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26 January, 2017  ▪  Lyubomyr Shavalyuk

Lessons learned

The benefits and flaws of PrivatBank transfer into state hands

There had been talk about the possibility of PrivatBank's transition into state ownership for a long time. In December the rumours have become reality and Privat was nationalised. This decision was unprecedented. The mere fact that such a decision was taken raised many questions from Ukrainians. The nationalisation process fraught with mistakes and miscalculations added more doubts and misunderstanding from the citizens. Why was the country’s largest bank taken over by the state, what consequences the move will have and which errors accompanied it?

The first question is "Why did this happen?" The answer is quite simple: the bank had a capital deficit of UAH 148bn ($5.4bn), which its former shareholders failed to cover. This was the result of PrivatBank's flawed business model: the bank collected deposits from individuals – it has 20 million Ukrainian customers – and issued loans to companies linked to the former owner Ihor Kolomoiskyi and others. Most of those companies had a paltry equity capital, were not actively operating and existed only on paper as a tool to move the money of Ukrainian clients out of the bank and dispose of it wherever and in whatever quantities they pleased. The bank itself got very little out of this. According to the National Bank of Ukraine (NBU), the proportion of such loans accounted for 97% of the corporate loan portfolio. Even if this figure is inflated, that does not change the bottom line: the money of PrivatBank depositors was siphoned off while distracting clients with talk of advanced IT services for them.

Ukraine’s top twenty banks included many of those where the NBU found capital deficits of varying sizes. For each, a program was designed to remove this deficiency. It was not easy to implement the plans: there were many delays, manipulations and broken promises. As of December 2016, the additional capitalisation programmes of the required scope were completed by all but PrivatBank (the process is still ongoing for financial institutions outside the top twenty, as they started later). The state had to act, because delays would only lead to an increase in capital deficit and exponentially aggravate risks to the banking system and economy. Considering the size and range of PrivatBank's clientele, however, the state could not allow its bankruptcy and opted for nationalisation, although there was no precedent, nor people with experience in dealing with such a major problem. Nationalisation was necessary, because the former owners would not return the depositors’ money. Meanwhile, the problem was becoming more and more painfully obvious and threatening to the country and assets of Ukrainians.

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Many analysts and ordinary people tend to claim that one oligarch (referring to Petro Poroshenko) "grabbed" PrivatBank from another oligarch (Ihor Kolomoiskyi). But what is the point in taking over an asset with a huge capital hole that needs to be immediately tucked up with real money? PrivatBank has no economic value for anyone except Kolomoiskyi and Co., who used it for their own benefit. Even the technical level and potential value of the Privat24 system for online money transfers is not enough to compensate for the UAH 150bn deficit. The social value of the bank is primarily an asset for the state, which intervened in the situation in order to preserve it.

We often hear that the state will spend an enormous amount of taxpayers' money on the nationalisation – over UAH 100bn ($3.6bn). Indeed, this is a considerable amount. But what does the state get in return? Firstly, continued cooperation with the IMF, which supported the government's decision and will likely soon give Ukraine the next loan tranche (the money, perhaps, is not as important as further implementation of the hundreds of projects that Ukraine has begun with foreign partners in order to reform the country). Secondly, the end of the banking sector reform process is now within reach. When the top twenty banks in the country start operating according to generally accepted international standards, it will be much easier to force the rest of the financial institutions to play by the new, legitimate and transparent rules. If it was possible to solve the PrivatBank problem, it will also be possible to overcome smaller difficulties. The third component, which is rarely mentioned, Ukraine managed to avoid negative scenarios, the risks of which were growing by the day. PrivatBank is the largest financial institution, which has not only twenty million clients, but also strong links with other Ukrainian banks. If it collapsed in an uncontrolled way under the pressure of its accumulated problems, the consequences would be massive and negative for the banking system, the economy and all Ukrainians. It is good that we did not have to bear witness to such a development, despite all the risks that existed until recently. Fourthly, Kolomoiskyi did not change the principles of the bank's operation. So the more they delayed, the larger the capital deficit would be. Therefore, the state has spent a large sum for good reason. Figuratively speaking, it has bought stability, a new banking system, the ability to continue reforms and minimise its own losses.

It should be understood that objectively there is no possibility of punishing Kolomoiskyi for moving money out of the bank. This would require a completely different law enforcement system, and in the long run a completely different country. So for now we will have to make come to terms with his impunity and wait for better times, though the issue of PrivatBank will eventually disappear from the agenda. One can hope that the former shareholders will return the missing funds, as they allegedly promised when handing PrivatBank over to the government, but this should not be expected. In this light, the money that the state will invest in PrivatBank is the price for 25 years of our economic system allowing operations of this kind to go unpunished, while the people we elected to govern it did everything to keep it the same way.

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Undoubtedly, the state and government should be praised: they were able to overcome a massive problem without provoking a disaster, as has often happened before. And this is oh-so difficult and required tough negotiations with Kolomoiskyi and external partners. However, it was not without errors. First of all, the news was leaked again. The nationalisation happened on Sunday night, and the media was already filled with details about it on Friday. As a result, people realised that something was going on and, without adequate information, began to prepare for the worst. On Saturday and Sunday, queues could be seen at PrivatBank ATMs, which gave the impression of panic. And all because someone cannot keep their mouth shut and the state is unable to prevent leaks.

Secondly, the state seems unable to learn how to communicate with its own citizens. Mass reassurances from politicians could be heard again. Ukrainians, however, have learned the hard way and customarily do not believe a single word, showing a diametrically opposite reaction: they went to ATMs to take out their money. On Monday, there were queues at cash machines again and a part of the withdrawn cash went onto the foreign exchange market, provoking a rise of several dozen kopiykas in the price of the dollar. The government should understand that direct calls for calm do not have the desired effect and that it is necessary to clearly and confidently articulate the tools that will make it possible to bring the situation under control. In developed countries, people listen to the authorities in such cases and believe them, because they make it clear how significant their arsenal of instruments to counter any excesses is. In Ukraine, the state does not usually talk about this, and if it does, the majority of the population does not have sufficient economic knowledge to understand. This is where all the problems come from: people fear what they do not know. This is a strategic problem for Ukraine, and systematic work will be required in order to overcome it.

Strategic issues are another important topic. Will the new leadership keep up the pace of the bank's technological innovation? Does it have enough resources for this? Will Kolomoiskyi entice current PrivatBank customers and leading experts into a new financial institution that he might build from scratch? Will the bank remain competitive or steadily begin to lose market share due to the ineffectiveness of new managers? The government, as the new majority shareholder, will still have to find answers to all these questions. Until now, it has never been an effective owner. Therefore, it is the moment of truth: either the state shows that it is truly changing and improving, or everything will be as it always has. Only this will come later. In the meantime, there is one big problem less in Ukraine.

Translated by Jonathan Reilly

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