Dmytro Solo­hub: "2017 is the key year to im­ple­ment vi­tal and of­ten un­pop­u­lar re­forms"

"2017 is the key year to im­ple­ment vi­tal and of­ten un­pop­u­lar re­forms"

The Ukrainian Week - - CONTENTS - In­ter­viewed by Lyubomyr Shava­lyuk

NBU Deputy Chair­man Dmytro Solo­hub on the qual­ity of change in Ukraine’s banking sys­tem

Crit­i­cism of the Na­tional Bank of Ukraine (NBU) has be­come a trend in the past three years. How­ever, it re­mains the state agency that has im­ple­mented the most changes so far. The Ukrainian Week spoke about the qual­ity of those changes and the new prospects they open for the coun­try's banking sys­tem with NBU Deputy Chair­man Dmytro Solo­hub.

In the eyes of many Ukraini­ans, the banking re­form boils down to the clos­ing of over 80 pri­vate banks and sig­nif­i­cant losses suf­fered by hun­dreds of thou­sands of de­pos­i­tors. What will the coun­try get in re­turn?

The NBU’s pol­icy in the fi­nan­cial sec­tor can be com­pared to a sur­geon's work. Pa­tients may well be un­aware of their chronic dis­eases. When a doctor says that im­me­di­ate surgery is nec­es­sary, be­fore it is too late, pa­tients of­ten refuse and say that they feel fine. The sit­u­a­tion with our banking sys­tem is sim­i­lar. On the sur­face, ev­ery­thing looked rel­a­tively good: there were banks, they had branches, cus­tomers opened de­posit ac­counts and could even re­ceive in­ter­est on them. How­ever, with­draw­ing a de­posit was a dif­fer­ent story, since fi­nan­cial in­sti­tu­tions ei­ther de­layed re­pay­ment or re­turned them us­ing the money de­posited by other cus­tomers, and so on.

At the same time, the banks’ prob­lems re­mained un­solved, ac­cu­mu­lated and ag­gra­vated. Inside, they were vir­tu­ally in­sol­vent. There was only an ex­ter­nal ap­pear­ance of sta­bil­ity and nor­mal busi­ness ac­tiv­ity. This was just an­other sim­u­lacrum, a term that well de­fines many Ukrainian in­sti­tu­tions. Take, for ex­am­ple, the army: it seemed to ex­ist with its gen­er­als and sol­diers, but as soon as the war broke out, it turned out that that in fact there was vir­tu­ally no army. It is very much the same with the Ukrainian banking sys­tem. If we look back at its his­tory, over the past 25 years the prob­lems only ac­cu­mu­lated and were never solved sys­tem­at­i­cally. How­ever, the ex­am­ples of other coun­tries and banking crises that hap­pened in un­der­de­vel­oped economies, as well as coun­tries like Swe­den in the early 1990s or the US in 2008-2009, show that com­pre­hen­sive ap­proach to prob­lems and the cleanup of the banking sys­tem can lay the foun­da­tion for a long-term healthy de­vel­op­ment of both the sec­tor and the econ­omy in gen­eral.

Can we ex­pect lower loan in­ter­est rates and what would be the un­der­ly­ing fac­tors en­abling them?

What are the loan rates made of? They can be bro­ken down into sev­eral com­po­nents. First of all, it is the price of re­sources. The bank is a me­di­a­tor, which does not print the money, but takes it from one source and gives it to an­other. This com­prises the cost of de­posits. Sec­ondly, the mar­gin en­ables the bank to op­er­ate, take on risks and so on.

What de­ter­mines the cost of de­posits? It de­pends on the in­ter­est rate at which peo­ple, com­pa­nies, and in­sti­tu­tional in­vestors are will­ing to in­vest money in a bank. Cus­tomers ex­pect the in­ter­est rate to in­sure them against in­fla­tion or any macroe­co­nomic im­bal­ances. Be­sides, of course, the rate is af­fected by the con­fi­dence in the banking sys­tem and the econ­omy in gen­eral.

We of­ten hear to­day that loans should be is­sued at 3% per an­num. Yet, no one wants to de­posit money at 1%. It is im­por­tant there­fore to un­der­stand that the cost of fi­nan­cial re­sources is based on ob­jec­tive macroe­co­nomic pa­ram­e­ters, pri­mar­ily, on the over­all macroe­co­nomic and fi­nan­cial sta­bil­ity in the coun­try. That, in turn, is de­ter­mined by the rate of in­fla­tion, the sit­u­a­tion on the for­eign ex­change mar­ket, and the over­all con­sumer con­fi­dence in­dex. If you look at in­fla­tion lev­els in Ukraine in the past com­pared to other coun­tries in


the re­gion, they were on av­er­age the high­est and the most vo­latile. The same goes for the ex­change rate: in the­ory, it was fixed, but in fact, there were al­ways some prob­lems around it. This ex­plains the need for the in­fla­tion targeting pol­icy in­tro­duced by the NBU. If we set the medium term in­fla­tion tar­get at 5% and peo­ple see that we can achieve this level, they will trust our re­sults and de­posit rates will go down.

What de­ter­mines the mar­gin of the banking sys­tem? It is the risks as­so­ci­ated with the op­er­a­tion of a fi­nan­cial in­sti­tu­tion. Even if a bank can at­tract as­sets at 3% but is not con­fi­dent that the loan re­ceiver will re­pay the sum, it will try to in­flate the loan price to set off its own risks.

What de­ter­mines credit risk? On the one hand, it is the gen­eral state of the econ­omy. On the other, it is the sys­tem of courts and law en­force­ment, pro­tec­tion of prop­erty rights, po­lit­i­cal sta­bil­ity, and so on. For the past 10 years, bankers have been talk­ing about these prob­lems. But lit­tle has changed, and risks re­main high. Get­ting a loan at 2% in an econ­omy that is im­bal­anced, has an un­sta­ble po­lit­i­cal sys­tem and an in­ef­fec­tive ju­di­cial one, is un­re­al­is­tic.

The ex­pe­ri­ence of other coun­tries shows that all these risks can be elim­i­nated through rel­e­vant re­forms. Just have a look at our neigh­bors in East­ern Europe: they didn’t al­ways had low in­ter­est rates. Loan in­ter­est rates in Poland ex­ceeded 20% un­til the early 2000's, and dropped to the cur­rent lows only af­ter in­fla­tion was sus­tain­ably curbed.

Mir­a­cles do not hap­pen. It takes long hard work to achieve the re­sult of low loan rates. Let's com­pare to­day's in­ter­est rates with the ones we had 3–4 years ago. We of­ten hear to­day that the econ­omy can’t work be­cause it is im­pos­si­ble to get a loan due to high in­ter­est rates. But have there ever been lower rates? For hryv­nia-de­nom­i­nated loans, at the NBU rate of 14%, loan rates range from 14% for large com­pa­nies to 20% for small busi­nesses, but usu­ally do not ex­ceed 20%. This is not a big dif­fer­ence from what we had be­fore. Even at zero in­fla­tion in 2012–2013, both de­posit and loan rates were high. In­ter­est rates on short-term de­posits in lo­cal cur­rency never went be­low 10%. The same ap­plies to loan in­ter­est rates, which never went be­low 15% for cor­po­rate clients.

This is chang­ing grad­u­ally. The NBU sets in­fla­tion tar­gets and, as 2016 has shown, can achieve them. We have re­peat­edly said that curb­ing in­fla­tion would re­sult in a re­duced dis­count rate, which, as we saw last year, af­fects all other rates in the econ­omy.

The banking sys­tem re­form de­pends not only on the NBU, and the eco­nomic growth does not de­pend on loans alone. What bot­tle­necks in­de­pen­dent of its ac­tiv­i­ties does the NBU see in both pro­cesses?

It is a very im­por­tant and a some­what philo­soph­i­cal ques­tion. What changes does the coun­try need? Should they be im­ple­mented im­me­di­ately or grad­u­ally? From my per­sonal ex­pe­ri­ence, I know that if you are in­vited to do some­thing, just do it rather than sit­ting around and wait­ing. Re­forms are a two-way street. Some­times we hear al­le­ga­tions that the NBU went too fast. How­ever, if we look at the sit­u­a­tion prac­ti­cally, what did we have to do? Sit and wait, or try to en­cour­age oth­ers with our ac­tiv­i­ties to im­ple­ment some re­forms, de­spite the crit­i­cism?

As for the bot­tle­necks, here we should go back to the first ques­tion. Why were the re­forms of the banking sec­tor un­pop­u­lar? An im­por­tant rea­son is that they were not fol­lowed to the log­i­cal end, namely, the pun­ish­ment of those who have done all this dam­age to the banking sys­tem. If all the moves by the Na­tional Bank of Ukraine and the De­posit In­sur­ance Fund re­lated to crim­i­nal in­ves­ti­ga­tions were car­ried through by the law en­force­ment agen­cies, this would have meant that be­sides some ex­is­ten­tial pun­ish­ment, for­mer own­ers of banks that still have plenty of as­sets would have to kiss them good­bye, mak­ing it pos­si­ble to com­pen­sate peo­ple for sav­ings lost in failed fi­nan­cial in­sti­tu­tions. How­ever, the bud­get only cov­ered losses not ex­ceed­ing UAH200,000, while the claimhold­ers of the third and fourth pri­or­ity and oth­ers were of­ten left with noth­ing.

There­fore, I be­lieve that the re­form of the ju­di­ciary re­mains the ma­jor bot­tle­neck. It can also be seen in the over­all con­text of the anti-cor­rup­tion fight, which is the coun­try's big­gest prob­lem that, un­for­tu­nately, ham­pers ev­ery­thing else and pre­vents from restor­ing con­fi­dence in the banking sys­tem, among other things.

To­day a lot is be­ing said about the need to re­vive the econ­omy in or­der to achieve the 8% an­nual growth, and so on. But here, again, mir­a­cles do not hap­pen. It re­quires long and hard work. For ex­am­ple, all re­forms that are be­ing dis­cussed to­day (land, pen­sion, etc.) lay the foun­da­tion for a more sta­ble and more dy­namic econ­omy in the long run. We are not the first to go through this. There­fore, say­ing that we would in­vite lo­cal or for­eign in­vestors or start sup­port­ing some ma­chineb­uild­ing as­sets so that they gen­er­ate GDP is im­pos­si­ble, be­cause the ba­sic pre­req­ui­sites have not been quite met. We should con­tinue mov­ing in that di­rec­tion, that is, re­form­ing those sys­tems that ev­ery­one com­plains about, such as tax, cus­toms, etc. These are the bot­tle­necks that per­sist and hin­der the growth.

Changes to the Ukrainian econ­omy are tak­ing place. They also de­serve a men­tion. They in­clude the banking sys­tem, pub­lic pro­cure­ment, en­ergy sec­tor, po­lice, and even some smaller things, such as the re­port pre­pared by the Min­istry of Econ­omy and show­ing the prob­lems that ex­ist in the na­tional prop­erty sec­tor. That is, cer­tain steps have al­ready been taken. How­ever, we are not forc­ing changes. In many sec­tors, we pledge and then hedge.

What can the banking sys­tem and its cus­tomers ex­pect in 2017?

If we want to have a com­pre­hen­sive view, let's start with the eco­nomic overview. Our fore­casts are based on the as­sump­tion that the eco­nomic sit­u­a­tion will grad­u­ally go back to nor­mal. Ukraine still de­pends on for­eign mar­kets. There­fore, it is im­pos­si­ble to cre­ate a lot of do­mes­tic growth driv­ers in the short term. The only hy­po­thet­i­cal hope for the rapid growth of the Ukrainian econ­omy are pos­i­tive dy­nam­ics of for­eign mar­kets. How­ever, no one ex­pects this, be­cause to­day ev­ery­one thinks that the things can only get worse, since our ex­port-led econ­omy has no po­ten­tial for rapid growth.

As for the in­ter­nal growth points, they de­pend on the re­forms that we have al­ready dis­cussed, and will not emerge fast. At the same time, the macroe­co­nomic picture could be slightly bet­ter than it would have been un­der the nor­mal eco­nomic state pol­icy and con­tin­ued co­op­er­a­tion with in­ter­na­tional donors: IMF, EU, and the World Bank. The lat­ter is the mat­ter of not just money, but also the con­fi­dence in our coun­try. Quick growth usu­ally re­quires in­vest­ment, which is es­pe­cially true for the de­vel­op­ing coun­tries. In­vest­ment vol­umes de­pend on the in­vest­ment cli­mate, struc­tural re­forms, etc. There­fore, donors such as the IMF send a strong mes­sage. Their sup­port and the im­ple­men­ta­tion of the re­forms are the keys to grad­u­ally im­prov­ing the in­vest­ment cli­mate in the coun­try. It is dif­fi­cult to ex­pect that a large in­ter­na­tional in­vestor, such as Hyundai or Siemens, would come to us and open a fac­tory, cre­at­ing 10,000 jobs. How­ever, there are also pos­i­tive ex­am­ples, in­clud­ing com­pa­nies operating in Western Ukraine and pro­duc­ing mo­tor ve­hi­cle parts. Other in­vestors have also in­creased their pres­ence.

I think that the banking sys­tem de­vel­op­ment will fol­low the coun­try's eco­nomic re­cov­ery. We can ex­pect the grad­ual growth of the de­posit base and the re­newal of lend­ing ac­tiv­i­ties, and there is a high prob­a­bil­ity of banks restor­ing their prof­itabil­ity. Last year a num­ber of fi­nan­cial in­sti­tu­tions that were the first to cleanup their port­fo­lios al­ready showed a profit, and this year the process will gain mo­men­tum. Af­ter all, there aren't that many "sick" banks left in the banking sys­tem.

If macroe­co­nomic sta­bil­ity con­tin­ues, this will cre­ate the po­ten­tial for eas­ing NBU's mon­e­tary pol­icy, that is, in­ter­est rates will grad­u­ally de­crease. How­ever, the risks re­main high, since our econ­omy de­pends on the fluc­tu­a­tions in ex­ter­nal mar­kets, as well as on sea­sonal fluc­tu­a­tions. Un­for­tu­nately, tem­po­rary fac­tors (such as mas­sive bud­get spend­ing be­fore the New Year) can af­fect the sit­u­a­tion on the cur­rency mar­ket. This cre­ates short-lived fluc­tu­a­tions, but we are used to them and know what to do.

I would like to draw your at­ten­tion to an­other im­por­tant de­tail. We should not re­as­sure our­selves, think­ing that the econ­omy is re­cov­er­ing and that all is well. If we look at a longer time hori­zon, we can see that in a few years the coun­try's for­eign debt re­pay­ments will in­crease sig­nif­i­cantly, when the grace pe­riod of the re­struc­tur­ing deal will end. Be­sides, so­cial ten­sions are grow­ing. The state is try­ing to soothe them with sub­si­dies and in­creased min­i­mum wages. How­ever, all these mit­i­ga­tion mea­sures cre­ate pres­sure on the fis­cal per­for­mance when there is no pen­sion re­form. Un­less eco­nomic growth and struc­tural re­forms, such as the pen­sion re­form, ac­cel­er­ate, this might af­fect Ukraine in a rather neg­a­tive way af­ter two or four years.


In ad­di­tion to that, you have a po­lit­i­cal cy­cle: elec­tions are due in 2019. In view of the above, 2017 is the key year to im­ple­ment vi­tal and of­ten un­pop­u­lar re­forms. There is no other way.

How can you make peo­ple duly ap­pre­ci­ate trans­for­ma­tions in the banking sys­tem?

Cen­tral bankers are in many ways sim­i­lar to sur­geons or den­tists: they hurt peo­ple now so that they feel bet­ter af­ter. This ap­plies not only to Ukraine. There are many ex­am­ples even in the de­vel­oped coun­tries, where politi­cians and the so­ci­ety al­ways have many ques­tions to their cen­tral banks. I am not say­ing that we take this for granted and do noth­ing. Our pol­icy of com­mu­ni­cat­ing and en­hanc­ing fi­nan­cial lit­er­acy of the pop­u­la­tion that we have pur­sued in the re­cent years is aimed, among other things, at ad­dress­ing this prob­lem.

At the same time, we un­der­stand the lim­its of our ca­pa­bil­i­ties. Fight­ing with po­lit­i­cal pop­ulists in their field is rather dif­fi­cult. Our an­swer, there­fore, is: ac­tive com­mu­ni­ca­tion, trans­parency and, most im­por­tantly, re­sults achieved. Un­for­tu­nately, in our coun­try any achieve­ment is of­ten per­ceived as a "trea­son." How­ever, cen­tral banks were es­tab­lished as tech­no­cratic, non-po­lit­i­cal bod­ies. As Jean-Claude Juncker put it, "We all know what to do, we just don't know how to get re-elected af­ter we've done it." Cen­tral bankers don't have such prob­lems. As I once said, tech­no­cratic bod­ies, such as fi­nan­cial reg­u­la­tors, ex­ist to save politi­cians from them­selves. Af­ter all, a pub­lic fig­ure will al­ways be tempted to go into pop­ulism, but they can't cross the line and in­flu­ence an in­de­pen­dent body, which ul­ti­mately helps the econ­omy and the so­ci­ety in the long term.

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