second halves of April and May. Increased government spending and currency interventions were the main
contributors to easing of the liquidity squeeze. During July 2008, the volume of dollar purchases by the NBU totaled
$2.5 billion or almost 3x the levels of May and June. Adverse near-term inflationary developments may trigger a
new wave of monetary tightening, again likely to pressure bank liquidity. The state's recent refinancing anc currency
intervention track record has been uneven, with some periods of reduced activity. The NBU's refinancing of
commercial banks reached its historical maximum of UAH4.6 billion (about $1 billion, or less than 1% of banking
sector assets) on May 19-20, 2008, compared with the gross overall refinancing of UAH2.5 billion for full-year
2007.
Although Ukrainian banks' open foreign currency positions are limited (about 8% of the equity on average on
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Macroeconomic Landscape
March 31, 2008), hryvnia liquidity is sensitive to any sharp changes in the country's currency policy, a vulnerability
compounded by nonresident long positions in the local currency corporate bond market estimated at some 4% of
GDP. Since 2002, the hryvnia has been de facto pegged to the U.S. dollar with one-shot nominal appreciations in
April 2005 and May 2008. In May and June 2008, the hryvnia appreciated by about 10%, adding to the domestic
interbank hryvnia liquidity pressure. Overall, the market has adjusted adequately to the new official rate. Roughly
one-half of outstanding lending stock is currently either foreign currency denominated or foreign exchange linked.
Consequently, potential hryvnia devaluation--triggered by a fall in global metals prices, for example--would threaten
borrowers' debt service ability.
Lending leverage and credit risk: Continued credit boom accentuates risks and masks potential
vulnerabilities
Rapid unseasoned credit expansion at an average annual rate exceeding 55% in the past five years and growing
indebtedness of households and corporations increase the system's risk profile. The NBU's tightening monetary and
regulatory policies, higher costs of attracting funding from abroad, and a rise in interest rates induced a deceleration
in lending growth in 2008, which still remains high though. Corporate loans grew by 22.4% and retail loans by
27% in the first seven months of 2008, compared with 63% and 98% respectively for full-year 2007.
Ukraine's economy has become quite highly leveraged in recent years. The total loans-to-GDP ratio hit 67% at
year-end 2007, comparable with levels in Kazakhstan, Hungary, and Slovakia, far above Russia's ratio but below
figures of many developed countries. The total debt exceeded a growing 26% of personal income and 260% of
companies' pretax profits in the first half of 2008 (see chart 3). With debt levels far higher than domestic savings,
the ratio of loans to deposits represented a fairly high 160% in July 2008, highlighting the country's growing
lending leverage (see chart 4). Almost two times slower than lending growth, corporate deposits increased by 16%
in the first seven months of 2008 (compared with 45.6% in full-year 2007) and retail deposits by 21% in the first
seven months of 2008 (54% in full-year 2007).
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Chart 3
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Chart 4
Current nonperforming loans (NPLs; including overdue and doubtful loans by local classification guidelines) are
unsustainable and poised to go up as portfolios season and lending growth slows (see chart 5). Over 30% of
Ukrainian enterprises are loss-making, with the largest concentration in gas, electric power generation, and water
distribution. But this figure is almost certainly exaggerated due to tax incentives. There is a strong need to further
strengthen lending and underwriting practices, along with risk-management procedures system-wide, to overcome
the potential volatility in the economy.
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Macroeconomic Landscape
Chart 5
Credit standing of corporate and retail borrowers has been on a positive trend, but is still vulnerable to any severe
market corrections, namely in the real estate sector, or prolonged periods of low prices on main Ukrainian exports
(mainly steel). Industry and single-party concentrations compare favorably with regional peers' while remaining high
by international standards (see chart 6). These concentrations call into question the sustainability of banks' financial
performance and continuity of operations. Of concern is banks' exposure to real estate companies (12% of total
loans on June 30, 2008) and mortgages (11%), as the Ukrainian construction and real estate market has been under
pressure with prices down by 5%-10% in some segments since the beginning of 2008.
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Chart 6
A key analytical measure that reflects relative economic risk is our estimate of the incidence of gross problematic
assets (GPAs) in a financial system under a reasonable--but not catastrophic--scenario of economic recession. This
estimate is expressed as a percentage of domestic credit to the private sector and nonfinancial public enterprises.
Problematic assets include overdue loans, restructured assets (where the original terms have been altered), foreclosed
real estate and other assets recovered in loan workouts, and nonperforming assets sold to special-purpose vehicles.
We believe that problematic assets as defined above could escalate in a Ukrainian recession and estimate potential
GPAs at 35%-50%, similar to China, Indonesia, Thailand, Russia, Belarus, and Kazakhstan. We recently revised
this estimate from 50%-75% (see "Ukraine Estimate Of Potential Gross Problematic Assets Is Lowered; BICRA
Affirmed At Group 10," published Aug. 5, 2008). Despite the benefits of economic growth, the Ukrainian banking
system is showing clear signs of overheating. Attesting to this is its high inflationary environment, a growing gap
between private consumption and overall GDP growth, and the associated rapid pace of household credit
growth--all of which are leading indicators of potential economic stress. High credit risks are compounded by
declining, albeit still acceptable, capitalization (see chart 7). Funding and liquidity vulnerabilities, in particular,
among some domestically owned banks, also exacerbate risks. Many domestically-owned banks are fast outgrowing
current owners' ability to inject fresh capital and funding, which are crucial to support growth. Some owners are
consequently looking to open up their banks' capital. The system's total regulatory capitalization ratio was about
13.4% at midyear 2008, but the Tier 1 ratio was only 10%.
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Chart 7
Ukraine's pace of credit expansion is untenable in the medium term. If credit growth continues at current rates, the
likelihood of a hard landing for the economy and the banking sector increases significantly. In this scenario,
Standard & Poor's views an economic readjustment as inevitable, causing a sharp deterioration in asset quality,
which will put great strain on profitability and capitalization. The risk of a hard landing for banks will continue to
heighten as long as debt levels exceed savings and exposures to foreign currencies and the real estate market
continue to grow.
3. Industry Risk
A. Business Dynamics
Competition: Highly fragmented banking sector
With 178 banks in Ukraine at midyear 2008, the sector remains highly fragmented with stiff competition fueled by
aggressive expansion strategies and increased FDI among large banks particularly (see tables 2 and 3). The banking
system is predominantly privately owned with only two banks, the former state savings bank Oschadbank, and
export-import-oriented Ukreximbank (both not rated), in state hands. The concentration of the top players remains
well below most other emerging markets' with the share of the top-five banks at only 33% of total system assets at
midyear 2008 (against 38% at year-end 2005). Standard & Poor's does not expect any meaningful consolidation in
the market, at least not in the next couple of years, unless system expansion falls back significantly. Ukrainian banks
are continuing to build their domestic franchises mainly through organic growth, while their international presence
remains scarce, with the most notable exception being the country's largest bank, Privatbank (not rated).
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Table 2
Top 17 Ukrainian Banks,
Midyear 2008
% of total Total nonbank % of total system Retail % of total system
(Mil. $) Total loan system loans deposits customer deposits deposits retail deposits
Privatbank 10,434.79 9.7 10,087.47 12.9 6,477.49 15.9
Raiffeisen Bank Aval 8,625.56 8.0 4,964.77 6.3 3,518.62 8.6
Ukrsibbank 7,170.04 6.7 2,497.96 3.2 1,487.30 3.6
Ukrsotsbank OJSC 6,154.00 5.7 3,163.83 4.0 1,671.77 4.1
Ukreximbank 5,339.88 5.0 3,076.43 3.9 1,327.20 3.2
Prominvestbank 4,717.71 4.4 4,651.25 5.9 2,472.53 6.1
Nadra Bank 3,555.57 3.3 3,227.70 4.1 2,026.50 5.0
State Oschadnybank 2,664.11 2.5 3,480.46 4.4 2,718.79 6.7
OTP Bank 4,075.19 3.8 3,454.81 4.4 534.40 1.3
Alfa-Bank Ukraine 3,370.78 3.1 2,033.54 2.6 193.14 0.5
Brokbusinessbank 1,958.32 1.8 534.40 0.7 576.08 1.4
VTB Bank 2,848.07 2.6 966.05 1.2 243.78 0.6
Finance and Credit Bank 2,552.20 2.4 2,049.32 2.6 1,196.92 2.9
First Ukr. International 2,181.36 2.0 557.02 0.7 557.02 1.4
Forum 2,321.52 2.2 809.55 1.0 809.55 2.0
Ukrainsky Promyslovy Bank 2,270.85 2.1 2,034.93 2.6 1,539.91 3.8
Kreditprombank 1,903.04 1.8 1,355.74 1.7 669.99 1.6
Total in the banking system 107,658.78 N/A 78,341.08 N/A 40,865.72 N/A
N/A--Not applicable. Source: National Bank of Ukraine.
Table 3
Foreign Direct Investment At Major Ukrainian Banks
Price (mil. Price/equity ratio
Investor Stake (%) Date $) (%)
Delta Bank Icon Private Equity Fund 49 June 2008 N.A. N.A.
Pravex Bank Intesa Sanpaolo 100 February 2008 N.A. 6.5
Ukrsotsbank UniCredit Group 94 January 2008 2,200 6.7
Forum Commerzbank Auslandsbanken 60%+1 October 2007 N.A. N.A.
Holding AG
Swedbank (formerly Swedbank 100 July 2007 735 4.6
TAS-Commerzbank)
Erste Bank (formerly Bank Prestige) Erste Bank-Gruppe 100 May 2007 104 N.A.
OTP Bank (formerly Raiffeisen Bank OTP Group 100 November 2006 830 5.2
Ukraine)
Ukrsibbank BNP Paribas 51 April 2006 360 3.4
Index Bank Crédit Agricole S.A. 98 2006 263 5.7
Raiffeisen Bank Aval Raiffeisenbank 96 August 2005 1028 3.2
N.A.--Not available.
Ukraine's accession to the World Trade Organization on May 16, 2008, should prompt greater deregulation of the
banking industry and the abolition of restrictions on the opening of branch offices by foreign banks. However, this
is unlikely to alter the banking landscape much because it requires additional supervision cooperation agreements
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between countries, with only very few signed up to date.
Operating environment: Flexibility somewhat restricted by resource and infrastructure limitations,
regulatory and political uncertainties
Economic and political volatility, limited hedging and risk mitigation possibilities, infrastructure deficiencies, the
deficit of experienced banking employees, in particular in risk management, and their high turnover challenge
operational flexibility of Ukrainian banks. Despite growing investments and management commitment, risk
management practices are still lagging behind commercial developments and international standards. Ukrainian
banks' expansionary ambitions and dominant commercial considerations undermine underwriting robustness and
consistency. The growing involvement and role of banks' foreign owners should help develop best international
practices. Increasing foreign ownership benefits the banking system in terms of capital injections, cheaper and more
stable funding, increased transparency, strengthened corporate governance, more sophisticated risk management and
new product development.
The Ukrainian banking system has been rather resilient to longstanding political instability in recent years, in
contrast to the severe liquidity shocks at many Ukrainian banks following the political dispute in the fourth quarter
of 2004. However, persistent political infighting, perpetual electioneering ahead of the next president election in
early 2010, and lobbying by vested interests make the regulatory framework uncertain and disrupt the business
environment in Ukraine. Governance issues continue to drag on the quality of public-policy making. The
pro-presidential Our Ukraine People's Self-Defense Bloc pulled out of the ruling Orange coalition in early September
2008, bringing even greater uncertainty to near-term political and reform processes, including putting the parliament
under risk to be dissolved. Many banks are vulnerable to political influence due to the close association between
senior managers and state officials in government or in state-owned companies. More importantly, many banks rely
on the business standing of their smaller and larger parent financial-industrial groups (FIGs), which are susceptible
to the volatile political scene.
Operating environment: Franchises are still shaky
The franchise value of most banks, especially smaller banks, is limited, lacking branding strength and customer
loyalty, with clients still easily switching from one bank to another. There are still many banks with small regional
franchises and/or strong connections to industrial groups, which are used for treasury activities, sources of liquidity,
and equity investment for their parents. About 55% of Ukrainian banks have the regulatory capital of less than €20
million.
Benefiting from a relatively friendly approval regime, the banking network has grown rapidly, but only the largest
players have a nationwide presence. The recent retail lending boom has been fueled by growing household
consumption on the back of rising personal income, generous social transfers, and public sector wage hikes.
Although corporate lending (64% of total system loans at midyear 2008) still dominates in most Ukrainian banks'
business profiles, retail deposits are playing an increasingly prominent role in banks' funding. Retail deposits grew
to 61% of total system deposits at midyear 2008, from 34% at year-end 2000, illustrating the population's growing
confidence in the sector and the deposit guarantee.
The increasing diversification toward retail banking is positive for banks' franchise development, because the
corporate customer base of most Ukrainian banks is, to a large extent, relationship driven and highly price sensitive.
Bank loans accounted for a limited but growing 16.6% of Ukrainian corporate fixed capital investments in 2007.
The business standing and reputation of the parent FIG often affects the ability of individual domestically owned
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banks to attract and retain large corporate customers. Confronting high competition and limited franchises, the
pricing power of most Ukrainian banks is low. But they have been able to maintain acceptable interest margins,
namely due to diversification into higher-yielding retail and small and midsize enterprise (SME) loans. Recently,
higher funding costs pushed up by tighter domestic liquidity and the global credit crunch have been mostly offset by
increased lending rates (see chart 8).
Chart 8
B. Regulatory Environment
Banking supervision and regulation: Still fragile framework despite demonstrated resilience
The NBU has made significant inroads in strengthening its regulatory and supervisory framework, but political
disagreements and the Ukrainian government's still largely formalistic and procedural approach constrain the central
bank's efficiency. The authorities are acutely aware of the dangers of the rapid growth in banking business,
single-name concentrations, and the resulting imbalances, but their corrective actions have not kept pace with
events.
Despite uneven progress, we view positively NBU's recent measures undertaken, including:
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• Requiring full disclosure of beneficiary owners of banks and enforcing their personal responsibility;
• Tightening liquidity, currency position, and underwriting requirements;
• Raising capital requirements;
• Enhancing banks' audit and risk management frameworks;
• Developing consolidated supervision;
• Introducing the Risk Measure System and "CAMELS" (Capital, Asset quality, Management, Earnings, Liquidity,
and Sensitivity to market risk) ratings for banks more proactive supervision;
• Bringing uniformity to pricing disclosure and contracts;
• Moving accounting principles closer to International Financial Reporting Standards (IFRS);
• Developing credit bureaus (several established but not yet fully operational).
The NBU raised obligatory reserves for banks' foreign liabilities in November 2007 and again for new and old
short-term loans (up to six months) from nonresidents to 20% from 4% in August 2008. In autumn 2007, the NBU
had intended to limit maximum rates paid on banks' foreign borrowings to the yield on Ukrainian sovereign
Eurobonds plus 2%, but this measure, considered too severe, was never introduced. However, starting from early
2008, all foreign capital market borrowings by commercial banks require NBU approval. In February 2008, the
NBU tightened bank capital adequacy requirements for longer term investments funded by shorter term liabilities
(50% risk weighting applied). Furthermore, in the second half of August 2008, the NBU decided to entirely subtract
banks' investments in unlisted securities from their regulatory capital calculation and to increase reserve
requirements for these investments effective from Oct. 14, 2008. In addition, the NBU aims to tighten regulatory
requirements on lending standards and to enforce better lending discipline, foreseeing increased reserve requirements
on retail loans, raising the standard minimum loan loss provisions to 4% from the current 2%, and imposing more
stringent requirements on loans in arrears.
Government propensity to rescue banks: Ukraine classified as "supportive," with no rating uplift for
private sector banks
The Ukrainian government relies mainly on prudent policies, as opposed to direct support, to maintain a sound
banking sector. The government's limited financial capacity could also curb its ability to provide timely support,
even to strategically important banks. Standard & Poor's expects that the Ukrainian banks, which are majority
owned by Western banking groups, will receive support from their strategic foreign owners. Household deposits at
Oschadbank are guaranteed at full amount, though in the early 1990s deposits at Oschadbank were frozen, and
have only recently been re-funded at nominal--that is unindexed---amounts translating into a very substantial loss of
value in real terms to depositors. The Fund for the Guarantee of Deposits of Natural Persons, set up in 1998,
provides a maximum cover of household deposits of UAH50,000 (about $10,000) per depositor, doubled in August
2007 following a series of previous increases, somewhat reducing the government's incentives to run full-scale
bailouts of problem banks.
The NBU may work to constrain runs on banks and support liquidity in the banking system in case of temporary
liquidity and operational problems, but the fairly positive track record so far in this area may not be an indication of
future support because of the unstable political environment. During the severe liquidity squeeze prompted by the
political crisis in late 2004, the NBU demonstrated its proactive role in preserving banking system stability. It
injected additional liquidity into the banks via a range of refinancing mechanisms, including unsecured loans. Also,
17 large banks were offered stabilization loans. Temporary restrictions on bank operations, deposit withdrawals,
and foreign-currency transactions were imposed.
Standard & Poor’s RatingsDirect | September 8, 2008 16
Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of Use/Disclaimer on the last page. 670002 | 300722294Bank Industry Risk Analysis: Ukrainian Banks Operating With High Risks And Vulnerability To Tough
Macroeconomic Landscape
C. Accounting Policies
Accounting and transparency: Good form, but questionable content
The average level of transparency of Ukrainian banks is still weak compared with international standards, despite
the continuing intensive development of the banking system, growth in trading volumes of banks' financial
instruments, change of ownership processes, and regulators' efforts to improve corporate governance (see
"Transparency And Disclosure By Ukrainian Banks 2007: Development Of The Banking System And Efforts By
Regulators Have Not Improved Transparency," published Dec. 5, 2007).
The banking sector was the first to adopt IFRS in Ukraine in 1998, but some local reporting particularities still exist,
namely with regard to tax, swap, and provisioning accounting. There is still a high degree of information risk in the
banking sector because the quality of underlying information about clients and transactions is questionable,
including commercial and ownership links among parties. This stems from the wide variation in the transparency
and quality of banks' financial reporting, although it is improving. In addition, the reliability and completeness of
data could be questioned, given the underdevelopment of management information systems.
Appendix 1: Basic Data On The Ukrainian Banking System
(As of July 1, 2008)
Number of banks
178
System deposits
UAH199.6 billion ($41.2 billion)
Deposits per capita
UAH4,334 ($894)
Form of regulation
The National Bank of Ukraine
Bank superintendent
Volodymyr S.Stelmakh, Governor of the National Bank of Ukraine
Appendix 2: Ukraine Sovereign Ratings
(See the latest summary on Ukraine published on RatingsDirect.)
Additional Contact:
Financial Institutions Ratings Europe; FIG_Europe@standardandpoors.com
www.standardandpoors.com/ratingsdirect 17
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