Deputy Minister of Finance on the revised plans for a strategic restructuring of the state banking sector in 2018-2022
In February, the Cabinet of Ministers approved revised principles for a strategic restructuring of the state banking sector over 2018-2022. These principles needed to be revised mainly because of the nationalization of PrivatBank. Not only did the takeover of PrivatBank increase the state-owned share of Ukraine’s banking system to 55%, but it also raised the need for a thorough analysis of the new situation on the market and the options for developing the banking sector over the next five years.
Moving on from the mostly completed old strategy
Since the previous strategy was drawn up and approved, we have managed to achieve considerable progress on most of its objectives. Under the leadership of Kyrylo Shevchenko, Ukrgasbank has begun operating in eco-banking or sustainable banking and has managed to generate a substantial portfolio of eco-loans. With less than 0.1% overdue, these are already showing strong performance results and are making it possible to attract long-term cheap money in euros. Ukrgasbank’s troubled old portfolio is now down to 20% of what it was even as the bank’s team is continuously being built up with well-known market professionals. Ukrgasbank has become the first bank to attract independent members to its supervisory board and set up all the necessary subcommittees, which have begun to work according to best international practice.
Oschadbank is being transformed from an inefficient soviet-style savings bank into a proper modern bank thanks to the active efforts of Andriy Pyshniy and the bank’s team. A total of 550 new-style branches have been launched while 1,300 of the older, inefficient ones have been significantly upgraded with better service. In addition, Oshchad24 online banking has been launched. Oschadbank has also made tremendous progress with its lending portfolio and is undergoing titanic transformations, from working actively with NPLs and undertaking four financial restructurings to filing the first, and hopefully successful, suit against the Russian Federation for the theft of Oschadbank assets in Crimea. Meanwhile, the bank has managed to completely change its philosophy of work and launched “Build Yours,” a large-scale program of micro and small loans aimed at developing entrepreneurship.
Under Oleksandr Hrytsenko, Ukreximbank has reduced its branches to 36 in recent years, centralized all its processes, left the retail market altogether, for both deposits and loans, and begun to return to its core competency: supporting import and export operations and participating in international financing programs.
All these steps have been noticed and have made it possible for both Oschadbank and Ukrgasbank to start attracting capital from international financial institutions. In November 2016, Oschadbank signed a strategic memorandum with the European Bank for Reconstruction and Development (EBRD), while Ukrgasbank signed one in November 2017 with the International Finance Corporation (IFC), a member of the World Bank Group.
Meanwhile, as part of the previous strategy, the Finance Ministry reduced its participation in the banking sector by withdrawing from the smaller state and quasi-state banks. Kyiv Bank was transferred to Ukrgasbank, the Land Bank was liquidated, Rodovid Bank has been slated for liquidation, and the Ukrainian Bank for Reconstruction and Development was sold through a transparent privatization tender to a Chinese strategic investor.
Still, December 2016 brought PrivatBank instead and the old strategy suddenly had to cover the biggest retail bank in the country while we worked on a new strategy. Because of this, a supervisory board was set up at the bank with predominantly independent members, who elected an independent chair, Turkish banker Engin Akçakoca. Within a year, this independent professional board together with the bank’s management has shown good results, first swiftly stabilizing the situation at the bank and since then working on its development.
Improving corporate governance as a strategic foundation
The old strategy required setting up supervisory boards consisting of a majority of independent members selected from among professional banking and financial specialists. Through the quality of their work both in oversight and in assisting bank management, the appointment of a supervisory board at PrivatBank and having a majority of its members be independent specialists at Ukrgasbank, demonstrated that independent boards are a mandatory component for any strategy to work. This kind of corporate governance makes it possible to put together a high-class management team, to approve quality policies and to reduce political influence at state banks to a minimum.
This philosophy of governance, which is supported by Premier Groisman and the Finance Ministry, is also being applied in the reform of corporate governance at other state enterprises. It provides assurance that lending decisions at the banks will be made strictly on a commercial basis and not for political reasons. Bill #7180, which establishes the necessary changes to extend corporate governance to Oschadbank and Ukreximbank, has already gone through complicated review involving all stakeholders over the past year. The bill is currently supported by the banking committee and has been placed on the VR agenda. I’m confident that it will be supported in the Rada as well.
Capitalizing banks as the government’s fiduciary duty to taxpayers
Various Governments have spent some UAH 266.2 billion over the last decade to prop up nationalized and state-owned banks. Every time this money went to forced capitalization rather than to developing the state banking sector: UAH 12.4bn to Rodovid Bank over 2009-2011, UAH 13.3bn to Ukrgasbank over 2009-2015, UAH 3.6bn to Kyiv Bank, and UAH 155.4bn to PrivatBank.
The 2014 crisis was no exception. Because of the troubled portfolios that it led to, Russia’s military aggression, the occupation of Crimea and parts of Donbas, the loss of the Russian market, incompatible lending practices and “political” lending, Oschadbank was injected with UAH 31.2bn over 2014-2017, Ukreximbank got an additional UAH 22.0bn, and Ukrgasbank a further UAH 3.8bn. This represents colossal public cost—money the government is spending to support the capitalization and liquidity of its own banks. This is the main reason why the new strategy is aimed at creating as much value as possible in each of these banks through a combination of future dividends thanks to improved operational profitability and income from the sale of some banks.
One of the anticipated results of implementing this strategy will be that banks in the public sector will be able to generate as much as UAH 160bn in value for the country, including nearly UAH 35bn in the form of dividends and taxes, and nearly UAH 85bn in the sale of shares. And this is only from standard banking activities.
In this way, even without any additional income that might come with successful suits against the former owners of PrivatBank, against the Russian Federation on behalf of Oschadbank and PrivatBank, and one on behalf of Rodovid Bank, we have set ourselves, the Supervisory Boards and bank managements the objective of bringing UAH 160bn to the budget over the next five years.
Finding real solutions to the problem of bad loans in 2018
We had our own idea of how to resolve the issue of bad loans, but our proposal did not make it into the old strategy: at that point in 2016, we were unable to find consensus with the National Bank and our international partners about the need to systemically and swiftly regulate the troubled portfolios that had accumulated prior to 2014. Back then, the Ministry proposed setting up a special institution where state banks would transfer all these bad loans. This would have required a special law, which we had already drafted, to establish an agency that would take over all the state bank portfolios, and an independent supervisory board based on the principles that we have now enshrined in Bill #7180 that would temporarily be granted broad powers to foreclose. But this did not happen and so every bank has been busy trying to regulate its bad loans and sue borrowers on its own. Since then, the banks have achieved some progress, but are still far from done, precisely because, as we see it, there is no systemic approach to this problem.
That’s why our new strategy clearly states that, unless the question of troubled portfolios is resolved, the strategy will be difficult to implement and it sets down the principles for this resolution. This most certainly will not be a bad bank—more than likely, at this stage, it won’t even be a separate institution. We’re talking about raising requirements of banks in order to resolve these issues in our quarterly KPIs. At the same time, we’re setting up a platform—an independent committee, at say, the Financial Stability Council—where policies will be discussed and approved, not in relation to a single bank, but system-wide. The structure of the committee and the mechanisms by which it will operate will be devised by the Finance Ministry with the support of IFIs over the next few months.
Such a platform will mainly work on borrowers who have chalked up debts at more than one bank, and so issues will have to be discussed in common. We tried to do this within the framework of the Law “On financial restructuring,” which provides a mechanism by which all banks who have the same problem borrower get together and handle the problem jointly.
When it comes to troubled assets, however, it is not just a matter of old portfolios. The Ministry of Finance has three main objectives with troubled assets at state banks:
to demand, as a shareholder, and encourage the banks to finally come to a decision on every problem loan in their portfolios that had accumulated prior to 2014 and to do so as publicly as possible;
to do the most to improve the state of affairs with both creditors’ rights and property rights;
to ensure the necessary corporate governance and processes so that banks don’t generate new bad loans in such volumes. This is where we present bank management and supervisory boards with specific KPIs for both old and new portfolios.
Accentuating individual strategies
Alongside work to revise strategic principles over the past year, the Ministry and the banks themselves were busy producing results that have had a significant impact on the final version of these principles. A strategy was drafted for PrivatBank and Oschadbank’s strategy was updated with the assistance of McKinsey, a global consultancy. Ukrgasbank’s strategy was also tested and approved. In addition, we carried out an analysis of troubled portfolios of three state banks with the assistance of the Promontory Financial Group and JICA, the Japanese International Cooperation Agency. After the draft strategy was presented to the portfolio VR committee in September 2017, it was actively discussed and rewritten for the following four months with specialists from the NBU, international partners, MPs, and the expert community. The result was a very clear vision of strategic principles for the four banks and properly detailed strategies for each of them, complete with specific goals and KPIs for management.
PrivatBank is the clear leader in retail banking in Ukraine, with a specific focus on the payment business. The main goal is to expand its retail portfolio and payment business, to rebuild a limited loan portfolio of low-risk loans to legal entities with an emphasis on lending to SMEs, and to strengthen the loan underwriting and IT platforms, as well risk management and control instruments. The goal is also to streamline pricing of assets and liabilities, and to restore the profitability of the bank, probably in 2018.
Oschadbank wants to preserve its position as the largest universal bank in Ukraine by introducing operational and commercial projects aimed at improving its efficiency and profitability. The bank will hold on to its strong market position in the corporate banking system and gradually shift its focus from major clients, including state enterprises, to medium corporate business and SMEs. In terms of its retail business, the bank will focus on promoting compatible credit and transactional products to its many clients and to expand its “Build Yours” program.
Ukreximbank will begin to focus most of its attention on financing export-import operations, including trade operations, by Ukrainian companies, for whom access to financing from private commercial bank is quite limited. To ensure the stable profitability, the bank will put together a detailed transformation plan what will include KPIs for the next five years and a plan for synergies with the Export Credit Agency (ECA).
Ukrgasbank will continue to develop as the main eco-bank in Ukraine, focusing on financing technology projects by corporate clients and SMEs that are connected to energy efficiency, renewable energy, resource efficiency, pollution reduction, and so on.
Based on these strategies, these four banks should see greater profitability and ensure return on equity over 12% by 2022.
Reducing the state presence in the banking sector to 24% by 2022
Reducing the state-owned share will bring the Ukrainian banking services market closer to its European neighbors, improve its investment appeal and make it more efficient. We propose gradually reducing the state’s presence on the banking market from 55% in 2018 to 24% in the medium term. Ukrgasbank and PrivatBank are expected to be completely sold off in 2020 and 2022.
We understand that bank investors are generally the most conservative and, before we can expect to see them in Ukraine, IFIs and portfolio investors are likely to come first. Plans are to establish conditions to attract minority shareholders such as IFIs for Ukrgasbank by the end of 2018, and for Oschadbank and Ukreximbank by the end of 2019.
The government will also avoid engaging in any initiatives that could lead to its share of the banking system expanding. Given this, there is no purpose to establishing any new state banks.
Successfully carrying out the strategy as a spur to economic growth
The government strategy in the banking sector is based on the goals of economic growth and on the state’s objectives as a shareholder in commercial banks. Among the main objectives in fostering economic growth are support for financial stability and easing access to loans and banking services. As a shareholder, the state also needs to generate financial value and compensate for the budget funds that have been invested. This means partly or fully selling state-owned banks.
Our strategy is the result of the efforts of many Ukrainian and international experts. It is a balance of ambitious and realistic goals. By implementing it, we will end up with a smaller and healthier public banking sector and growing competitiveness in the entire industry. This, in turn, should provide a good spur for Ukraine’s economy to start growing more quickly.