Interviewed by Lyubomyr Shavalyuk
In the eyes of many Ukrainians, the banking reform boils down to the closing of over 80 private banks and significant losses suffered by hundreds of thousands of depositors. What will the country get in return?
— The NBU’s policy in the financial sector can be compared to a surgeon's work. Patients may well be unaware of their chronic diseases. When a doctor says that immediate surgery is necessary, before it is too late, patients often refuse and say that they feel fine. The situation with our banking system is similar. On the surface, everything looked relatively good: there were banks, they had branches, customers opened deposit accounts and could even receive interest on them. However, withdrawing a deposit was a different story, since financial institutions either delayed repayment or returned them using the money deposited by other customers, and so on.
At the same time, the banks’ problems remained unsolved, accumulated and aggravated. Inside, they were virtually insolvent. There was only an external appearance of stability and normal business activity. This was just another simulacrum, a term that well defines many Ukrainian institutions. Take, for example, the army: it seemed to exist with its generals and soldiers, but as soon as the war broke out, it turned out that that in fact there was virtually no army. It is very much the same with the Ukrainian banking system. If we look back at its history, over the past 25 years the problems only accumulated and were never solved systematically. However, the examples of other countries and banking crises that happened in underdeveloped economies, as well as countries like Sweden in the early 1990s or the US in 2008-2009, show that comprehensive approach to problems and the cleanup of the banking system can lay the foundation for a long-term healthy development of both the sector and the economy in general.
Can we expect lower loan interest rates and what would be the underlying factors enabling them?
— What are the loan rates made of? They can be broken down into several components. First of all, it is the price of resources. The bank is a mediator, which does not print the money, but takes it from one source and gives it to another. This comprises the cost of deposits. Secondly, the margin enables the bank to operate, take on risks and so on.
What determines the cost of deposits? It depends on the interest rate at which people, companies, and institutional investors are willing to invest money in a bank. Customers expect the interest rate to insure them against inflation or any macroeconomic imbalances. Besides, of course, the rate is affected by the confidence in the banking system and the economy in general.
We often hear today that loans should be issued at 3% per annum. Yet, no one wants to deposit money at 1%. It is important therefore to understand that the cost of financial resources is based on objective macroeconomic parameters, primarily, on the overall macroeconomic and financial stability in the country. That, in turn, is determined by the rate of inflation, the situation on the foreign exchange market, and the overall consumer confidence index. If you look at inflation levels in Ukraine in the past compared to other countries in the region, they were on average the highest and the most volatile. The same goes for the exchange rate: in theory, it was fixed, but in fact, there were always some problems around it. This explains the need for the inflation targeting policy introduced by the NBU. If we set the medium term inflation target at 5% and people see that we can achieve this level, they will trust our results and deposit rates will go down.
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What determines the margin of the banking system? It is the risks associated with the operation of a financial institution. Even if a bank can attract assets at 3% but is not confident that the loan receiver will repay the sum, it will try to inflate the loan price to set off its own risks.
What determines credit risk? On the one hand, it is the general state of the economy. On the other, it is the system of courts and law enforcement, protection of property rights, political stability, and so on. For the past 10 years, bankers have been talking about these problems. But little has changed, and risks remain high. Getting a loan at 2% in an economy that is imbalanced, has an unstable political system and an ineffective judicial one, is unrealistic.
The experience of other countries shows that all these risks can be eliminated through relevant reforms. Just have a look at our neighbors in Eastern Europe: they didn’t always had low interest rates. Loan interest rates in Poland exceeded 20% until the early 2000's, and dropped to the current lows only after inflation was sustainably curbed.
Miracles do not happen. It takes long hard work to achieve the result of low loan rates. Let's compare today's interest rates with the ones we had 3–4 years ago. We often hear today that the economy can’t work because it is impossible to get a loan due to high interest rates. But have there ever been lower rates? For hryvnia-denominated loans, at the NBU rate of 14%, loan rates range from 14% for large companies to 20% for small businesses, but usually do not exceed 20%. This is not a big difference from what we had before. Even at zero inflation in 2012–2013, both deposit and loan rates were high. Interest rates on short-term deposits in local currency never went below 10%. The same applies to loan interest rates, which never went below 15% for corporate clients.
This is changing gradually. The NBU sets inflation targets and, as 2016 has shown, can achieve them. We have repeatedly said that curbing inflation would result in a reduced discount rate, which, as we saw last year, affects all other rates in the economy.
The banking system reform depends not only on the NBU, and the economic growth does not depend on loans alone. What bottlenecks independent of its activities does the NBU see in both processes?
— It is a very important and a somewhat philosophical question. What changes does the country need? Should they be implemented immediately or gradually? From my personal experience, I know that if you are invited to do something, just do it rather than sitting around and waiting. Reforms are a two-way street. Sometimes we hear allegations that the NBU went too fast. However, if we look at the situation practically, what did we have to do? Sit and wait, or try to encourage others with our activities to implement some reforms, despite the criticism?
As for the bottlenecks, here we should go back to the first question. Why were the reforms of the banking sector unpopular? An important reason is that they were not followed to the logical end, namely, the punishment of those who have done all this damage to the banking system. If all the moves by the National Bank of Ukraine and the Deposit Insurance Fund related to criminal investigations were carried through by the law enforcement agencies, this would have meant that besides some existential punishment, former owners of banks that still have plenty of assets would have to kiss them goodbye, making it possible to compensate people for savings lost in failed financial institutions. However, the budget only covered losses not exceeding UAH200,000, while the claimholders of the third and fourth priority and others were often left with nothing.
Therefore, I believe that the reform of the judiciary remains the major bottleneck. It can also be seen in the overall context of the anti-corruption fight, which is the country's biggest problem that, unfortunately, hampers everything else and prevents from restoring confidence in the banking system, among other things.
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Today a lot is being said about the need to revive the economy in order to achieve the 8% annual growth, and so on. But here, again, miracles do not happen. It requires long and hard work. For example, all reforms that are being discussed today (land, pension, etc.) lay the foundation for a more stable and more dynamic economy in the long run. We are not the first to go through this. Therefore, saying that we would invite local or foreign investors or start supporting some machine-building assets so that they generate GDP is impossible, because the basic prerequisites have not been quite met. We should continue moving in that direction, that is, reforming those systems that everyone complains about, such as tax, customs, etc. These are the bottlenecks that persist and hinder the growth.
Changes to the Ukrainian economy are taking place. They also deserve a mention. They include the banking system, public procurement, energy sector, police, and even some smaller things, such as the report prepared by the Ministry of Economy and showing the problems that exist in the national property sector. That is, certain steps have already been taken. However, we are not forcing changes. In many sectors, we pledge and then hedge.
What can the banking system and its customers expect in 2017?
— If we want to have a comprehensive view, let's start with the economic overview. Our forecasts are based on the assumption that the economic situation will gradually go back to normal. Ukraine still depends on foreign markets. Therefore, it is impossible to create a lot of domestic growth drivers in the short term. The only hypothetical hope for the rapid growth of the Ukrainian economy are positive dynamics of foreign markets. However, no one expects this, because today everyone thinks that the things can only get worse, since our export-led economy has no potential for rapid growth.
As for the internal growth points, they depend on the reforms that we have already discussed, and will not emerge fast. At the same time, the macroeconomic picture could be slightly better than it would have been under the normal economic state policy and continued cooperation with international donors: IMF, EU, and the World Bank. The latter is the matter of not just money, but also the confidence in our country. Quick growth usually requires investment, which is especially true for the developing countries. Investment volumes depend on the investment climate, structural reforms, etc. Therefore, donors such as the IMF send a strong message. Their support and the implementation of the reforms are the keys to gradually improving the investment climate in the country. It is difficult to expect that a large international investor, such as Hyundai or Siemens, would come to us and open a factory, creating 10,000 jobs. However, there are also positive examples, including companies operating in Western Ukraine and producing motor vehicle parts. Other investors have also increased their presence.
I think that the banking system development will follow the country's economic recovery. We can expect the gradual growth of the deposit base and the renewal of lending activities, and there is a high probability of banks restoring their profitability. Last year a number of financial institutions that were the first to cleanup their portfolios already showed a profit, and this year the process will gain momentum. After all, there isn’t that many "sick" banks left in the banking system.
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If macroeconomic stability continues, this will create the potential for easing NBU's monetary policy, that is, interest rates will gradually decrease. However, the risks remain high, since our economy depends on the fluctuations in external markets, as well as on seasonal fluctuations. Unfortunately, temporary factors (such as massive budget spending before the New Year) can affect the situation on the currency market. This creates short-lived fluctuations, but we are used to them and know what to do.
I would like to draw your attention to another important detail. We should not reassure ourselves, thinking that the economy is recovering and that all is well. If we look at a longer time horizon, we can see that in a few years the country's foreign debt repayments will increase significantly, when the grace period of the restructuring deal will end. Besides, social tensions are growing. The state is trying to soothe them with subsidies and increased minimum wages. However, all these mitigation measures create pressure on the fiscal performance when there is no pension reform. Unless economic growth and structural reforms, such as the pension reform, accelerate, this might affect Ukraine in a rather negative way after two or four years.
In addition to that, you have a political cycle: elections are due in 2019. In view of the above, 2017 is the key year to implement vital and often unpopular reforms. There is no other way.
How can you make people duly appreciate transformations in the banking system?
— Central bankers are in many ways similar to surgeons or dentists: they hurt people now so that they feel better after. This applies not only to Ukraine. There are many examples even in the developed countries, where politicians and the society always have many questions to their central banks. I am not saying that we take this for granted and do nothing. Our policy of communicating and enhancing financial literacy of the population that we have pursued in the recent years is aimed, among other things, at addressing this problem.
At the same time, we understand the limits of our capabilities. Fighting with political populists in their field is rather difficult. Our answer, therefore, is: active communication, transparency and, most importantly, results achieved. Unfortunately, in our country any achievement is often perceived as a "treason." However, central banks were established as technocratic, non-political bodies. As Jean-Claude Juncker put it, "We all know what to do, we just don't know how to get re-elected after we've done it." Central bankers don't have such problems. As I once said, technocratic bodies, such as financial regulators, exist to save politicians from themselves. After all, a public figure will always be tempted to go into populism, but they can't cross the line and influence an independent body, which ultimately helps the economy and the society in the long term.
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Dmytro Solohub was born in Minsk in 1978. In 2000, he graduated from the Belarusian State University majoring in Economics. In 2002, he received his Masters of Economics from The Economics Education and Research Consortium (now Kyiv School of Economics) and the Kyiv-Mohyla Academy. He has worked for the International Monetary Fund Resident Representative Office in Ukraine and for Raiffeisen Bank Aval. Since March 2015, he has held the position of Deputy Chairman of the National Bank of Ukraine.
Translated by Anastasia Leonova
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