Since early 2017, systemic risks to the Ukrainian banking system have subsided overall. That trend is expected to continue in the second half of the year, as outlined in the third Financial Stability Report.
In the first half of the year, the macroeconomic environment was favorable for the economy and the banking sector, even though growth in the economy and in corporate earnings have slowed as a consequence of the suspension of trade with the areas in the east not controlled by the government.
The clean-up of the banking sector, which took three years, is now complete. The nationalization of PrivatBank was the key event that took place after the last Financial Stability Report (December 2016). With the goal of maintaining financial stability, the government has already spent the equivalent of 5% of GDP to recapitalize PrivatBank.
The banking sector has been generating profits since the start of 2017, in-line with National Bank’s expectations. Cheaper funding is driving growth in net interest income, while net commission income is also on the rise on the back of growing demand for banking services from households and businesses.
The real sector and the household sector are facilitating a recovery of bank lending. Corporate profitability in the real sector is on the rise. Last year, companies in most industries increased fixed investment, which will drive greater demand for medium-term loans. Real disposable household incomes are also on the rise as inflation has been tamed and as minimum wages grow. This makes consumer lending more attractive for banks. However, consumer lending is mainly concentrated in card credits and loans for current needs. Mortgage lending is slowly starting to recover.
The weak protection of creditor rights remains the most substantial impediment to lending recovery. Advances in this respect over the past year have been largely nominal in nature. A significant number of court rulings deny creditors’ rights for foreclosure and collateral. Legal amendments and changes in court practices are needed to protect the rights of creditors and bona fide borrowers. Without these, a significant increase in lending is unlikely.
The government’s strong presence in the banking sector and high NPL rates are the key risks for the financial sector.
The PrivatBank nationalization raised the government’s share of the banking sector to 56% by net assets and 62% by retail deposits. Over the next few years, the government will need to reduce its presence in the banking sector. The first step towards reforming and preparing to privatize state-owned banks should be the adoption of a law that introduces independent supervisory boards and separates them from influence from political interests.
A high rate of non-performing loans (57% of total loans) is a drag on the banking sector. Financial institutions need to be more proactive in restructuring the debts of good (bona fide) borrowers whose financial condition is recovering. Servicing of the remainder of the NPLs is unlikely to be restored. They should therefore be provisioned for and written off. This will require amendments to tax legislation to mitigate the negative effect on banks’ tax liabilities.
The Financial Stability Report is a key publication for central banks worldwide. The report aims to highlight risks to financial stability in Ukraine, analyze their potential impact on the financial system and the national economy, and recommend actions to enhance financial stability. The report focuses specifically on risks and related recommendations. The National Bank of Ukraine publishes the report biannually. The first Financial Stability Report was released in June 2016.