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26 January, 2012  ▪  Maria Minska

A Competition of Profitability

Banks’ generosity in late 2011 and early 2012 points to a worsening situation in the financial sector

The fight over money held by Ukrainians erupted among financial institutions in the fall of 2011 and has continued since then. Interest rates on deposits for individuals and companies have been steadily increasing. Ukrainian banks were actively cutting interest rates on deposits in July-August 2011, but staged a real rally at the end of the year. In late December, the maximum annual interest rate on deposit accounts in hryvnias for individuals reached 25%. Compared with June-July 2011, interest rates on one- to three-month deposits doubled or tripled and added 4-5 percentage points on long-term deposits (8-11 months). Tellingly, in the corporate sector, rates increased even on deposit lines that are traditionally not a high-yield instrument, reaching a record 24.54% on hryvnia deposits by late December.

The policy pursued by banks is understandable: in the fall of 2011, they faced an outflow of capital essentially for the first time since the onset of the crisis which hit Ukraine in October 2008. The net capital outflow from accounts in hryvnias exceeded UAH 4 billion in August-October 2011. Banks’ losses were set off at the time by swelling savings in hard currency – expecting the hryvnia to devalue, Ukrainians tried to protect their savings in dollars and euros. In November, money began to flow out of hard-currency accounts.

The banking system again experienced low liquidity: Ukrainian banks have rarely had more than UAH 15 billion, and sometimes even less than UAH 10 billion, on their correspondent accounts since the fall of 2011. Available funds were typically concentrated in several large financial institutions and government-run banks. In order to function normally, Ukraine’s banking system needs to have at least UAH 16-17 billion on its correspondent accounts.


Bankers believe that there was only one solution to the situation – enticing depositors with high interest rates. This auction of generosity is continuing: people can still take advantage of New Year and other special offers first extended by financial institutions in December 2011.

Experts say that the permanently and significantly changing interest rates on deposits point to, mildly speaking, an ailing financial system in general. Theoretically, sky-high interest rates can be offered perhaps only by institutions that focus on consumer credits (cash credits, card loans, etc.) With their loans at 120-150% APR (the CreditMarket Cash Index reached 132.61% on of December 27, 2011) specialized financial institutions are capable of paying 25% APR or even more on deposits in hryvnias. But this is what nearly all financial institutions have been doing recently and is an alarming signal.

This practice provided a partial solution to the problems banks faced during the financial crisis in 2008-2009. But it played a mean trick on many people – everyone remembers how difficult or nearly impossible it was to receive your own money back from problem-ridden financial institutions.

Steady growth of interest rates on deposits is impossible. Banks must operate in order to pay interest in due time and in full measure, i.e., they must lend their money. However, there are very few people or organizations that want to borrow hryvnias at rates exceeding 20% APR. An incessant increase in interest rates on deposits will eventually make banks pay interest by drawing on newly attracted resources. Then deposits will turn from the safest into a very risky investment, and the banking system will resemble a financial pyramid, so to speak. There have been a number of cases in Ukraine when, under pressure from their clients who demanded to have their money back, financial institutions launched energetic advertisement campaigns to attract expensive deposits, and several months later the National Bank ushered in temporary administrations to save them – Ukrprombank (failed), Rodovid Bank, Nadra Bank, etc.


Bankers say that the National Bank alone can improve the liquidity of the banking system. Since mid-2011, the NBU has unswervingly pursued a strict monetary policy which, in fact, caused the shortage of hryvnias. On the interbank market, the value of hryvnia resources spiked to 40% APR, a level previously recorded only during the 2008 bank crisis.

In December 2011, Director of the NBU General Department for Monetary and Credit Policy Olena Shcherbakova assured that the National Bank could relax its policy in the first quarter of 2012. However, this move may not produce the desired results. On November 30, 2011, the National Bank changed norms regulating bank reserves and permitted transferring to its special account 70% of the amount reserved instead of the previous norm of 100%. After this, balances on correspondent accounts exceeded UAH 20 billion. But bank representatives claim that the financial system has barely enough money to maintain its operation and secure transactions, current operations, payment of interest, etc.

On December 30, the balance on correspondent accounts grew to UAH 28 billion. This, however, is no reason to be optimistic – market players are convinced this is just a temporary phenomenon, because money from taxpayers traditionally lands on bank accounts close to the end of each year. Due to low business activity in early January, the balance usually remains the same. Indeed, it was UAH 28.37 billion as of January 5. After a long holiday season, things will resume their normal course: interest rates on the interbank market will go up due to problems with liquidity, and financial institutions will be forced to borrow expensive hryvnias.

Even if the National Bank relaxes its monetary policy in 2012, it will do so to a very insignificant extent. A shortage of hryvnias is an important factor that permits the NBU to curb real inflation and maintain a stable hryvnia exchange rate. It is going to face the same problems in 2012 as it did in 2011. According to the forecast of the National Bank, inflation should not exceed 7% in 2012, even though there are plenty of factors that may drive prices up. Gas may become more expensive if Ukraine fails to persuade Russia to drastically cut its price. Utility bills will be bigger, and tariffs were already raised in a number of regions in January. The national currency may devaluate; retailers may want to cash in on the Euro 2012 soccer championship and so on.

Pressure on the hryvnia exchange rate will grow, and in order to keep it stable (the government’s benchmark for 2012 is 8 UAH/USD, according to the latest redaction of the 2012 state budget), the National Bank will have to continually expend its resources. In January-November 2011, it spent nearly USD 4 billion to support the hryvnia. It will have less room for maneuver in 2012 as Ukraine's gold and hard currency reserves have dropped to USD 32 billion, and part of this sum is IMF money which has to be returned by the end of this year.

The National Bank does not conceal problems and recognizes that increasing the country’s gold and hard currency reserves is a first-priority task. However, it is unclear how it will be approached. There is talk about switching to rubles in payments for Russian gas, which would allegedly save USD 8 billion for Ukraine. Another USD 5 billion are going to be saved by decreasing people’s appetite for hard currency, which means continuing the practice of severe administrative measures. In September-November 2011, after a regulation was issued requiring people to present ID to buy hard currency, the average daily demand for US dollars dropped from USD 100 million to USD 60 million. But all of these are tactical solutions. It is unreal to provide an economy with enough currency without fixing Ukraine's balance of payments (which is nearly impossible to do).

According to official sources, the deficit of Ukraine's balance of payments increased six-fold from November 2010 to November 2011. It is expected to reach USD 3 billion for 2011. The cumulative deficit of our trade balance has already exceeded USD 10 billion. This is caused primarily by problems in the European and world economy which hurt Ukrainian exports. If this trend persists and problems are further aggravated, the National Bank will hardly be able to maintain a stable hryvnia exchange rate.

Meanwhile, expert forecasts are more or less optimistic. For example, macroeconomist Iryna Piontkovska of Troyka Dialog Ukraine believes that the exchange rate will reach 8.5 UAH/USD in 2012. Eric Nayman, partner at the Capital Times investment company, concurs: “If we are talking about a basic scenario for 2012, I expect the average annual exchange rate to be at 8.5 UAH/USD. An optimistic forecast is 8.2 and a pessimistic one 8.8.”

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