Ukraine: The Country and Its Banking System Andrew BLINOV Senior Economist, International Centre for Policy Studies Budapest, 27 May 2004 BACEE’S 10 th CENTRAL AND EAST EUROPEAN BANK AND COUNTRY RISK SEMINAR

УКРАЇНА UKRAINE Republic Independence: 24 August 1991 Territory: 603,700 sq. km Population (2003): 47.7 mn Capital: Kiev (Kyiv), 2.6 mn GDP per capita (2003, current rate): US $1,040 GDP per capita (2002, PPP): US $2,870 Number of licensed banks (2004): 157 Bank assets (2004, current rate): US $21.2 bn Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Presentation plan 1.About the International Centre for Policy Studies 2.Economic Outlook 3.Political Environment and Reforms 4.Banking Sector Overview 5.Banking System Indicators 6.Risks and Challenges Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

About the International Centre for Policy Studies

What is the International Centre for Policy Studies? ICPS is an independent research organization founded in 1994 by the Soros-funded Open Society Institute Our goal is to promote public policy concepts and procedures in Ukraine ICPS works with a variety of interest groups— government, business, NGOs, the media Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Research areas Economic policy Policy analysis Public administration reform European integration Regional policy and local government Development of non-government organizations Education policy Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Regular publications Quarterly Predictions—a quarterly overview of Ukraine’s economy with 3-year development forecast. Since 1997 Political Commentary—a monthly evaluation of Ukraine’s political situation, government policy, political competition and public dialog. Since 2003 Consumer Confidence—a unique Ukrainian quarterly survey of household expectations. Since 2000 Economic Statistics—a monthly table of key statistical data for doing business in Ukraine. Since 2000 Regional Trends—analysis of regional development and policy covering 1990–2002. Since 2003 Policy Studies—an occasional journal containing the results of ICPS research on key government policy issues, including annual analysis of the impact of legislative changes on Ukraine’s business climate. Since 1999 Information about ICPS services is posted on Internet shop launched in May 2003 Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Analysis of public policy alternatives and formulation of recommendations Analysis and development forecasts for specific markets Medium-term forecasts for macroeconomic and regional development indicators Impact analysis of company activities, particularly investment projects Analytical support for strategic planning Research into consumer behavior Business services Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Economic Outlook

New millennium brings rapid growth GDP, real % change Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

What’s behind Ukraine’s economic revival? A population that is “getting” what business and market conditions mean A favorable pricing situation in global markets Active privatization Growing prosperity among consumers Financial stability Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

External demand drives growth Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Active privatization = Growth in FDI Factors behind FDI growth: Large state-owned enterprises for sale High rates of economic upturn in a relatively stable political and social environment Ukraine’s removal from FATF blacklist of non-cooperating countries EU enlargement and shift of business from new EU member states aimed at minimizing labor costs Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Net foreign direct investment, millions USD Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Consumer Confidence Index hits a new record high Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Nominal exchange rate (UAH/USD) is stable Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Moderate price dynamic is vulnerable Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Consumption is slower than investment Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Construction and export servicing boom Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Pressure is taken off the Government regarding urgent systemic reforms, primarily in infrastructure Additional revenues from economic growth are not being directed towards reforms To reach 1990 levels, Ukraine’s economy will have to grow 10% annually for another seven years—until 2010 The euphoria of success carries risks Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Rapid growth is not reflected in Budget revenues, which are growing much more slowly than the economy There is a widening income gap in Ukrainian society Poverty is very high and the middle class too small—less than 15% of the population Internal demand is weaker than external demand Inadequate reforms = Social problems Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Wages grow, but not their share of GDP Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Ukraine’s sovereign ratings: up but still low AgencyRatingForecast Standard&Poor’s B Issuer Credit Rating — BPositive  Moody's Investors Service B1 Long-term bonds and notes — B1  B2 Long-term bank deposits — B2  Stable Fitch B+ Long-term foreign currency — B+ B Short-term foreign currency — B B+ Long-term local currency — B+ Stable Rating&Investment Information Inc. (R&I) B+ Long-term foreign currency — B+Stable Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Political Environment and Reforms

A shifting geopolitical situation Despite the fact that Ukraine has declared almost 20 countries as its strategic partners, we consider Russia, the EU, and the USA to be the main foci of Ukrainian foreign policy On one hand, the EU and NATO enlargement to Ukraine’s borders is strengthening the influence of the West and making it imperative for the country to introduce European standards of governance and democracy On the other hand, the result of the March election in Russia has confirmed increased expansionist intentions towards Ukraine, primarily in economy Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Foreign policy priorities Joint projects with Russia: (1) Common Economic Area, (2) Gas Transport Consortium Improving relations with the US and the European Union is motivating Ukraine to carry out domestic economic and democratic reforms The EU considers Ukraine as a ‘new neighbor’—but not a potential member state Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Political competition In November 2002, the formation of a Cabinet of Ministers based on a majority formed in the legislature came to fruition. This improved political competition in Ukraine The failure of Constitutional reform, which would have limited the powers of the next president, was a painful defeat for the ruling coalition, which lost control of the legislature There could be considerable abuse during the presidential election, which threatens to turn into a dirty match Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Political competition and reforms Though Viktor Yushchenko of the Nasha Ukraina bloc is favored to win the presidency in 2004, his main rival, Premier Viktor Yanukovych, is rapidly closing the gap on the tails of rapid economic growth The effectiveness of current policy is dubious: in terms of pushing through tax and pension reforms and resuming large-scale privatization, the Cabinet clearly lacks a consolidated strategy. It is very passive in reforming monopolies and not efficient with price stabilization The opposition operates on the basis of slogans rather than specific programs Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Banking Sector Overview

The banking system of Ukraine Two-pillar; National Bank of Ukraine functions as the central bank and the banking sector regulator State banks do not dominate, though Oshchadny Bank, the savings bank, has the privilege of personal deposits state guarantees Low foreign capital participation—12% of charter capital Not well integrated into world banking system, undercapitalized. Assets amount to US $21.2 bn or 36% GDP, but capital totals only US $2.6 bn or 4.3% GDP Highly concentrated—Top 10 banks control more than half of all assets Interested in expanding into insurance and pension markets Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

More dynamic than the general economy Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Banking indicators and GDP growth % nominal change Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Capitalization goes down Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Greater oversight of banking system Intensified after 1998 financial crisis Major issues: –new IAS-based accounting standards implemented in 1998 –anti-laundering procedures since 2003 –increased minimum charter capital requirements since 2003 –increased reserves coverage for asset transactions, from 61% in 2000 to 96% in 2003 –toughening of liquidity ratios, namely mandatory capital adequacy (not less than 10% since March 2004) –state mortgage register launched in 2004 –special attention to shareholders who own more than 10% of a bank and to insider lending Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Number of banks Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Bankruptcy Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Coming and going Registered over 2003–4: ARMA (Kyiv) DANIEL (Kyiv) LEADER (Kyiv) STOLITSA (Kyiv) TRUST-CAPITAL (Kyiv) SOTSKOMBANK (Odesa) UKRAINSKIY FINANSOVIY MYR (Donetsk) FOKAS (Kyiv)–Swiss investor Aspra Finanz Holding UKRAINIAN BANK FOR RECONSTRUCTION AND DEVELOPMENT (Kyiv)–owned by Ukrainian State Innovation Company Liquidated over 2003–4: TECHNOBANK (Dnipropetrovsk)– could renew activity OLBANK (Kyiv) UKRSPETSIMPEXBANK (Kyiv) NASH BANK (Zaporizhzhia) ROSTOK BANK (Kyiv) CREDIT SUISSE FIRST BOSTON (Ukraine) Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Minimum charter capital requirement escalation Since 17 January 2003, new licensing principles introduced. Until 2004, the minimum charter capital value had to be at least: –for nationwide Ukrainian banks — €5 million –regional banks — €3 million –cooperative local banks — €1 million Each year, until 2007, requirements must be upgraded. For 2004, the minimum charter capital value should be at least: –for nationwide Ukrainian banks — €5.5 million –regional banks — €3.5 million –cooperative local banks — €1.15 million Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Charter capital structure Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Banking System Indicators

Assets structure Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Liabilities structure Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Income structure Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Expenditures structure Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Top-performing banks in 2003 Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Risks and Challenges

Sector problems: external factors Low asset diversification (lack of financial instruments, weak non-bank financial sector, restrictions on capital flows) Poor adaptation to international standards, including Basel requirements Absence of full-fledged register of borrowers and property owners Creditors’ rights need strengthening: currently, borrowers have more rights Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Sector problems: internal factors Low level of financial mediation: credits-to-GDP ratio (as well as deposits-to-GDP ratio) is less than 25% Disproportionate rates of growth of personal deposits and loans to individuals, relatively high interest rates on deposits (significantly higher than on government bonds) Balance capital rates of growth are lower than money mass and liabilities Absence of long-term (5+ years) loans, shortage of medium- term (1+ years) loans Large share of bank overheads (often for non-bank activity) Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Challenges Increase capitalization Improve corporate governance, management and internal audit quality Improve NBU banking risk oversight system and outside audit, with more attention to IAS norms Increase transparency of banking operations with more responsibility for disclosure Lobby indispensable legislation to improve both creditor and investor rights Міжнародний центр перспективних досліджень International Centre for Policy Studies Tel. (380-44) Web:

Thank you for your attention

Ukraine: The Country and Its Banking System Andrew BLINOV Senior Economist, International Centre for Policy Studies Budapest, 27 May 2004 BACEE’S 10 th CENTRAL AND EAST EUROPEAN BANK AND COUNTRY RISK SEMINAR