Ukraine's commercial banks were hit hard by the economic turmoil in Ukraine. The last three years were exceptionally challenging: several devaluations of the Hryvnia, the annexation of Crimea and the outbreak of war in parts of the Donetsk and Lugansk regions, huge amounts of non-performing loans, a three to fourfold crash of the value of real estate and most other formerly bankable assets. These and a number of other drastic events contributed to waves of panic and massive capital flight from the banking sector. Barely two thirds of the commercial banks in Ukraine survived the crisis. On 1 July 2016 Ukraine had 106 operational commercial banks (compared to 180 on 1 January 2014 and 163 on 1 January 2015), which still seems quite a lot for the current level of Ukraine’s GDP.
In the second and third quarter of 2016 the financial situation in Ukraine seems to be stabilizing with IMF funding likely to be resumed in September and significant efforts undertaken by the National Bank of Ukraine and the Ministry of Finance to re-start reforms. The second and third quarter showed some signs of the Hryvnia strengthening, which is likely to be seen as a positive signal for the banking sector. A huge challenge remains to restore the conditions in which banks can actually resume active lending to businesses and individuals with reasonable prospects of being repaid on time and in full. However, in May 2016 several mid-sized banks (Fidobank, Mykhaylivski) have become insolvent and if this tread continues only strongest banks are likely to survive in Ukraine.
From the legal perspective there have been welcome changes in the regulatory environment for many stable and reputable Ukrainian banks and numerous changes are expected in the course of 2016. Ukraine’s ambitious program of approximating its legislation to the EU’s directives and regulations is yet to be implemented in the banking sector and the self-imposed deadlines are approaching fast. Investors are eager to look into these changes with a view to finding new opportunities in the financial services sector, which is undergoing tectonic shifts.
Ownership Transparency v. Insider Lending
While the fall of Ukrainian commercial banks seems to have reached at its peak in 2015 and continues during the first half of 2016, the management team at the National Bank of Ukraine can have had very few choices but to adopt aggressive measures aimed at making bank ownership transparent. Such ownership transparency often resulted in the imposition of immediate restrictions on the volume of insider lending at banks. This creates huge headaches for many shareholders of Ukrainian banks. Historically, many Ukrainian owners tended to be unscrupulous about insider lending (often substantially exceeding the permissible overall threshold of 25% of the regulatory capital) and these banks are now facing the dilemma of either finally disclosing their ownership structure and increasing capital immediately, or going out of business as a result of failure to meet the regulatory requirements.
The National Bank of Ukraine successfully implemented measures aimed at making the banks’ ownership transparent and imposed strict deadlines for the shareholders of banks to disclose their genuine ownership structure. These measures were supported by clear sanctions applied to offending banks and a clear intention to continue applying such sanctions in the future.
Importantly, limited partnerships and other investment vehicles used by international investors can now receive approval for acquisition of substantial shareholdings (i.e., shareholdings exceeding 10, 25, 50 and 75 per cent of capital) in Ukrainian banks. The National Bank of Ukraine has approved the use of such structures in its updated rules for approving the acquisition of substantial shareholdings in Ukrainian banks along with a number of long-overdue technical improvements relating to the submission of documents by qualified investors in Ukrainian banks.
The results of the “Panama papers” on banks' ownership structures and insider lending are yet to be analyzed. It is clear, however, that the ownership structures of most Ukrainian banks were cleaned up sufficiently to meet the challenges of any information leakages in the future. For most banks the process of cleaning up the ownership structures implemented by the National Bank of Ukraine in 2015 effectively prevented major dire consequences relating to the disclosure of genuine information about the beneficiaries of their shareholders.
Big Data at the NBU
Unlike the “façade reforms” of the previous governments at the National Bank of Ukraine, the present management team seems to be implementing a comprehensive overhaul of the central bank as the principal governing institution for the banking and financial services markets. One obvious result of such reforms has been a massive scaling down of unnecessary functions at the National Bank of Ukraine (including closing its educational institutions, hotels and recreational facilities) that has resulted in significant economies of public funds and a substantial reduction of the personnel at the NBU (from nearly 12,000 to a still staggering number of around 5,000 staff).
Another welcome feature of the present reforms is that the NBU has started to actively include lots of at first sight seemingly useless information on its website, such as official exchange rates for many years, ownership structures of commercial banks, various market data for payment services and inflation reports. Apart from providing useful tools for experts and analysts, this approach is likely to become the cornerstone for developing new opportunities and attracting new businesses in the financial and other markets in the near future. The floodgates are now open to everyone and professional experts will benefit immensely from this new approach of the NBU.
Capitalization and Restructuring
In pursuance of the IMF program the NBU implemented an ambitious program for recapitalization of commercial banks and set the deadline of January 2017 for increasing the regulatory capital of smaller banks to a minimum of UAH 300 million. Following active discussion of the recapitalization plans with smaller banks the deadline was moved to the middle of 2017 and many smaller and mid-sized banks are now racing against time to implement their recapitalization schedules. These measures are likely to improve the viability of many smaller and mid-sized banks and to ensure their survival in case of further deterioration of market conditions.
In many respects the measures of the National Bank of Ukraine aimed at streamlined capitalization and restructuring of commercial banks were long overdue. The situation in the banking sector is still quite complicated. The restrictive measures were aimed principally at improving the liquidity position of commercial banks in order to protect the interests of depositors and other creditors of commercial banks. More than 50 commercial banks were regarded as insolvent over a period of slightly more than one year and there are potentially a number of smaller and mid-sized commercial banks that may still be in the pipeline for insolvency.
The cleaning up of the banking sector had been expected for some time and the critical economic situation in Ukraine in 2015 triggered mass insolvencies of commercial banks. In fact the NBU has no choice but to implement aggressive steps for restructuring and recapitalization of commercial banks to save the Ukrainian banking sector from complete meltdown.
But the crisis is also a period of huge opportunities. In the banking sector the strongest and fittest banks will survive and the sector should become much more transparent, resilient and reliable. That said, the whole process of reforming the banking sector is likely to take several years.
One of the measures effectively implemented by the National Bank of Ukraine was debt for equity-swap transactions with subordinated debts of commercial banks. This initiative permitted the prepayment of loans for implementing a debt for equity swap transaction with the bank’s shares. This initiative of the NBU should allow equity capital increases in a more efficient and less time-consuming manner for the banks.
Liability of Banks' Beneficiaries
The rules for establishing the liability of the ultimate beneficial owners of Ukrainian commercial banks for fraudulent and suchlike activities were significantly strengthened in 2015. It remains to be seen how the new rules are going to be applied in practice. The existing practice of enforcement of such rules against the beneficiaries of the shareholders of commercial banks in Ukraine has been ineffective for numerous reasons. The National Bank of Ukraine has proposed modernizing these rules and to make the liability of the beneficial owners of substantial interests in Ukrainian banks a reality rather than a theoretical rule of law. The rules are now being tested in court and hopefully the results of these cases will ensure that transparency of ownership and risk-taking by commercial banks in Ukraine reaches a new level.
Recent amendments to the Joint Stock Companies Law introduced a number of changes aimed at protecting the investors of commercial banks in Ukraine. In particular, a shareholder with 10% or more of all shares of a Ukrainian bank, or a number of shareholders holding in aggregate 10% or more of all shares, will have the right to bring an action on behalf of the bank against one or more officers of the bank for damages when the bank suffered losses as a result of acts or failure to act by such officers. Notably, not only directors but also members of various boards – e.g., the supervisory board or the audit committee, can be regarded as officers of the bank.
These amendments to the Joint Stock Companies Law provide a non-exhaustive list of circumstances entitling a shareholder to bring a derivative action. For example, an officer of a bank can be liable when that bank suffered losses as a result of any of the following:
- acting in excess of his/her authority;
- actions taking in violation of specific requirements of the bank's charter;
- the officer obtaining prior approval or other authorization by presenting inaccurate information;
- failure to act when the officer was required to take certain actions in accordance with his/her duties; and
- other intentional (as opposed to negligent) acts of the officer.
Interestingly, an officer who is a respondent in a derivative action may not (i) represent the company in the proceedings, or (ii) appoint an attorney to represent the company in the proceedings.
The same amendments to the Joint Stock Companies Law introduced the requirement for a commercial bank to have independent directors. In particular, a public joint stock company such as any commercial bank in Ukraine is required to have no less than two non-executive members on its supervisory board (independent directors). In a public joint stock company the number of supervisory board members must be five or more. As previously, the supervisory board members of a bank will be elected through cumulative (proportional) voting. On a resolution to appoint supervisory board members a shareholder will have one vote per each share held, multiplied by the number of supervisory board members to be elected.
Interestingly, the appointing shareholder(s) and their supervisory board member may now be held jointly and severally liable for a loss to the company caused by such appointed supervisory board member.
In order to serve as an independent director of the bank, an individual must meet the criteria set out in the Joint Stock Company Law and the applicable banking regulations. In particular, the nominee must not:
- in the preceding five years, have been an affiliate of the shareholders, the bank or a subsidiary of the bank, or an officer of the bank or its subsidiary;
- have ever received any significant, additional remuneration from the bank or its subsidiary, other than any fees for serving as an independent director;
- in the preceding year, have had any significant business relations with the bank or its subsidiary;
- in the preceding three years, have been an employee of the current/previous independent auditor of the bank or its subsidiary; and
- have ever been a director in an affiliated company.
An independent director who ceases to meet the above independence criteria must resign.
Previously supervisory board members of bank had to be re-elected at least every three years; the new rules require their re-election at each annual general meeting of shareholders. If the annual general meeting of shareholders is not held by 30 April, the supervisory board members of the bank will be required to step down.
In June 2016 the National Bank of Ukraine lifted the long-standing prohibition against the distribution of dividends to offshore accounts of shareholders in local companies. The National Bank of Ukraine permitted foreign investors entitled to dividends for 2014 and 2015 to repatriate such dividends from Ukraine, provided that in a calendar month the amount of repatriated dividends cannot exceed the higher of either (a) USD 1 million; or (b) 10 percent of the overall amount of dividends to be paid to a single shareholder but not exceeding the overall monthly threshold of USD 5 million. The prohibition on remitting dividends offshore was the single biggest obstacle to renewing investment into Ukrainian companies, including banks.
Notably, the recent amendments to the Joint Stock Company law permitted commercial banks to pay dividends directly to shareholders (rather than only through the depositary system) after 1 May 2016.
Protection of Creditors' Rights
The single most important topic among bankers and financiers in Ukraine is the protection of creditors' rights, which is lacking to a substantial degree at almost every stage of the life circle of any financial product in Ukraine. The National Bank of Ukraine and independent business associations of banks and other businesses have developed several drafts laws to improve the protection of creditors' rights. The draft laws were duly submitted by the Cabinet of Ministers of Ukraine to Parliament. Hopefully the prompt adoption of these laws will significantly contribute to the reduction of risks for lenders in Ukraine. Once the risks are reduced and become predictable commercial banks may re-start lending on reasonable terms.
Both the business community and the National Bank of Ukraine seem to be implementing an ambitious plan to increase the volume of cashless payments in Ukraine. Ukraine has traditionally had a huge portion of cash payments, which, by some accounts, exceed cashless payments significantly. Given the systemic nature of this issue, which involves banking, tax and many other aspects, it remains to be seen whether these actions will be successful. The success of such plans could provide an additional boost to banking business models that are barely off the drawing board at the moment.
New market entrants: credit card companies and other providers of payment services
Under the EU-Ukraine Association Agreement, Ukraine has undertaken to unbundle the banking market to new entrants such as credit card companies and other providers of payment services. Whilst most of the traditional banking services (remittance of payments, opening accounts, credit cards, e-money etc) can now be provided only by commercial banks in Ukraine, the EU rules permit other market participants to be involved in these banking and financial services with substantially less onerous regulations applied to the providers of such niche services. The draft law on unbundling the banking services market is already being considered in Parliament but its prospects for adoption are not yet clear. However, the Government's plan indicates that by the end of 2016 the relevant law on unbundling the banking market should be in place. It remains to be seen if these ambition plans become reality.
Survival of the Fittest
Whilst commercial banks face numerous and often unpredictable risks in Ukraine, the market for banking and financial services in Ukraine may present a great many opportunities for quick growth and high-return investments. The problems of commercial banks in Ukraine are often basic in nature, such as the violation of property rights and the general lack of protection of the rights of banks as creditors. Failure to protect creditors' rights results in the banks’ failure to repay deposits.
The numerous initiatives of the National Bank of Ukraine, the Cabinet of Ministers of Ukraine and of independent associations of banks and businesses have done much for the resumption of growth in the banking and financial services sectors. Whilst many of these measures have already been adopted, a significant number still need to be formally adopted and implemented. The fittest will definitely survive and reap the benefits of hugely profitable market in the largest country of continental Europe.