Ukraine’s parliament blocks bank reform

News and opinion on finance

Vitaly Vavryschuk, head of financial stability at the National Bank of Ukraine

Ukraine’s parliament has dealt a blow to banking sector reform efforts by striking down a draft law designed to tackle corruption and weak governance at the country’s state-owned lenders.

The IMF-backed bill, which had been in the works for more than 18 months, mandated the introduction of independent supervisory boards at Ukreximbank and Oschadbank. Ukraine’s largest public-sector bank, Privatbank, has had independent directors since its nationalization in December 2016.

Vitaly Vavryschuk, head of financial stability at the National Bank of Ukraine (NBU), described the voting down of the bill at the end of March as “a huge disappointment”.

“This is a crucial issue for the NBU and the finance ministry,” he added. “We urgently need to insulate state banks from politicians, from government, from anyone who wants to influence their decision-making processes.”

Ukraine’s state-owned banks have long been notorious for poor governance and politically motivated lending. Reformists had hoped that the appointment of independent supervisory boards would pave the way for the replacement of senior management.

Getting the bill past vested interests in Ukraine’s parliament, however, was always likely to prove challenging.

“The biggest non-performing borrowers are currently members of parliament, so they have no motivation to push this legislation,” says Anastasia Tuyukova, a banking analyst at Dragon Capital in Kiev.

The failure of the bill does not bode well for a raft of other legislation due to come before parliament later this year as part of a wide-ranging drive by policymakers to tackle Ukraine’s mountain of bad debts.

At 56% Ukraine’s non-performing loan ratio is currently the highest in the world. State-owned banks are the worst offenders, with nearly three-quarters of all loans classed as overdue.

The NBU, in conjunction with the IMF and EBRD, has drafted a range of laws designed to remove legal and tax-related obstacles to bad debt restructuring, streamline insolvency procedures and create an operational framework for debt management companies.

Resolution plans

Ukrainian banks have also been ordered by the NBU to produce “credible” resolution plans for their NPL portfolios by the end of this year.

“We believe banks should be more active in managing bad debts,” says Vavryschuk. “We want banks to explain how they plan to offload NPLs from their balance sheet, either through write-offs, sales to professional investors or other methods.”

Whether or not buyers can be found for Ukrainian NPLs remains to be seen. At present, distressed debt sales are a purely domestic business, focused on the retail segment. There are signs, however, that the size of Ukraine’s NPL stock is starting to attract the attention of investors from outside the country.

Martin Machon, head of Czech distressed debt specialist APS Holding, is among those currently eyeing Ukraine.

“It is clearly a market where you need to be very careful, but it’s also one you can’t ignore,” he says. “There are billions of dollars to trade, and there’s no serious competition.

“We’re not comfortable yet, which is why we haven’t invested. The risk will have to be priced in – but at some point, someone will need to buy this debt.”

We are strongly opposed to debt forgiveness for businesses that were built around political connections 

 – Vitaly Vavryschuk, National Bank of Ukraine

Tuyukova sees foreign investors as crucial to the development of the NPL market in Ukraine.

“There is a lack of resources locally to buy NPLs, so external investment is very important,” she says. “It will also likely have a positive effect on local standards in terms of legal practice and borrower discipline.”

Others are more sceptical, particularly about foreign investors’ ability to make an impact on the portfolios of soured corporate debt that make up the vast majority of Ukraine’s NPLs.

The NBU estimates that at most 15% of defaulted corporate loans in Ukraine were made to companies that have failed to service their debt due to financial difficulties. The remaining debtors – which include many of Ukraine’s largest business groups – have simply refused to pay.

Daunting navigation

Anyone acquiring large chunks of Ukrainian corporate NPLs therefore needs to be prepared to navigate the country’s notoriously corrupt and fragmented judicial system.

“When it comes to NPLs, the fundamental problem is the very poor enforcement of credit agreements in Ukraine,” says Vavryschuk. “The rights of lenders are not properly protected and borrowers always have the upper hand in any dispute.”

He is not convinced that bringing in outsiders will make a difference.

“Ukrainian banks have deep knowledge of the local market and powerful teams of lawyers dealing with NPLs,” he says. “If they can’t retrieve money from the businesses of politicians, it’s very unlikely that foreign investors will be more successful.”

For the state banks, where NPLs are highest, there has been talk of setting up a bad bank. The NBU has opposed the suggestion, however, due to concerns that it could become a mechanism for deliberate defaulters to erase their debt.

“We are strongly opposed to debt forgiveness for businesses that were built around political connections, are not operating in a transparent manner and, in most cases, are not even paying taxes,” says Vavryschuk.

The central bank has called instead for the appointment of independent consultants to manage NPL portfolios at state banks.

Officials admit, however, that addressing Ukraine’s NPL problem will be a lengthy business.

“We expect a slight reduction in the overall NPL ratio this year due to the resumption of lending growth, but it’s very unlikely that the stock of bad debts will decline significantly in the next 12 months,” says Vavryschuk.

At the same time, he is keen to stress that high provisioning levels – particularly in the private sector and at PrivatBank – mean Ukraine’s lenders are well-placed to withstand further external shocks.

“The banks have taken the hit, and the NPL coverage ratio is now close to 85%,” he says. “So, while the headline NPL ratio may be scary, we don’t expect any new rounds of negative effects for the banking sector.”

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