War-Weary Ukraine Shutters Cash-Starved Banks as Trust Falls

Maidan Square in Kiev, Ukraine

(Bloomberg – bloomberg.com – Volodymyr Verbyany, Andras Gergely – June 12, 2015)

When Vasyl Klos plunked $9,000 into a bank branch in his hometown of Lviv, Ukraine, in 2013, he assumed it was safe because it was German owned. He was wrong.

Bank Forum JSC had already been sold by Commerzbank AG to Ukrainian businessman Vadim Novinsky, a fact Klos only found out as he completed the deposit. He decided it was too late to back out, but within a year, Forum was declared insolvent and the cash was returned to him in hryvnia, whose later plunge cut the value of his original deposit by about half. The experience has left him poorer, but wiser.

“I’m not going to open any more deposit accounts until the economy stabilizes,” said Klos, a 33-year-old field researcher. “And even then, I would only put money in a foreign-owned bank.”

As if fighting a year-long war against pro-Russian separatists wasn’t enough, Ukraine is also scrambling to shore up a banking system that’s bleeding assets amid a tumbling economy, wavering talks with creditors about overdue debt and skyrocketing inflation, which the central bank estimates will end this year at between 45 percent and 50 percent. A run of liquidations has shaken consumers’ confidence in the often mismanaged financial institutions they once trusted to protect their money.

Insolvency Wave

Since 2014, the central bank has declared a quarter of the former Soviet republic’s 180 domestic banks insolvent, liquidated 37 of them as of the end of May and earmarked 36 billion hryvnia ($1.7 billion) for bailouts this year alone.

Cleaning up the troubled banks, left with insufficient supervision for years, has been a painful process as the country fights rebels in a conflict that’s killed at least 6,400 and displaced 1 million citizens. Thousands of Ukrainians and some oligarchs, such as egg magnate Oleg Bakhmatyuk and chemical tycoon Dmitry Firtash, saw some of their assets vanish as banks were declared insolvent.

The cleanup is needed to “rebuild people’s trust in banks,” said Anastasia Tuyukova, an analyst at Dragon Capital investment company in Kiev. “This is a step they should have made in 2008-2009, but didn’t.”

The reorganization is also designed to cut reliance on the public purse at a time when the government is trying to restructure $23 billion in sovereign debt.

The affected banks, ranging from small players to the country’s fourth-largest, Delta Bank, have suffered from their inability to drum up enough capital in the economy expected to contract 9 percent this year, according to the International Monetary Fund’s forecast. Many of the smaller banks only served affiliated businesses and ran into troubles when debtors didn’t repay loans.

Bank Bailouts

Ukraine follows other east European nations that have had to bail out their banks since the 2008 global financial crisis. Household lending in dollars and a sharp hryvnia depreciation in 2008 during years of political turmoil has caused the share of non-performing loans in Ukraine to soar.

Bad loans rose to 25.5 percent of the total of all loans from January to April alone, compared with 19 percent at the end of 2014, the central bank said on Thursday. The International Monetary Fund calculated the ratio of non-performing loans was at 32 percent as of Jan. 1.

Ukraine and Russia both sustained too many lenders for the size of their economies while still often failing to provide basic services to all, said Anastasia Nesvetailova, a professor at City University London.

Yevhen Hrebeniuk, a financial sector consultant at the World Bank’s office in Kiev, also pointed to similar events in Turkey and Indonesia, which governments eventually overcame.

Bank Surfeit

“There was no particular good reason for Ukraine to have so many banks,” Nesvetailova said by phone on Thursday. “A lot of them were either very corrupt or implicated in strange economic activities.”

The crisis escalated last year when former President Viktor Yanukovych fled Kiev, Russia annexed Crimea in March and the separatist insurgency in Ukraine’s easternmost regions pitted Russia against the U.S. and the European Union in their worst standoff since the Cold War. The conflict deepened the woes of an already fragile economy and banking sector, Nesvetailova said.

“There are villages or small towns where there is absolutely no cash,” she said. “People dependent on pension transfers or basic banking systems don’t get it fulfilled.”

New Team

Premier Arseniy Yatsenyuk took power last year and picked Natalie Jaresko, an American-born investment banker, to head the Finance Ministry. The task of Jaresko and Valeriya Gontareva, who has chaired the central bank since June 2014, was clear: stabilize the economy and overhaul the banking system.

“Their back is against the wall now, they have don’t have an option, they have to reform,” Nashwa Saleh, a London-based analyst at Exotix Partners LLP, said in a phone interview on Thursday. “They also have the right technocrats in place to undertake the reforms.”

Ukraine has so far compensated retail savers with about 50 billion hryvnia through the state guarantee fund, representing about 10 percent of the country’s annual budget revenue, Gontareva told lawmakers in March. Retail deposits are covered up to 200,000 hryvnia per person.

Stress tests carried out last year showed a 66 billion-hryvnia capital need. Still, there’s a “high chance” the government may not need to use all the funds it earmarked for bailouts this year, central bank Deputy Governor Oleksandr Pysaruk said in a May 22 interview in Kiev.

Delta Blues

The biggest case in the country so far was Delta Bank, the country’s fourth-largest lender, which was declared insolvent in March after failing to repay a 4.2 billion-hryvnia loan. The government declined to nationalize the lender, saying its assets were of poor quality and it needed a 22 billion-hryvnia capital injection.

Banks owned by Yanukovych’s associates also haven’t been spared.

Nadra Bank, owned by billionaire Firtash, was declared insolvent in February as its owner was detained in Austria pending a U.S. extradition request. The request was rejected in April, allowing Firtash to leave the country.

The list of failed banks also includes VBR Bank, run by Yanukovych’s son, Oleksandr.

Other wealthy Ukrainians such as Bakhmatyuk, whose empire includes the country’s largest egg producer, had his majority shareholding in VAB Bank wiped out in insolvency proceedings. The bank was, along with others, taken over by the Deposit Guarantee Fund for administration and is now being liquidated.

Foreign Lenders

Foreign lenders with Ukrainian units that include Italy’s UniCredit SpA, Raiffeisen Bank International AG in Austria and Hungary’s OTP Bank Nyrt., have also had to inject fresh capital to keep up their presence in the country. Finding buyers for such units has proven a tougher option.

Authorities say the cleanup effort may be nearing its end more than a year after it started.

“Just a few troubled banks remain,” Pysaruk said. “We are working thoroughly with their shareholders to solve their problems.”

Article ©2015 Bloomberg L.P. All Rights Reserved. Article also appeared at bloomberg.com/news/articles/2015-06-11/war-weary-ukraine-shutters-cash-starved-banks-as-trust-plummets