Al­most dif­fer­ent:

How re­forms change the banking sys­tem

The Ukrainian Week - - CONTENTS - Lyubomyr Shava­lyuk

How re­forms change the fun­da­men­tals of Ukraine’s banking sys­tem

Changes, even the su­per­fi­cial ones, al­ways cre­ate in­con­ve­niences not only to those who lose some­thing as a re­sult, but also to those who just ab­hor them or are not men­tally readyto face them. Such cit­i­zens of­ten­make up the ma­jor­ity of the elec­torate and can­not be ig­nored. Any re­form can be jus­ti­fied only by the re­sult that it is bound to even­tu­ally en­sure a change of life for the bet­ter. This is some­thing that politi­cians and ad­vo­cates of changes un­der­stand too well: there must be a rea­son for a re­form.

How­ever, if we trust what the TV tells us, we can get the im­pres­sion that re­forms in Ukraine’s banking sys­tem boils down to su­per­fi­cial changes, neg­a­tive with­out ex­cep­tion. Closed banks, lost de­posits, un­ac­count­able bankers, un­paid re­fi­nanc­ing and a lot more have be­come buzz­words for most Ukrainian, as well as pop­ulist politi­cians that try to im­prove their rank­ings bye­cho­ing neg­a­tive news. At that, the essence of the on­go­ing re­form re­mains in the shad­ows.

The best known change so far has been the trans­parency in­tro­duced not only to the work of the Na­tional Bank of Ukraine (NBU), but to the en­tire banking sys­tem. The amount of in­for­ma­tion pub­lished by the NBU in the past three years has prob­a­bly dou­bled. The NBU it­self re­ports on its ac­tions in mon­e­tary and ex­change rate pol­icy. The NBU web­site pro­vides in­for­ma­tion on bank own­ers, re­fi­nanc­ing pro­vided to banks, and much more. Trans­parency is grad­u­ally in­creas­ing. One could won­der how trans­parency is linked to the living stan­dards of Ukraini­ans. In the de­vel­oped coun­tries, this re­la­tion­ship is para­mount. More trans­parency means more trust, fewer mar­ket fluc­tu­a­tions means fewer risks, and all that leads to cheaper loans, more sta­ble fi­nan­cial sys­tem, fewer and less se­vere crises.

Trans­parency mat­ters for Ukraini­ans for a dif­fer­ent rea­son as well. For ex­am­ple, when so­ci­ety did not know the iden­tity of bank own­ers, it was eas­ier for them to en­gage in fraud and avoid ac­count­abil­ity. They didn’t risk los­ing their prop­erty that could be used to cover the claims of de­pos­i­tors of a bank­rupt bank. Now, the sit­u­a­tion is dif­fer­ent. The bankers will have to think twice be­fore com­mit­ting a crime, and this is bound to re­duce the risks of both spe­cific banks and the sys­tem as a whole. That is, even this vis­i­ble change has its im­pact on the qual­ity of the sys­tem even if the im­pact is not re­ally ob­vi­ous yet.

This re­form brought about an­other one that will rad­i­cally change the banking sys­tem. When the NBU knows fi­nal ben­e­fi­cia­ries of all banks, it can track their re­lated com­pa­nies. This cre­ates the pre­req­ui­sites for elim­i­nat­ing the scheme whereby most Ukrainian banks used de­posit money to give loans to the com­pa­nies of their own­ers. As soon as the banks faced prob­lems, the own­ers fled abroad, the money re­mained in the ac­counts of their com­pa­nies, usu­ally off­shore ones, and the bank to­gether with the cheated in­vestors was put at the mercy of the state, that is, the tax­pay­ers. This will no longer be pos­si­ble. The NBU now tracks re­lated com­pa­nies and for­bids lend­ing to them (more pre­cisely, it only al­lows loans that make up a small por­tion of the bank’s as­sets). So, the num­ber of spon­ta­neous bank­rupt­cies, as well as the num­ber of cheated in­vestors, is bound to de­crease. At the same time, the risk in the banking sys­tem in gen­eral will de­crease, and the state will not have to in­ter­vene so fre­quently throw­ing tax­pay­ers' money down the drain. This in it­self is a huge change that will have an in­vis­i­ble but sig­nif­i­cant pos­i­tive im­pact on the cit­i­zens' wal­lets.

Re­duced lend­ing to re­lated en­ti­ties will com­pletely re­draw huge cash flows in the econ­omy and the fi­nan­cial sec­tor. Pre­vi­ously, the oli­garchs had to open a bank and use it as their own pocket in or­der to have enough fund­ing for their busi­nesses. This is no longer pos­si­ble. Oli­garchs still have their fund­ing needs, and will have to com­pete for money re­sources. This will push them to be more trans­par­ent, struc­ture their busi­nesses prop­erly, and so on. In short, they will have to be­come civ­i­lized play­ers.

Sec­ond, the banks will have huge amounts of liq­uid­ity that they will no longer be able to pump off-

shore. Once the de­mand of big busi­ness for loans is sat­is­fied, they will be able to lend to small and medium busi­nesses at rather af­ford­able rates. The struc­ture of the econ­omy will turn up­side down, be­cause the loans is­sued now will not be large, in­ert, in­ef­fi­cient and non-trans­par­ent, but small and lu­cra­tive. At the same time, the econ­omy might un­dergo struc­tural changes.

Third, de­posit and loan in­ter­est rates will drop. Ear­lier, the oli­garchs at­tracted de­pos­i­tors' sav­ings at any rates be­cause they could not find other fund­ing. They also know that they could shut the bank down (along with the money of the de­pos­i­tors) as soon as this be­came un­prof­itable. Cur­rent changes in the banking sys­tem have closed the space for such scams. Given the ex­cess of liq­uid­ity, fi­nan­cial in­sti­tu­tions will try to limit the in­flow of de­posits by re­duc­ing de­posit in­ter­est rates. At the first glance, this will im­pact de­pos­i­tors neg­a­tively. AT a closer look, their sav­ings will be pro­tected. The real value of the sav­ings will grow at a pace not slower than be­fore if the NBU man­ages to reach its in­fla­tion tar­gets.The ob­vi­ous win­ners will be the bor­row­ers: low de­posit rates mean cheaper loans.

An­other large-scale and com­plex prob­lem of all banks with­out ex­cep­tion un­til re­cently was the qual­ity of the col­lat­eral. Bankers can quote many cases, when a pledged ve­hi­cle was sold with­out the bank’s knowl­edge and the re­spec­tive loan was never re­paid, when a num­ber of res­i­dents was reg­is­tered in a pledged apart­ment so that the bank could not seize it, and mort­gage was not re­paid, or when cor­rupt courts awarded ob­vi­ously un­fair de­ci­sions in cases re­lated to the seizure of pledged as­sets from busi­nesses or in­di­vid­u­als. Ukraini­ans may ex­pe­ri­ence schaden­freude at the mis­for­tunes of the vo­ra­cious banks. How­ever, the con­se­quences are reaped by ev­ery­one, since fi­nan­cial in­sti­tu­tions would fac­tor these risks in their lend­ing rates (mak­ing them un­af­ford­able), re­fused to lend to hon­est bor­row­ers. In the end, this fac­tor could be the last straw that would lead some banks to a col­lapse. This is an in­cred­i­bly com­plex prob­lem, and the gov­ern­ment is try­ing to solve it. Dur­ing the past year, two bills were en­acted that en­sure quick seizure of pledged as­sets. The Cab­i­net has passed a res­o­lu­tion that re­duces the risk of pledged ve­hi­cles be­ing sold with­out the knowl­edge of the bank, while some Supreme Court rul­ings have also stepped up le­gal pro­tec­tion for cred­i­tors. The cur­rent sit­u­a­tion is far from be­ing ideal, and this in­hibits lend­ing. The re­form­ers have a vi­sion of how to over­come the ex­ist­ing prob­lems: it is pre­sented in bills that are now gath­er­ing dust in Par­lia­ment. This is ex­actly the case when a re­form re­quires con­sol­i­dated ef­forts of ba­si­cally all key gov­ern­ment agen­cies. So far, there are no such ef­forts and, there­fore, no re­sults.

An­other prob­lem is as fol­lows: when a bor­rower in a down econ­omy gets into a dif­fi­cult fi­nan­cial sit­u­a­tion, the case re­mains frozen for years. Tri­als on it can last for­ever and nei­ther party is able to win. The bor­rower has to carry an over­whelm­ing debt bur­den, not be­ing able to ever re­pay the loan, while the bank keeps trash on its balance sheet and is not able to get rid of it. In­ter­na­tional ex­pe­ri­ence in­di­cates that the prob­lem is quite se­ri­ous: it took the US a year to clean out balance sheets of its banks through spe­cial laws. Af­ter this, the Amer­i­can banking sys­tem has come a long way for­ward. The EU was un­able to ac­cept the new re­al­ity and kept fight­ing the debt cri­sis and its im­pact on the banking sec­tor for about five years. In some mem­ber-states, such as Italy, some banks have not re­cov­ered still, and are on the verge of bank­ruptcy. There was an at­tempt at solv­ing this prob­lem by pass­ing the law on “fi­nan­cial re­struc­tur­ing". It en­ables an out-of-court res­o­lu­tion of a dis­pute be­tween the bank and the bor­rower through vol­un­tary writ­ing off of part of the debt, while the bor­rower still re­pays what he or she can and the bank does not have to write off the en­tire loan. In the­ory, such schemes ben­e­fit both par­ties. In prac­tice, there may be bar­ri­ers to their im­ple­men­ta­tion in an en­vi­ron­ment where no­body trusts any­body.

There is also the prob­lem of laun­dro­mat banks en­gaged in money laun­der­ing, con­ver­sion into cash, si­phon­ing abroad, and sim­i­lar schemes. It would seem that it is not the busi­ness of an av­er­age Ukrainian if some­one takes their money out of Ukraine or con­verts the earn­ings in cash in or­der to pay salary in en­velopes. The an­swer is sim­ple: if a bank owner is ready to com­mit sys­tem­atic crim­i­nal acts, then he is not ready to guar­an­tee in­vest­ment se­cu­rity. In the end, av­er­age Ukraini­ans, de­pos­i­tors of such banks, had to pay for ques­tion­able op­er­a­tions of their bankers. The NBU has been try­ing to deal with the prob­lem since the be­gin­ning of the re­form. As it turned out, the law over­looked some shady schemes pre­vi­ously used by the banks, and there­fore such schemes did not ex­actly qual­ify as il­le­gal. This prob­lem has been iden­ti­fied and re­solved, and the gen­eral re­quire­ments to banks have be­come much stricter. This gives us rea­son to hope that money laun­der­ing at the pre­vi­ous scale is over.

Last but not least is the is­sue of na­tional se­cu­rity. While dozens of banks with Ukrainian cap­i­tal have gone bank­rupt, Rus­sian banks were dili­gently pour­ing ad­di­tional cap­i­tal into their Ukrainian sub­sidiaries. This ex­pan­sion con­tin­ues. This is­sue is not nec­es­sar­ily within the com­pe­tence of the NBU, but it def­i­nitely needs to be re­solved.

Over­all, Ukraine’s banking sys­tem has un­der­gone dozens of changes. Not all of them were suc­cess­ful since they re­quire co­or­di­nated ef­forts of many gov­ern­ment agen­cies, and some of those act as if they missed the Maidan. Yet, a lot has been done. The changes brought about by the banking re­form jus­tify the losses suf­fered by the coun­try in the process of im­ple­ment­ing it, even though they are not yet re­flected in the statis­tics or dis­cussed on TV.

PRE­VI­OUSLY, THE OLI­GARCHS HAD TO OPEN A BANK AND USE IT AS THEIR OWN POCKET IN OR­DER TO HAVE ENOUGH FUND­ING FOR THEIR BUSI­NESSES. THIS IS NO LONGER POS­SI­BLE.

De­fense in par­lia­ment. Re­forms in the banking sys­tem im­ple­mented by the NBU and its Chair Va­le­ria Hontareva have been ac­com­pa­nied by big scan­dals in the Verkhov­naRada. But the NBU’s team has proven re­silient

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