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Banks and Bank Regulation

Ukraine has a two-tiered banking system. The National Bank of Ukraine (NBU) is the country’s central bank. Commercial banks, including Ukreximbank, the state export-import bank of Ukraine, and Oschadny Bank, the state savings bank of Ukraine, operate under the authorization and supervision of the NBU.

National Bank of Ukraine
 
The 1999 National Bank Law states that the primary function of the NBU is to ensure the stability of the monetary unit of Ukraine, the hryvnia (UAH). The NBU is also tasked with maintaining the stability in the banking system and price stability, within the scope of its power.
The National Bank of Ukraine exercises regulation and banking supervision in accordance with the provisions of the Constitution of Ukraine, the Law of Ukraine “On Banks and Banking”, the Law of Ukraine “On the National Bank of Ukraine” and other legislative acts of Ukraine and regulations of the National Bank of Ukraine.

The purpose of banking supervision is stability of the banking system and protection of interests of depositors and creditors as to the safekeeping of client’s funds on banking accounts.

Supervisory activity of the National Bank of Ukraine covers all banks, their subdivisions, affiliated and related parties of the banks on the territory of Ukraine and abroad, offices of foreign banks in Ukraine, as well as other legal entities and individuals in their compliance with the requirements of the Law of Ukraine “On Banks and Banking” as to performing banking activity.

In order to exercise its functions, the National Bank is entitled to obtain free of charge from the banks, bank unions (associations) and legal entities that have been granted a license by the National Bank to perform certain banking transactions, as well as from the persons whose activities are supervised by the National Bank pursuant to the Law of Ukraine “On Banks and Banking”, the information of their activities and explanations with regard to the obtained information and effected transactions.

The obtained information is not to be disclosed, except in the cases prescribed by the laws of Ukraine.

In the course of banking supervision, the National Bank of Ukraine has the right to require that the banks and managers thereof eliminate banking legislation violations, fulfill NBU regulations in order to avoid or to overcome undesirable consequences, which could jeopardize safety of the funds, entrusted to these banks or inflict damage on a proper banking activity.

The National Bank of Ukraine carries out the banking supervision in the form of on-site inspections and off-site supervision.

The highest governing body of the NBU is the 15-member Council. Seven members are appointed by the Verkhovna Rada (the Parliament) and seven by the President. The Bank Governor, who is nominated by the President and appointed by the Rada, acts ex officio as the 15th member. The Council is responsible for developing the principles underlying the country’s monetary policy.

The banking sector
 
The Ukrainian banking sector has historically suffered from a number of significant weaknesses, including undercapitalization, weak corporate governance and management, poor asset quality, and even excessive political intervention in some instances. The situation is improving and reforms are continuing. Today, Ukraine’s banks are required to prepare accounts based on International Financial Reporting Standards (IFRS).
 
Most banking services are available in Ukraine, and consumer credit facilities are expanding rapidly. Intermediation costs remain fairly high, although the presence of Western banks, particularly in retail banking, should force the sector to become more efficient over time. In November 2006, the Parliament passed a law that permit foreign banks to operate branch offices in Ukraine since the country joined the WTO.
 
As of January1, 2017, 96 commercial banks were registered in Ukraine, including 38 that had foreign capital     (compared with 176 and 53 accordingly as of January 1, 2013).
 
Ukraine’s banking sector has a high level of concentration. According to NBU data, as of May 1, 2017, over 95% of sector’s total assets are held by the 20 largest banks.

Ukraine is experiencing one of the most challenging periods in its modern history. The ongoing economic, social and political crisis has hit all market segments and the banking sector in particular. Industrial output decline, capital outflows, job cuts, and the vast volatility of the monetary fundamentals and the exchange rate created an extremely challenging environment for local banks.

One of the key problems currently faced by Ukrainian banks is the liquidity short¬age, enhanced by vast deposit outflow. During 2014, the Ukrainian banking sec¬tor lost UAH 200 bn in deposits, which is about 15% of the banking sector's to¬tal assets. As a result, banks faced a liquidity crunch, and many of them had no other option but to close and leave the market. As of May 1, 2017, 82 banks are going through the liquidation process held by the Deposit Guarantee Fund, thus leaving the market. The rapid and sharp decline in the economic environment has also caused a spike in the NPL ratio. NPL ratio in the Ukrainian banking system is expected at 31% as of December 2017.

In addition to the revenue shortfall due to escalated credit and market risks and the vastly depreciated domestic currency, banks are forced to create extra provi¬sioning for bad loans and FCY-denominated loans.

In the end of 2016, nationalization of the biggest market player – PrivatBank – took place. Stress testing revealed higher than previously reported related-party lending and shortfalls in loan-loss provisions and, thus, capital. Total capital needs were estimated between UAH 117-148 billion, according to the Ministry of Finance. Shareholders did not provide sufficient capital support, therefore, on December 18, 2016 PrivatBank was declared insolvent and transferred to the Deposit Guarantee Fund (DGF). On December 21, the bank was sold to the Government by the DGF for UAH 1 due to its systemic importance. Now that PrivatBank has been nationalized, the state owns four biggest banks in Ukraine the share of state capital in the banking sector exceeds 50%.

In financial year 2016, 31 among 93 operating banks received lost  UAH 169.3 billion in total. Approximately 80% of the expenses (UAH 135.3 billion) were paid by PrivatBank.  Other banking institutions completed the reporting period with a positive financial result, having collectively received UAH 10.82 billion profit. Among the most profitable inthe last year were exclusively foreign financial institutions – Raiffeisen Bank Aval, OTP Bank and Citibank. The top-3 of most profitable banks in 2016 earned 57.5% of total income in the banking sector.

Ukraine has received a $1 billion installment of $17.5 billion financial support for reforming its government, following the IMF’s report on the state of Ukraine`s economy. While its economy is slowly recovering after a severe economic crisis of 2014-2015, the country must do away with a legacy of weak governance and stop-and-go reforms to generate the sustainable growth needed for higher incomes and better social conditions.


Key banking sector indicators

 

Balance sheet data

2010

2011

2012

2013

2014

2015

2016

Total assets (EUR mn)

88,167

101,788

106,339

114,627

68,469

47,835

44,200

growth in % yoy

15.0

15.4

4.5

7.8

(40.3)

(30.13)

(7.6)

in % of GDP

87.0

81.3

80.0

88.5

86.0

63.37

52.7

Total loans (EUR mn)

67,809

76,268

76,353

81,155

51,039

43,880

35,392

growth in % yoy

8.3

12.5

0.1

6.3

(37.1)

(14.03)

(19.34)

in % of GDP

66.9

60.9

57.4

62.7

64.1

58.13

42.2

Loans to private enterprises (EUR mn)

48,674

57,402

59,078

64,246

41,730

29,970

29.800

growth in % yoy

15.9

17.9

2.9

8.7

(35.0)

(28.18)

(0.57)

in % of GDP

48.0

45.8

44.4

49.6

52.4

39.70

35.5

Loans to households (EUR mn)

19,134

18,866

17,275

16,909

9,309

5,811

5,524

growth in % yoy

(6.7)

(1.4)

(8.4)

(2.1)

(44.9)

(37.58)

(4.94)

in % of GDP

18.9

15.1

13.0

13.1

11.7

7.7

6.7

Mortgage loans (EUR mn)

8,686

7,526

6,174

3,455

2,802

2,833

2,044

growth in % yoy

(4.8)

(13.3)

(18.0)

(44.0)

(18.9)

1.12

(27.86)

in % of GDP

8.6

6.0

4.6

2.7

3.5

3.75

2.4

Loans in foreign currency (EUR mn)

31,569

31,071

28,261

27,624

24,083

24,134

18,404

growth in % yoy

(1.5)

(1.6)

(9.0)

(2.3)

(12.8)

0.21

(23.74)

in % of GDP

31.2

24.8

21.3

21.3

30.2

31,972

21.9

Loans in foreign currency (% of total loans)

47

41

37

34

47

55

52

Total deposits (EUR mn)

38,767

46,806

53,995

59,959

35,239

26,949

28,395

growth in % yoy

35.8

20.7

15.4

11.0

(41.2)

(23,53)

5.37

in % of GDP

38.3

37.4

40.6

46.3

44.2

35.7

38.9

Deposits from households (EUR mn)

25,431

29,560

34,836

39,209

21,649

14,837

15,382

growth in % yoy

38.0

16.2

17.8

12.6

(44.8)

(31,47)

3.67

in % of GDP

25.1

23.6

26.2

30.3

27.2

19.67

18.3

Total loans (% of total deposits)

175

163

141

135

145

163

125

Structural information

 


Number of banks

1 76

1 76

1 76

180

1 63

117

96

Market share of state-owned banks (% of total assets)

17

17

18

18

22

30

51

Market share of foreign-owned banks (% of total assets)

43

38

33

27

31

42

34

Profitability and efficiency

 


Return on Assets (RoA)

(1.5)

(0.8)

0.5

0.1

(4.1)

(5.5)

(2.48)

Return on Equity (RoE)

(10.2)

(5.3)

3.0

0.8

(30.5)

(51.9)

26.56)

Capital adequacy (% of risk weighted assets)

20.9

18.2

18.1

18.3

15.6

12.7

13.0

Non-performing loans (% of total loans)

11.2

9.6

8.9

7.7

13.5

22.1

31.0

 

* Loans that are in default according to NBU data;
**LCY depreciation against the EUR in 2014: -41%
Source: NBU, RBI/Raiffeisen Research, Rurik Research


New regulations of the National Bank of Ukraine: advanced shareholding disclosure rules & enhanced solvency requirements for UBOs

Following the adoption by the Parliament in March 2015 of the Law, which increased responsibility of persons related to a bank (the Law), the National Bank of Ukraine (the NBU) developed several regulations (Regulation No. 328 and Regulation No. 332 of 21 May 2015 and Regulation No. 357 of 4 June 2015 – collectively referred to as the Regulations) aiming at practical implementation of new requirements established by the Law.

To remind, the Law expanded the list of persons related to a bank as well as liability of such persons, set out new restrictions on transactions with related persons, introduced new requirements regarding disclosure of the banks' ownership structure and reconsidered the approach to obtaining approval for acquisition of a significant interest in a bank.

Being inspired by the IMF support of the targeted transparency of the Ukrainian banking system, the NBU has further developed most of the novelties established by the Law. In particular, the NBU changed the requirements to solvency of the ultimate beneficial owners of Ukrainian banks (the UBOs) and established new approaches to disclosure of bank shareholding structure.


New regulations - important takeaways:

Pragmatic approach to UBO solvency: to be cleared by the NBU, a UBO should have income exceeding the bank's regulatory capital

The NBU enhanced requirements to financial standing of the UBOs. Under the new rules, the UBO's income should be sufficient to ensure further capitalization of the bank. In setting out the UBO income sufficiency test, the NBU linked the UBO's income to the bank's regulatory capital or its charter capital, in case it exceeds the regulatory capital.

Example: a person acquiring 50% shareholding in a bank with regulatory capital of UAH 500m should prove legitimate income in amount exceeding UAH 250m. Otherwise, such person will not obtain the NBU approval for the acquisition of a significant interest in such bank.
In case a bank claims absence of the UBO, the NBU may apply 'informal ownership concept' or inspect ten largest 'ultimate key stakeholders'

In case a bank’s shareholding structure does not reveal a clear link with a particular UBO, the NBU will most likely suspect such bank in having nominee shareholders acting in the interests of a real UBO. In such case, the NBU will be able:

to apply the so-called 'informal ownership concept' in case the lack of information on the formal ownership in a bank. As a result, the NBU will be entitled to recognize a person having a significant or decisive influence over the bank's management and activity as an owner of a significant interest in such bank. To the moment, the NBU has already tested the informal ownership concept on several occasions. In particular, the NBU identified and imposed sanctions on several informal owners of a significant interest in Ukrainian banks. Furthermore, the NBU is planning to dramatically increase fines applicable to informal owners of a significant interest in a bank, who did not obtain the respective NBU approval; or to check financial standing of ten largest 'ultimate key stakeholders' – persons holding at least 2% shareholding in a legal entity in the bank's ownership chain and which do not themselves have key stakeholders (e.g., individuals or foreign public listed companies). If at least two ultimate key stakeholders holding more than 5% shareholding in a bank or one person holding ultimately at least 10% stake fail to prove sufficient financial standing, the NBU may designate ownership structure of a bank as "non-transparent".

Banks designated by the NBU as having non-transparent ownership structure may face serious adverse consequences. In particular, the NBU may refuse to grant a refinancing loan to such bank, prevent it from purchasing foreign currency or otherwise restrict banking operations. Business reputation of the managers of such bank may be seriously affected. In the worst-case scenario, the NBU may designate such bank as a "problematic" one.

New NBU approach requires investors to conduct thorough and careful structuring of acquisition of Ukrainian banks

The Regulations established new rules directly affecting the structures commonly used by lawyers when documenting an acquisition of a Ukrainian bank:

New formula for calculation of indirect ownership in a bank. The formula should provide the NBU with additional instruments for identifying indirect owners of a significant interest in a bank. According to the Regulations, the NBU will use the formula in addition to the criterion of control.

Ban on discretionary trust structures. Regulations designate the ownership structure of a bank as non-transparent if significant holding in a bank is transferred to a discretionary trust making it impossible to determine all owners of a significant interest in a bank.

Certain exemptions for private investment vehicle structures. The NBU appreciated the fact that some private investment vehicles, such as limited partnerships, may find it difficult (if possible at all) to provide all documents and comply with formal requirements commonly applied by the NBU to the acquirers of a significant interest in a Ukrainian bank. Therefore, in case private investment vehicles meet the criteria envisaged by the Regulations, the NBU may exempt such vehicles from obligation to comply with all formal requirements.

Separate submission procedure for persons qualified as indirect owners of a significant interest in a bank following the adoption of the Law