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Archive 2011

  • 13.03.2011

    The Banking Sector in Ukraine: Past Developments and Future Challenges

    (Code:PP_02_2011)

    Ukraine’s banking sector has followed a “boom-and-bust” cycle over the last couple of years. Rapidly growing loans -often denominated in foreign currency (FX) and funded by cheap shortterm external borrowings- led to a build-up of macroeconomic and sector-specific vulnerabilities. With the arrival of the global financial crisis in late 2008, the bubble burst and the sector was confronted with severe liquidity and solvency problems. This resulted in a credit crunch, which put additional stress on the real sector, which entered into a severe recession. Quick and determined policy action by the authorities, supported by international financial institutions, prevented a complete meltdown, and calmed the situation.

    The currently observable period of stabilisation in the banking sector allows us to conduct a thorough analysis and assessment of the overall situation. By doing so, we can derive some important lessons learnt to make the system more stable, without impeding the system’s important financial intermediation function for the real sector. The following policy recommendations summarize our position:

    1. Macroeconomic policy: Ukraine needs to improve its macroeconomic framework further, in order to achieve macroeconomic stability. A flexible exchange rate system and the gradual introduction of inflation targeting are key elements in this respect.
    2. Credit growth: In a situation where credit is still scarce, the authorities should refrain from using instruments that limit credit further. Thus, the current de-facto prohibition as well as the planned legislative ban on FX loans to unhedged borrowers should be reconsidered. We prefer the application of macro-prudential rules to control FX risks rather than outright bans.
    3. Consolidation: Market-driven consolidation may help to improve the efficiency of financial intermediation, but the current legislative framework for M&A is a serious impediment. The respective steps to create a positive legal environment need to be taken.
    4. Asset side: Tackling the high level of bad debt must become a major policy priority, as otherwise banks will be reluctant to provide new credit. It is encouraging that the NBU seems willing to push for changes in the legal framework for bad debt resolution.
    5. Liability side: We support current plans to cancel the right of depositors to withdraw time deposits any time, as this will mitigate liquidity risks and facilitate long-term lending.
    6. Relationship between asset and liability side: Given the current restricted amount of long-term funding in local currency, one way to facilitate the increase in long-term lending in local currency would be the introduction of FX hedging mechanisms. In the medium term, the development model must follow the principle “domestic deposits fund domestic loans”.
    7. Capital: An adequate capitalisation of the sector is a key element in the rehabilitation process. The fulfillment of recapitalisation plans by all actors is thus needed. For the state-recapitalised banks, a strategic decision on what to do is needed.
    8. Rights of lenders and borrowers: The protection of lenders’ rights is crucial for fostering sustainable lending. The authorities need to improve the legal and judicial environment.
    Attached file  (872.5 kb)
    Authors:  Kravchuk Vitaliy, Äæó÷÷³ гêàðäî, ʳðõíåð Ðîáåðò, Cyrus de la Rubia
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