The Ukrainians who founded banks in the 1990s on US $3,000 with main offices located in one- or two-bedroom flats and have recently sold these banks to foreign companies are now billionaires. It could not have happened any other way. Banking corporations have reaped astronomical profits in all economic circumstances and under all governments. This is not to mention the financial fraud they have resorted to (among these, financial pyramids built using citizens’ money are the least criminal). The National Bank of Ukraine (NBU) has shown its regulatory impotence by issuing licences to fast-moving fraudsters. As a result, we are hearing about more and more futile high-profile investigations into bank fraud.
When the national economy was down after the hyperinflation period of 1993-94 and Ukrainians stopped being paid salaries and pensions, bankers made most of their profits by servicing budget money flows as they charged ministries, government agencies and local administrations for banking services. Corrupt links to the government were a decisive factor back then, and those with a Komsomol background were most successful. Financial institutions also did not shy away from plain resale involving ordinary goods, antiques, cars, flats, metal and petrol. Some stole money deposited by enterprises after which responsible bank employees would disappear and their institutions would resort to fraudulent bankruptcy.
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Another type of unlawful transaction was the issuance of loans to insolvent government-owned companies in order to later seize their property as compensation for their debts. Ownership rights were then purchased by the nouveau riche for a pittance. One of the banks that accumulated a large amount of such debt was ProminvestBank, one of the first to get involved in schemes aimed at alienating government property by bypassing public procedures. It is quite possible that by acquiring the rights to claim the assets of a large number of post-Soviet enterprises, this bank made itself especially attractive to Russian capital. The Russians have always shown interest in Ukraine’s strategic enterprises, and ProminvestBank was the first financial institution to be declared insolvent at the peak of the 2008 financial crisis. It was confronted with a dubious liability for debts and became the property of Russia’s VneshEconomBank. Now a foreign owner received an opportunity to grab industrial Ukrainian enterprises as compensation for debts.
Ukrainian financial institutions played a similarly instrumental role in driving highly profitable government companies into large debts. To this end, their CEOs were persuaded to refuse to pay off loans and interest. This gave the crediting institution grounds to sue a company and have it declared bankrupt. Its assets were then transferred to the masterminds of the fraudulent scheme. Government property worth billions of hryvnias was alienated over millions indebted. The highest concentration of such cases was in Kyiv, Dnipropetrovsk, and Donetsk oblasts, all of which gave rise to the biggest oligarchic clans.
In the late 1990s, more civilized ways of making money became available. Financial institutions were allowed to work with government securities that carried annual interest of over 30% and involved minimum risk. The economic boom that began in Ukraine after 1999 and ended in 2008 permitted crediting enterprises and rising household incomes, prompting banks to vIhorously enter the market of consumer services. They guarded themselves against defaults on loans by demanding extremely large collateral in the form of assets and in cases of non-payment earned on reselling seized property.
Another shameful page in the history of Ukrainian financial institutions during the period of crisis when assets lost value and lenders defaulted on loans was the involvement of collectors who unlawfully forced borrowers to cough up the money (with the silent assent of law enforcement agencies and the NBU), thus triggering confrontations between society and banks.
After the collapse of the banking system in 2008 and the launch of the policy of centralizing available loan funds (since 2010), financial institutions again started to earn on the government’s internal debt. But this has been a business for the chosen, primarily government-owned banks and bankers with close ties to the regime. The rest were allowed to purchase NBU deposit certificates for which commercial banks had to deposit money in the central bank for 1-12 months at a certain interest rate (2.5-17%). The rates were not exactly high, but the important thing was that financial institutions did not run the slightest risk or incur any costs in these transactions.
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The problem is not that banks are seeking to make money in any way possible (often by walking a fine line), or that they always end up in the black and are not afraid of crises. Nor is it that they offer a wide range of services with exorbitant fees and interest rates. The problem is that they are not fulfilling the one function that no other economic entity can perform – they are not issuing enough loans to manufacturing enterprises, instead falling short of the demand in the real sector of the economy. When they do loan money, they charge unreasonable interest rates, up to 25-30%. When the NBU or government officials say that average interest rates on loans to enterprises are at 20% (the figure taken from the NBU’s statistical report for 2012), they fail to explain that first, these do not reflect debt-related and non-debt-related payments—Ukrainian banks are quite skilful in pumping extra money out of their clients. Moreover, this figure includes various privileged loans to high-priority sectors and to entities that are part of oligarch-owned conglomerates. In other words, these are not market rates. Hence, the reported average loan interest rate is as meaningless as the average body temperature in a hospital. Borrowers without good connections find loans virtually unaffordable as they are much more expensive for them (upwards of 30%). Ukraine has essentially no credit market competition.
The main function of banks is not limited to crediting as such. The national economy needs production loans because consumer loans are unproductive and inessential to economic growth. As it is now, banks are diverting resources from productive purposes. Enterprises could use them to expand their production facilities, but this is not happening in Ukraine. It seems that the suppliers of goods are artificially increasing effective demand for their products above the actual state of the market, thus distorting the true proportions. Given the existing credit system, outdated means of production are being perpetuated, while new industries are being stalled.
Not all loans issued to finance production needs are useful – only those that are given to the most advanced production companies whose products society really needs. These would be the most profitable companies. In this way, banks must fulfil a kind of sanitary mission: they extract from circulation money that is invested in outdated and uncompetitive enterprises and channel it to useful and promising production facilities. This happens when debtors—whose key creditors are usually financial institutions—go through bankruptcy proceedings.
However, when Ukrainian banks issue property-secured business loans, old Soviet-era enterprises that have large premises, infrastructure, land, etc. stand a higher chance of attracting them. The instruments of guarantees and backing are more readily available to business owners that are close to the government. Meanwhile, new companies are left out as they fail to meet the normative regulations set by the NBU. In these circumstances, banks are not looking for innovative enterprises. They are working with companies with which they have established relationships. Earlier loans keep getting prolonged, which works in favour of both Soviet-era enterprises and the banks themselves as they avoid new risks. Financial instruments keep circulating in this closed cycle. This leaves new businesses, projects and plants without sources of bank financing. In fact, crediting old enterprises carries more risk, but budget guarantees prompt financial institutions to make even riskier (including corrupt) transactions.
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The same is true of loans issued to small companies. They are virtually non-existent. There are several reasons why small companies are of little interest to banks. First, they operate on a small scale, and servicing small and medium businesses is more labour-intensive. Second, these types of businesses have limited assets and hence cannot guarantee compensation in case of default. Third, they are geographically mobile and are hard for financial institutions to monitor, which is why bankers perceive them as riskier.
This approach to crediting shows that bankers are not interested in how profitable their clients’ businesses are, even though more profitable companies could be charged higher credit interest rates. On the contrary, banks are happier to credit companies that have already reported enormous profits than those that plan to make money in the future. But it is the latter that need loans. As a result, capital fails to be concentrated in promising sectors. Banks are reluctant to risk their money only to credit fledgling businesses. They are, in a way, quite content with the status quo: no economic growth, competition, or business fluctuation, no searching for new clients or offers of new services. This is a life without risks or the desire to open new markets for banking services – only fake activity. Meanwhile, the most promising, innovative companies are crying out for loans. The economy needs to be become more profitable. The structure of capital needs to be modernized. But the current banking system is incapable of fulfilling these functions. It is stalling the transition of the entire national economy to market conditions. Of course, not all banks and bankers are the same, but this generalization is, by and large, valid.
UKRAINE’S BANKING MARKET: DIVIDE AND CONQUER
Ukraine’s banking sector is quite heterogeneous. The key distinguishing factor is the predominant type of crediting. It is the main kind of banking activity and, unlike payments and other banking services, defines economic growth.
Common to all financial institutions working in Ukraine is the non-market nature of their operations. They usually fill certain niches in the monetary-credit system and find ways to obtain advantages from administrative and regulatory bodies, while at the same time becoming dependent on them. These groups of banks have certain distinct qualities.
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Operators on the market of government bonds and government order crediting (including government purchases, contract work, budget-financed loans, etc.) are making piles of money on large-scale transactions with high interest rates and without any serious competition at that. They have the highest profit margin and the lowest overhead and risks of default. Their credit funds are often replenished with money freshly issued by the National Bank. It is the cheapest money available – the discount rate is 7.5% and the rate on transactions by the NBU on the open market is 8.5-10.5%, which is 4-5 percentage points lower than the market value of monetary resources.
Operators owned by oligarchic financial-industrial groups are the key creditors of enterprises that are part of oligarch-owned conglomerates. They have no problem obtaining financial resources, as they receive money from the budget and funds emitted by the central bank for purposes of refinancing at privileged and discount rates. They attract additional resources through an extensive network of local offices by luring citizens with high deposit rates and various special officers. These banks are not, of course, financially liable for the unsuccessful placement of capital: their credits are knowingly unproductive as they cover holes in the balance sheets of outdated plants, while the state always comes to the rescue if necessary.
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Creditors financing the import of goods and services are content with having huge volumes of commercial operations in their sector. The guarantees of repayment are, above all, the established standing of their clients – import companies that have found ways to pass border and customs checks without any problems. Second, importers enjoy a monopoly on the domestic market of consumer goods, energy or raw materials. Sources of financial resources are surplus balances of companies and individual bank deposits, as well as loans from foreign financial institutions at a 5-10% interest rate in foreign currency.
Crediting domestic wholesale commercial transactions is attractive to bankers because these transactions are secured with stocks of goods, have relatively low risk, and rapid turnover. In this sector, short-term credits are issued, which reflects the structure of bank resources. Money comes from individuals who deposit their savings at a 10-20% annual interest rate. Exorbitant loan interest rates are paid with monopolistic profits reaped by suppliers on markets with varying degrees of integration and scale.
Providers of retail banking services include both national and foreign financial institutions, usually large organizations with extensive networks of local branches. They are drawn to this sector because of extremely high effective interest rates (up to 25-35%) on consumer and mortgage loans. Another reason is the lack of restrictions on fees charged for money transfers, payments, card servicing and even information provision, as is the case with PrivatBank. Also, citizens are eager to deposit their savings, especially in US dollars. This especially attracts foreign banks that, due to the financial crisis and high risks of operating in Ukraine, have focused on pumping hard-currency reserves out of the country to the West.
Ukraine’s banking sector also includes extra-large companies that operate in several segments of the crediting market at the same time. They are special not only in their multifaceted activity but also in their treatment of clients: they tend to be more arrogant, violate the terms of contracts, steal certain sums by exploiting loopholes in legislation, and charge exorbitant rates and fees. The reason for such liberties is their monopolistic grip on certain financial and geographical markets, especially in their dealings with physical persons.
However, the main threat posed by such monsters lies elsewhere. They have unjustified competitive advantages over smaller banks due to concealed state guarantees: the state will pay for their failures. The bankruptcy of large financial institutions creates systemic risks for the entire economy. For example, the bankruptcy of a top-10 bank may well undermine the currency exchange rate and the fake stability of the national monetary system. And this is a fairly likely event, considering that some of these banks are owned by oligarchs who may at any moment find themselves out of favour with the current government—a regime that lets only the most loyal players come close. In these confrontations, tycoons may use their banks for blackmail: either you leave me alone or I bankrupt my bank and undermine the financial system. Something along these lines took place in the conflict between Ihor Kolomoisky—one of the owners of PrivatBank—and the government in early 2013. The bankruptcy of his AeroSvit company caused a several-week-long collapse on the air transportation market.
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Insolvent financial institutions that are “too big to fail” have rarely come to bankruptcy until now. They are just too big to vanish from the market without any consequences. That is the reason why large banks feel overly confident and assume excessively high risks without due regard for consequences. As a result, the entire monetary-credit system of the country becomes weak and unstable.
Thus, banks in Ukraine are not operating in market conditions and are not financing companies with the biggest competitive edge. They have unequal, non-market access to sources of financing and face different levels of risk. Moreover, a large part of their operations would not be profitable in market conditions. Due to the way Ukraine’s banking sector works, their profits come largely not from the fastidious selection of promising borrowers but from their ability to access sources in which certain types of income are artificially created.
Ukraine’s banking sector is administratively segmented – joining a certain group without government assistance is an impracticable dream. Banks are strictly divided according to where they obtain the financial resources that they make available for crediting. They are focused at meeting subjective needs that have nothing to do with economic growth, but are aimed at enriching bureaucrats and their partner oligarchs. Ukrainian banks are looking to attract money flows of non-market, non-economic, non-entrepreneurial and often very dubious origin, for example, privileged loans issued by the government or the central bank, monopolistic profits, etc. In many cases, they are tuned to force oppressive crediting conditions on their clients, which is grossly at variance with providing socially useful services. Not only is the banking sector failing to support the national economy, it is draining its resources to secure huge profits for a restricted circle of the chosen.
