The government is seeking to seize control of private financial institutions. Why the share of state banks is rising

The government is seeking to seize control of private financial institutions. Why the share of state banks is rising

And what are the risks for everyone involved

The government is seeking to seize control of private financial institutions. Why the share of state banks is rising

In the near future, lawmakers may approve the government's entry into the capital of large private banks. The relevant bill, nicknamed the "Bank Nationalisation Bill", has been registered in the Verkhovna Rada.

It provides for the possibility of nationalising banks, including the largest ones, based on their owners' business reputation. Bankers say that the bill is tailored for Sens Bank (formerly Alfa-Bank Ukraine). Earlier, in March 2023, the National Bank stated that Sens' shareholders have an imperfect business reputation due to the sanctions imposed by the West. However, the draft law may also apply to other Ukrainian banks if the reputation of their beneficiaries is found to be questionable.

Mind looked into the threats to the financial sector posed by this unprecedented expansion of the regulator's powers and how broadly the concept of "imperfect reputation" can be interpreted.

Does the state really need additional banking assets? The state's share in the banking sector is almost 60%. Its further increase contradicts the official position of the Ministry of Finance, which has been planning to reduce state participation in the banking sector for years.

Since 2008, the MinFin has adopted several strategies for the development of state-owned banks, the main idea of which was to gradually reduce the share of state-owned banks through their sale. In practice, however, the public sector in banking only grew. By 2022, it was due to the nationalisation of new banks, and in 2022, it was due to wartime government policies.

Though the Ministry of Finance acknowledged that this was "not a market story" and planned to reduce the state's share in the banking to less than 25%.

How will the impeccable business reputation be determined? This is the main concern of market participants.

Ukraine has not yet developed a mechanism for nationalisation based on an imperfect business reputation. "National Bank Resolution No. 149 states that the NBU can recognise the business reputation of owners who are under sanctions as imperfect. However, shareholders have no legal mechanism to take over the bank – as long as the bank meets all the regulator's requirements. The bill provides such a legal mechanism," explains banking expert Olena Domuz.

Why was such vague wording needed? Because it is not always possible to legally charge the " undesirable" banks.

Sens Bank, for example, has good financial performance, and in spite of all the constraints, it remains operationally profitable. At the end of the war year, its operating profitability was 19%, and in 2021 it was 21%. Earlier, the bank appealed to the UK government for a $1 billion capitalisation. The institution is also considering attracting a foreign investor, and litigation is ongoing in Europe against its shareholders, Mikhail Fridman and Petr Aven, who deny the sanctions against them.

"According to the NBU, the equivalent of the bank's liabilities to individuals at the end of January 2023 was about UAH 43 billion, which is slightly more than $1 billion. The bank has good liquidity – there is a solvency margin. For example, highly liquid funds amounted to UAH 14 billion," says Domuz. "I think the NBU may try to nationalise the bank so as not to trigger a panic in the banking market. "Sense is the largest [commercial] bank with a huge customer base, and all banks are interconnected."

Why did Ukraine have such a tremendous state ownership share in banking? At the first stage of independent Ukraine's existence, in the 1990s, the effectiveness of state-owned banks was questionable: they were often used for non-market lending. "In the early 2000s, Ukraine even imposed restrictions on Oschadbank's activities because there was too much political lending that was not being repaid, and the branch network was generating operating losses. By 2008, Oschadbank and Ukreximbank were gradually losing their shares, and it was possible to sell them, but unrealistic for political reasons," says banking expert Stanislav Shlapak.

The global financial crisis gave an impetus to the development of state-owned banks.

In 2008, Ukraine nationalised Ukrgasbank, Rodovid and Kyiv. Ukraine's international partners, such as the IMF and the World Bank, closely monitored the country's banking sector policy, as they partly provided loans to cover the financial system's problems.

In 2016, the largest bank, PrivatBank, was nationalised, giving the state a huge share of the banking system – more than 50%. This raised a number of questions not only about the reduction of the state's share in the sector, but also about the competitiveness of Oschad and Ukrexim, which, in the midst of increased competition, began to invest in the service component.

As was reported, in 2022, it was the state-owned bank sector that saw the main development.

Are there any signs that state-owned banks are being prepared for sale? One of the apparent achievements in state-owned banking is the corporate governance reform. "The state-owned banks have tried to reduce the influence of politics on decision-making through independent supervisory boards. We can say that the corporate governance reform has made the state-owned banks stronger, more transparent, more commercially oriented and ultimately more efficient," says Shlapak.

He points out that although the banks did not fully follow the strategic guidelines recommended by the Ministry of Finance, certain specialisations have become noticeable. For example, Oschadbank has been brought into the general deposit guarantee system and has a clear development strategy. Ukrgasbank has moved forward with its upcoming privatisation by signing a convertible debt agreement with IFC.

"In terms of selling stakes in banks in which the state has a stake, Ukrgasbank has gone further than anyone else by signing an agreement with the International Finance Corporation to obtain a loan that can be converted into equity. Of course, PrivatBank has also done a lot, but it has a very serious element of slowdown, tied up in litigation with former shareholders," says Denys Chernyshov, Deputy Chairman of the Board of Ukrgasbank. According to him, Privat's results in preparing (and possibly even selling) the bank would have been much more significant if not for the lawsuits.

Share of non-performing loans (NPLs) in banks, %.

Oshchadbank, a bank that was close to signing an agreement with the EBRD, also had plans to sell its stake. "The EBRD and IFC, as organisations with a development mandate, traditionally go where commercial investors are not ready to go at this stage for various reasons," says Stanislav Shlapak.

Is the "state-owned" status synonymous with "efficient"? It is not uncommon to see long-term (up to 10 years) restructuring of loans to large clients among state-owned banks. They are granted a grace period – for example, three years – during which the borrower pays nothing to the bank. Such benefits have a negative impact on the borrower's motivation to service the loan, resulting in NPLs that last for years. State-owned banks usually have the highest levels of non-performing loans in the market.

The profitability of state-owned banks also remains questionable.

Operating profitability on assets (ROA), %.

At first glance, state-controlled banks appear to be operationally profitable. The average return on assets (ROA) excluding provisioning for 2019-2022 for PrivatBank was 9.8%, and for the other three state-owned financial institutions it was between 1.5% and 2.3%, compared to the market average of 5.3%.

Operating return on assets (ROA) after deducting gains on securities, %.

However, after deducting the gains banks make on securities, three out of four state-owned banks' profits will turn into losses. "We can see a distorted understanding of the tasks that banks have to perform in wartime. Even among the state-owned banks, there are institutions that did not lend but are making a profit. They were mainly engaged in servicing individuals," says Denis Chernyshov. "Banks that lend make provisions for these loans and get a negative financial result. But it is these loans that ensure the viability of the military and the economy. It is not entirely correct to judge the performance of banks in wartime by their profit alone."

What are the risks for state-owned banks? The most vulnerable areas in state-owned banks are their governing bodies, supervisory boards and general meetings of shareholders. "The issue is not their instability or incompetence, as the level of teams in supervisory boards is very high. But these bodies are still subject to some influence and possible pressure from the government," says Chernyshov.

The increased attention to the work of state-owned banks also imposes certain restrictions on internal protocols, in particular, on team motivation.

For instance, Kyrylo Shevchenko, the former Head of Ukrgasbank and former Governor of the NBU, was accused of paying remuneration to private intermediaries who helped raise funds from businesses and state-run enterprises. In the private sector, such an incentive scheme is not a crime, but a normal way of working. One could assume that after the charges against Kyrylo Shevchenko, other bankers will simply be reluctant to work for state banks or will be afraid to make serious decisions about their development.

"In the case of Ukrgasbank, the pre-trial investigation body says that clients would have come to this bank without any other efforts. However, the competition between state-owned banks is ongoing and has not disappeared," Denys Chernyshov said.

In his opinion, such competition de facto reduces the financial result for their sole majority shareholder, the state. But solving this problem is a post-war task.

Graphs were created with Flourish.

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