Risk Governance & Control: Financial Markets & Institutions / Volume 9, Issue 3, 2019
OWNERSHIP STRUCTURE AND RISK PROFILE OF BANKS IN EMERGING ECONOMIES
Dmitriy Riabichenko *, Martin Oehmichen**, Yaroslay Mozghovyi ***, Andreas Horsch ****
* Deloitte, Ukraine ** Freiberg University of Mining and Technology, Germany *** Virtus Global Center for Corporate Governance, Ukraine **** Corresponding author, Freiberg University of Mining and Technology, Germany Contact details: Freiberg University of Mining and Technology, Akademiestraße 6, 09599 Freiberg, Germany
Abstract
How to cite this paper: This article analyzes the relationship between ownership structure Riabichenko, D., Oehmichen, M., Mozghovyi, Y., & Horsch, A. (2019). and risk profile based on the data from the emerging banking Ownership structure and risk profile of market. Using Kohonen self-organizing maps, we divide banks into banks in emerging economies. Risk clusters according to the type of risk profile. This mapping Governance and Control: Financial technique is based on panel data dimensionality reduction, as risk Markets & Institutions, 9(3), 46-65. http://doi.org/10.22495/rgcv9i3p4 profile is changeable over time. We adopted the Basel Committee on Banking Supervision recommendations regarding the types of Copyright © 2019 The Authors concentration of funding serving also as a basis for determining the
This work is licensed under a Creative risk exposure of banks and used them as an input for Kohonen Commons Attribution 4.0 International maps. We conclude that business models and, consequently, risk License (CC BY 4.0). exposures of banks significantly depend on sources of capital https://creativecommons.org/licenses/ (domestic private, foreign, state). Our empirical results show that by/4.0/ ownership type is a major, but not the only factor influencing bank ISSN Online: 2077-4303 risk profiles. These findings call for a change of the regulatory ISSN Print: 2077-429X paradigm in emerging (banking) markets.
Received: 12.06.2019 Keywords: Bank Ownership Structure, Risk Profile, Banking Accepted: 29.07.2019 Regulation, Kohonen Self-Organizing Maps, Emerging Banking JEL Classification: G21, G38, G32 Market DOI: 10.22495/rgcv9i3p4 Authors’ individual contribution: Conceptualization – D.R., M.O., and A.H.; Methodology - D.R.; Writing – D.R., M.O., Y.M., and A.H.; Formal Analysis - D.R.; Investigation - D.R.; Visualization - M.O. and D.R.; Resources - M.O.; Supervision - A.H.; Funding Acquisition - A.H.
1. INTRODUCTION to the real economy, decreasing GDP and a global recession for several years. Furthermore, it prepared In many developed economies, banks play a crucial the ground for the crisis of several EU member role: while they transform volumes, values, terms, states, and, finally, the Euro and the EU themselves. and risk in ways that allow handling the problems of Numerous financial crises in history transaction cost and information asymmetry continuously draw the attention of researchers and efficiently (originally, Benston and Smith 1976; regulators to the activity of banks, their Leland and Pyle 1977; as an overview, Greenbaum, performance, and factors of their success and Thakor, and Boot 2015). Thereby they are selecting failures. In particular, such issues as banking their borrowers individually, depending on their risk ownership structure and risk profile are crucial portfolio. parts of the research agenda in many countries The financial crises have shown that (Chun, et al., 2011; Dong et al., 2014). overindebtedness or illiquidity of banks leads to This paper approaches the problem of bank massive distortions in local as well as in global risk profiles in conjunction with the bank ownership financial markets and may affect the development of structure. Compared to other studies, current economic key figures for a long-term, and in research accumulates data on the ownership contagious ways. The last crises started with structure in several directions: state/private and American banks granting real estate loans to foreign/domestic. We choose Ukraine with its subprime debtors, and (via the MBS-market) resulted developing banking system as a very suitable case in worldwide liquidity problems of banks, spillovers
46 Risk Governance & Control: Financial Markets & Institutions / Volume 9, Issue 3, 2019
for such empirical research due to the presence of risk attitude, structures, and processes, and the banks of all kinds of ownership. existence of a governmental safety net), it may We use Kohonen self-organizing maps that influence a bank’s performance in a particular way, allow dividing banks into clusters according to the as managerial, regulatory and funding procedures in type of risk profile, making in-depth analysis state-owned banks differ from those in privately possible. The majority of previous papers that divide owned banks. banks into clusters use k-means or hierarchical Apart from ownership, researchers also take clustering methods (Rashkovan & Pokidin 2016). Our into account, actors of which level of the political paper proposes Kohonen self-organizing maps as a system exercise ownership or control rights less widely used, but still valid alternative to (Iannotta & Nocera, 2013; Schmielewski & Wein, conventional methods. This approach is particularly 2013; Tandelilin et al., 2007). A federal or central strong in terms of dividing data into homogeneous government usually has more power and funds to groups, but it also provides researchers with support and direct institutions under its ownership. extensive data visualization, which helped us On the other hand, banks that are owned by local distinguishing the banking groups selected for this administrations may experience higher control and research. tighter monitoring levels due to the physical Ukrainian data is unique since the banking proximity of the owner and the fact that local system in Ukraine includes viable banks of each governments usually have a good knowledge of ownership group: banks with foreign capital regionally based banks that conduct business under (Russian capital, in particular, taking into account their jurisdictions. Consequently, the situation is the complex relationship between the two countries), different for local governments that own banks domestic banks with private capital and domestic located in different regions, but such cases appear banks with the state capital. There are few examples to be a rare exception. of other countries providing a comparable banking As for privately owned banks, previous system in terms of ownership characteristics, research divided them into foreign banks and making Ukraine a perfect research object for domestic banks. This distinction is important for exploring the relation between bank ownership cross-country studies (Laeven & Giovanni, 2008; structure and risk profile, which is the aim of this Nicolò & Loukoianova, 2007) or studies that focus paper. In addition, the Ukrainian financial industry emerging economies, where foreign banks can play a experienced the same trends of capital inflows (and particularly significant role, as the institutional subsequent outflows) from Western Europe as banks framework of rules and organizations is still under operating in CIS markets. construction (Rahman & Rejab 2013). This approach To our knowledge, this is the first study that can be explained by the strong support and analyses the relationship between bank risk profile experience that foreign banks can obtain from and ownership structure of the banks in Ukraine in parent companies. Especially if the bank is a terms of several ownership groups including representative of a strong international financial domestic state/private owned, and foreign banks. group, it can rely on substantial financial backup The structure of the work is as follows: Section while developing its structures and operations in the 2 provides a brief overview of the relevant literature domestic market. Local banks, as a rule, have to present a theoretical background and to identify superior knowledge of market peculiarities, of how the research gap to be filled in by this paper. Section to find approaches to clients and possibly better 3 moves to the ownership structure of Ukrainian informal connections to decision-makers in political banks in order to illustrate the practical background and regulating institutions. of the problem and the conditions under which the Some studies (Cooper & Uzun, 2009; Lee, 2008), empirical analysis takes place. It also focuses on pay special attention to insider or institutional recent trends in the Ukrainian banking system and ownership, as institutional and owners, represented provides important information on the regulations by insiders have more influence on the operations of that influence the methodology and calculations a bank. provided in Section 4. Section 5 shows the empirical Another approach is to analyze the ownership results of the analysis based on the Kohonen maps structure of banks according to its concentration. As approach and provides their explanation. Section 6 a rule, organizations that are owned by numerous contains a short overview of the paper’s main small (minority) shareholders behave differently findings and key concluding statements. compared to those that are owned by a few large stockholders, because they have to deal with 2. LITERATURE REVIEW different agency problems and costs. This analysis shows that there is no single approach to ownership 2.1. Bank ownership types and structure structure in previous research. Table 1 (see Appendix) summarizes the period
of study, the covered markets, and the different Previous studies contain extensive analyses of ownership types compared in previous studies. various bank ownership structures and their A larger number of bank’s failures highlights correlation with performance indicators of the the fact that banking in Ukraine is still riskier than respective financial institutions. Traditionally, in most developed countries. Therefore, examining researchers distinguish several parameters of the determinants of banks’ risk-taking seems crucial ownership: first of all, attention is paid to the issue for the understanding of the prospects of the of state ownership. Some authors (Barry et al., 2009; stability and profitability of the banking system in Dong et al., 2014; Zhu & Yang 2016) argue that due particular and for future economic development and to the specificities of state ownership (in particular growth in general (see, for example, Fungáčová & political considerations influencing a bank’s goals, Solanko 2009).
47 Risk Governance & Control: Financial Markets & Institutions / Volume 9, Issue 3, 2019
2.2. Risk profiles in banking stock markets, bank’s stock prices depend on the earnings, and respective announcements. If Bank managers are obliged to increase shareholders’ managers fail to provide competitive earnings, the value by enhancing bank performance. To achieve market will react negatively. Barry et al. (2009), this goal, they have to take risks and thus must deal Lassoued et al. (2010) use as a variable for return with the issue of risk management. While the risk volatility the standard deviation of the return on environment of banks usually is divided into market average assets (SDROA). On the contrary, Iannotta (price) risk (such as interest rate risk, securities price and Nocera (2013) use a market measure instead of risk, currency risk, commodity price risk), credit risk an accounting measure, employing the volatility of (including country risk), liquidity risk, operational bank stocks returns, or their stocks’ beta. While risk, and other risk categories (Crouhy et al., 2014; market measures work fine in countries with Hull, 2015), their management attempts to avoid developed stock markets, emerging economies like losses and liquidity shortages, and to stabilize cash Ukraine require a different approach, taking into flows and thus shareholder value instead (Tandelilin account the amount of reliable information. We use et al., 2007). accounting measures in this study due to the level of Lamy (2012) provides a different system of information disclosed the structure of reporting and bank risk categories, taking into account their the weak development of the stock market in connection to a bank’s ownership structure, which is Ukraine. also particularly interesting for this research. The Several authors take capital adequacy ratios author develops a theory that insolvency risk, (CAR) as an indicator of a bank’s risk position (see, systemic risk, and idiosyncratic risk may be present for example Lassoued et al., 2010; Dong et al., 2014; in banks – and be connected to their ownership Tandelilin et al., 2007; Cheng et al., 2013), thus structure, as the risk-taking the behavior of banks is focusing their loss cushion shielding them – and the result of two main agency problems. The first their depositors – from insolvency. The capital agency problem affecting bank risk (taking) is the adequacy ratio is defined as tier 1 or/and tier 2 owner/manager agency problem, which may capital divided by risk-weighted assets. This ratio incentivize managers to act in general and to take a differs from others because of its regulatory roots risk in particular in a self-interested way instead of and attention. National and international regulators acting in the best interest of the shareholders of banking markets worldwide set standards (Jensen & Meckling, 1976). The second agency including CAR and monitor CAR to protect problem affecting bank risk arises from conflicts depositors and maintain trust in the banking between controlling and non-controlling system. shareholders. Controlling shareholders may seek Similar to previous indicators, some authors private benefits at the expense of non-controlling (see, for example, Cheng et al. 2013; Barry et shareholders which may lead to higher bank risk al., 2011) use loan loss provisions to approach bank (Shleifer & Vishny, 1997). risk. The ratio of loan loss provisions to total assets Previous studies approached the issue of (LLP) shows, which percentage of a bank’s assets is measuring bank risk differently. One of the most devoted to reserves against potentially defaulting widespread variables used to estimate a bank’s risk loans. Similar to CAR, LLP represents cushions exposure is the nonperforming loan (NPL) ratio, against losses, helping a bank to withstand losses which is usually used to demonstrate a bank’s credit and to ensure depositors’ property rights. risk exposure (Cheng, Zhao, & Zhang, 2013; Zhu & Accordingly, several national regulators have Yang, 2016; Dong et al., 2014; Tandelilin et al., 2007; adopted requirements for loan loss provisions (see, Rahman and Rejab 2013). NPL is the total amount of for example, Laeven & Majnoni 2003). One of the issued loans that were not repaid by the debtor in more complex indicators of bank risk profile is the due time. Once a loan is nonperforming, the value at risk (VaR), which measures and quantifies probability that it will be debt serviced and (at least the level of financial risk within a firm or investment partly) repaid is considered lower. The NPL ratio portfolio over a specific period. Value at risk is used itself is calculated as a ratio of nonperforming loans by bank risk managers in order to measure and to total loans issued by the bank. control the level of risk the firm undertakes. The Alternatively or in addition to NPL ratios, the risk manager's job is to ensure that risks are not so-called Z-score is used in a number of studies to taken beyond the level at which the firm can absorb demonstrate insolvency risk of banks (Zhu & Yang, the losses of a probable worst outcome. Due to the 2016; Nicolò & Loukoianova, 2007; Riewsathirathorn complexity of this indicator, it was used only by et al., 2011; Schmielewski & Wein, 2013). The Z-Score Tandelilin et al. (2007) among the studies attempts a quantitative measurement of a bank’s investigated in the literature review. financial health. It highlights factors contributing to According to current risk measurement a company’s financial health and uncovers emerging practices, bank risk is measured in various ways and trends that indicate improvements or deterioration should be gauged using and comparing more than in financial conditions. Bouwens and Verriest (2014) one approach to produce reliable results. propose to calculate Z-Scores defined as the bank’s Aforementioned approaches and indicators suit capital assets ratio (ratio of equity over assets) plus different research aims for particular markets and the return on assets (ROA), the sum of both divided conditions. Due to the specifics of the Ukrainian by the standard deviation in ROA. banking sector, which are described in Section 3, we Another variable to determine bank risk is stick to the metrics proposed by the Basel return volatility (Zhu & Yang 2016). This variable Committee on Banking Supervision which, based on shows the ability of bank managers to make main types of the concentration of funding, allow to sustainable, less uncertain profits on the bank’s determine the risk exposure of Ukrainian Banks. The assets. Especially in countries with highly developed respective indicators are provided in Section 4.
48 Risk Governance & Control: Financial Markets & Institutions / Volume 9, Issue 3, 2019
2.3. Correlation between ownership structure and a higher proportion of total equity. This can be risk profile of a bank explained by the more risk-averse decision making of individual and direct investors who invest their Previous research has approached the issue of the own money compared to managers who re-invest connection between the ownership of the banks and money that others invested in the company they their risk profile in several dimensions (see Figure 1 manage. Schmielewski and Wein (2013) neither in Appendix). confirm nor contradict this insight, finding that First, various authors have analysed how banks private banks seem to be more risk-averse than with a more concentrated ownership structure banks with alternative ownership structures such as perform compared to the banks with dispersed those with dispersed minority shareholders or ownership structure in terms of risky activity. affiliates of commercial banks. Laeven and Giovanni (2008) conclude that banks The fourth approach tends to take into account with more powerful owners tend to take greater the origin of controlling shareholders, by dividing risks. These findings are supported by Martinez & them into resident and foreign owners. Lassoued et Ramírez (2011), who argue that risk is higher in al. (2010) conclude that foreign ownership of banks large banks with concentrated ownership; but in the Middle East and North Africa reduced risk- decreases with the degree of market competition. In taking. Chou and Lin (2011) support this insight, essence, bank risk depends on the party that declaring that Taiwan banks with higher foreign predominantly controls the financial institution’s institutions’ ownership and relatively stricter assets (manager or owners), but the operating scale governance are associated with lower volumes of and the actions taken by other market competitors overdue loans and higher regulatory capital. have also relevant effects. Nicolò and Loukoianova However, their results seem to be significantly (2007) go beyond analyzing the concentration of influenced by the market that is researched, as bank ownership by adding factors of market share Fungáčová and Solanko (2009) contradict the and detecting that the connection between aforementioned observations by proving that concentrated ownership and risk is strongest when Russian foreign-owned banks exhibit higher state-owned banks have sizeable market shares. On insolvency risk than domestic banks. the contrary, Riewsathirathorn et al. (2011) found A couple of studies considered the problem of that more concentrated ownership is associated with bank ownership and risk-taking based on Ukrainian poorer bank performance and lower risk-taking. In data. Rashkovan and Pokidin (2016) also employed particular, a rise in ownership concentration by one the methodology of Kohonen Self-Organising Maps standard deviation lowers the degree of risk-taking (SOM) in order to cluster and identify six distinct by about 10 percent. Lamy (2012) supports these bank business models. The authors also analyzed results by adding that large shareholders have the risk profiles of the banks’ business models and preferences toward lower risk levels. Bouwens and differentiated between safest and riskiest ones. Verriest (2014) reinforce the aforementioned Thus, their study clearly showed that Kohonen maps reasoning by supporting the hypothesis of a can be used in order to analyse banking activity in concentration-risk connection, however admitting Ukraine. However, the authors used data limited to that higher managerial equity incentives decrease a the 4-year-period from 2013 to 2016. In addition, bank’s risk-taking. Chun et al. (2010) partially they did not regard bank ownership structure as an confirm these findings based on the Japanese important variable, but divided banks in terms of banking system. However, at the same time, the their business models. Consequently, our study authors admit that managerial ownership alone does offers further insights by encompassing a longer not affect either the risk or the profit levels of research period as well as important criteria banks. At the same time, Chou and Lin (2011) argue neglected so far. that banks in Taiwan with higher insider ownership Another study by Love and Rachinsky (2015) and higher government ownership have higher presented evidence on the relationship between overdue/nonperforming loan and lower capital ownership, corporate governance and operating adequacy ratios. performance in banks. However, the authors used Secondly, the authors tried to learn whether the financial data from the period of 2003-2006 and banks controlled by the state outperform privately corporate governance data based on a survey owned banks in terms of risk-taking and risk profile. performed by the IMF. It is important to note that Dong et al. (2014) find that banks controlled by the the first recommendations on corporate governance government tend to take more risks than those in Ukraine were issued by the NBU only in 2007 and controlled by private investors. Concentrated before that, there were no unified documents to ownership even increases this difference. At the regulated issues of corporate governance for the same time, Iannotta and Nocera (2013) argue that banks in Ukraine. In addition, the authors did not government-owned banks have lower default risk, consider the issue of risk in their study. but higher operating risk than private banks, Kyj and Isik (2008) analyzed the operational indicating the presence of governmental protection efficiency of commercial banks in Ukraine from that induces higher risk-taking. 1998 to 2003 based on several factors, including the The third dimension of research on the topic origin of capital (foreign/domestic). The authors addresses issues of ownership controlled by concluded that banks with foreign capital tend to families, individuals, or institutional investors. Barry outperform their domestic peers. However, the et al. (2009) state that risk exposure is lower in authors did not take into account the risk profiles of banks where a higher proportion of total stocks is the banks in their study. held by families and individuals, and that the Tsapin (2010) analyzed the role of ownership probability of default of banks is higher when non- impact on the link between bank risk and lending in financial companies and institutional investors hold Ukraine. The author concludes that there is a
49 Risk Governance & Control: Financial Markets & Institutions / Volume 9, Issue 3, 2019
negative impact of ownership concentration on According to Figure 2 (see Appendix), this led interbank loans, which may lead to higher liquidity to increasing volumes of foreign capital invested in risk. However, this study is limited to the period Ukrainian banks until 2009, with the first wave of from 2003 to 2006, too. The author does not analyse foreign investment occurring within the subsequent ownership structure in terms of its type but in terms years because of the consequences of the financial of its concentration and approaches only liquidity crisis. Although the invested volumes increased, the risk. adoption of GATS standards did not attract new Altogether, previous literature provides various players, because those foreign intermediaries who approaches toward the relation between bank wanted to be present in Ukraine, had already ownership structure and risk profile. However, operated in this country by 2008 via buying stakes existing studies that employ banking data from in local banks. Ukraine mostly overlook the issue of bank risk The presence of foreign (first of all European) profile and ownership structure, analyzing the players in the domestic financial market was among operational efficiency and business models instead. the most powerful drivers for its ownership The results of previous studies that do take into structure transformation. Two other groups of account bank risk profile and ownership structure investors (Russian investors and Ukrainian state) cannot be transferred to emerging banking systems increased their presence later (see Figure 2 in like the Ukrainian one without alterations. In Appendix). addition, these studies present contradictory results The crisis has shown the presence of four that are not homogenous and depend on many clusters of Ukrainian banks according to their factors. Consequently, there is a necessity to ownership (see Table 2 in Appendix): perform an empirical study based on the Ukrainian 1. banks with predominant private Ukrainian banking system, as it shows important peculiarities: owners; the presence of state-owned, privately owned, 2. banks with predominant public Ukrainian different in size banks, as well as banks in owners; ownership of non-residents (who in their turn have 3. banks with predominant foreign (non-Russian) to be divided into groups due to their specifics). All owners; this provides a unique opportunity to draw valuable 4. banks with predominant Russian owners. results for the emerging economy. On 1: The market behavior of the private banks with Ukrainian capital was to supply financial 3. THE OWNERSHIP STRUCTURE OF UKRAINIAN resources to all solvent clients of different origins, BANKS: EVOLUTIONARY ASPECTS AND primarily enterprises of the real economy. The level PERSPECTIVES of transparency before the crisis was very low due to the weak regulation. Thus, many banks with private
domestic capital in Ukraine performed as treasury The Ukrainian banking system played an important units of big corporate groups (Kirchner et al., 2011). role in economic development and overcoming the On 2: The state banking sector was initially crisis of public finance in neighbouring Russia in assigned the task to promote economic 1998 through the development of suitable development, including the support of export- mechanisms for resolving the crisis both for banks import activities and guaranteeing deposits of the and for the state. Therefore, Ukraine was able to population. During the 2008-2009 crisis, shares in avoid defaulting on domestic public borrowing in certain commercial banks were purchased by the 1998-1999. Until 2005, the ownership structure of state through direct recapitalization. In order to the Ukrainian banks was rather homogeneous, as a fulfill special tasks, functional banks were vast majority of banks were owned by private established. Oschadbank, Ukreximbank, and domestic investors. While there has been a rapid Ukrgazbank have gradually developed as universal growth of foreign ownership since 2005, USD banking institutions operating in all sectors of the became a primary currency in private banking, Ukrainian economy, issuing large-sized loans to legal leaving about 80 percent of mortgages denominated entities. In 2014 and 2015, operations of the banks in foreign currency and creating serious currency were loss-generating. Non-performing loans exchange risks. constituted a considerable portion in the portfolio of Before Ukraine joined the World Trade these banks (as well as in the whole banking Organization, the activity of foreign banks in system). The Strategy for State Banking Sector Ukraine was heavily regulated in order to protect Development (2018) is based on the assumption that domestic financial institutions from European and state-owned banks will be fully or partially sold to North-American competitors. This protective private investors. regulation happened simultaneously with the rapid On 3: The strategic goal of banks with foreign development of the Baltic countries’ banking (European) capital was lending to households to systems, which quickly showed high levels of allow them for the purchase of imported goods. This ownership concentration and large foreign stimulated public consumption by Ukrainians of ownership (Koivu, 2002). In 2008, Ukraine joined goods manufactured outside Ukraine. Thus, the WTO and accepted GATS standards (including entry of these banks into the domestic market of Article XVI, which obliges member countries to Ukraine was driven by expected future incomes due reduce barriers to entry and operations so that firms to high-interest margins compared with the entrants’ of any other member-state are treated as local firms home country, as well as initiatives of parent regarding the terms, limitations, and conditions of companies on geographic expansion to strengthen business). Ukraine introduced the necessary their global market position. amendments to the institutional framework with the On 4: Banks with Russian capital attempted Law of Ukraine ‘On Banks and Banking’ in May 2008. lending to companies of the highest
50 Risk Governance & Control: Financial Markets & Institutions / Volume 9, Issue 3, 2019
creditworthiness, facilitating their transition under companies (namely Barclays Plc, Credit Suisse Group the control of Russian capital and strengthening the AG, HSBC Holdings Plc, Lloyds Banking Group, Royal position of the latter in the Ukrainian market. Terms Bank of Scotland Group Plc and Standard Chartered of the banking business in Ukraine are similar to Plc) of Ukrainian banks. During the processes of Russian ones, so the adaptation of the Russian crisis-driven re-regulation, the probability of investors to the Ukrainian business environment was emergency state support for banks was explicitly comparably rapid. reduced, while it was emphasized that the owners Unlike most private foreign banks that used have to bear losses of their financial institution with their parents’ equity for retail loans, domestic- little or no governmental support (IMF, 2012). Thus, owned banks used deposits from individuals for that European banks were increasingly interested in purpose. The support from parent companies was a cleansing their balance sheets from potentially real advantage of banks with foreign capital. There troubled assets. Whereas, their subsidiaries in were 17 banks in Ukraine that demonstrated more Ukraine offered no attractive risk-return-positions to than 25 percent in annual loan portfolio growth for potential buyers. two subsequent years. Twelve of them were banks Currently, the banking market in Ukraine is with foreign capital, which received significant influenced by several factors: financial support from parent companies. Five banks devaluation of the national currency; were represented by Ukrainian investors. the loss of assets in the Crimea and the area of Subsequently, all of them experienced serious anti-terrorist operations (territories occupied liquidity problems. by Russian troops) which encounters a loss of In 2015, Fitch Ratings downgraded the largest more than 15 percent of total assets of banks; state-owned banks Oschadbank and Ukreximbank deteriorating solvency of borrowers, mass significantly. Partially, this downgrade was caused layoffs and the continuation of a series of bank by a significant accumulation of government bonds defaults (for example, during 2014, 33 banks in the asset portfolios of the aforementioned banks. that controlled 13.5 percent of the market Thus, there was a considerable conflict of interest, deposits of the population and 13.9 percent of as the government acts as the issuer of bonds, and banking system assets were officially declared buys these bonds through its own banks to cover insolvent); budgetary gaps. massive withdrawals (outflow of deposit funds The conflict between Russia and Ukraine of the population amounted to USD 10 billion additionally impacted the behaviour of depositors, of deposits denominated in foreign currency who withdrew their deposits in particular from and more than 40 billion in UAH) putting banks with Russian capital, leading them to reduce banks’ liquidity and profitability under stress. their activity in the Ukrainian market and to adjust At the same time, as shown in Figure 3 (see their expansion plans. At the same time, in spite of Appendix), insolvency was not the only reason for the European and US sanctions intended to block the liquidation of banks (Deposit Guarantee Fund of access of Russian parent companies to the Ukraine, 2015). Another was governmental international capital markets, their subsidiary banks intervention: Eight banks were withdrawn from the in Ukraine were supported by additional funds market for money laundering, six banks had through providing their subsidiaries with long-term significant amounts of transactions with related loans and capital injections. parties, and two banks were owned by the persons Due to the financial crisis, most banks with against whom sanctions were imposed by the EU. To foreign capital operating in the market in 2008 built meet the requirements of international lenders for up the necessary reserves against losses connected the next tranche from the IMF, in 2015 the Law of to their toxic assets. At the beginning of 2011, the Ukraine ‘On Amendments to Certain Legislative Acts number of banks with foreign capital began to of Ukraine Regarding Responsibility of Persons decrease due to the gradual decline of the Ukrainian Related to a Bank’ was adopted. However, no economy. criminal proceedings against members of top The political and economic crisis in Ukraine, management or owners of failed banks were which is intertwined with the military operations in initiated, so that the effectiveness of the regulatory Eastern parts of the country, had a severe negative act remained low at first. Figure 3 illustrates the impact on the economy in general, and on economic timeline of governmental sanctioning of bank expectations of foreign owners of Ukrainian banks in behavior during the peak year of 2014. Recently, the particular. Recalculations of loans issued in foreign NBU launched the project ‘Reasons and Results of currency at new exchange rates led to a significant the Big Banking Cleaning’ (available in Ukrainian increase of the share of non-performing loans in the only via badbanks.bank.gov.ua) that represents the total loan portfolio during 2014. At the same time, structure and business models of liquidated banks, the suspension of banking operations in annexed recent timelines for the liquidation/temporary and occupied territories, and the lack of administration process, results of banking cleaning mechanisms for a collection of outstanding loans and punishment of top managers. We did not issued in the Crimea, Donetsk and Lugansk regions include the subsequent events related to the period caused an increase of bad debts, putting bank of research as this information is irrelevant to the performance under even more stress. objectives of this paper. Additionally, the decrease of the country’s Using the new supervisory standards (NBU, credit rating has led to an analogous decrease of 2015d) in the banking system is based on a credit ratings of resident Ukrainian banks, turning proactive approach to management, so permanent Ukrainian subsidiaries of international financial identification and monitoring of risks must take into groups into possibly toxic assets. This led to lower account the variability of banks' business models. credit ratings of affected international parent Activities of the National Bank of Ukraine in this
51 Risk Governance & Control: Financial Markets & Institutions / Volume 9, Issue 3, 2019
direction is aimed at introducing the cluster model, sanctioning of responsibilities of owners and senior according to which supervisory regimes and managers for proven violations of laws. procedures may differ depending on the group to The use of the cluster approach for supervisory which the bank belongs. While the main criterion for purposes is designed to help optimize the workload the mode of supervision still is the size of bank of supervisors; determine the most urgent areas for assets, this criterion seems not informative enough the analysis of bank operations; coordinate of with regard to a bank’s business portfolio and risk supervisory activities of the central bank’s exposure. departments, financial monitoring, and currency With the use of cluster analysis (Figure 4 of the control. Appendix), the central bank groups banks of comparable business models and risk profiles. As 4. DATA AND METHODOLOGY one of the clustering criteria, the NBU chose ownership structure (see Figure 3 of the Appendix). To determine the risk profile of banks in Ukraine, Differentiation of banks of the 3rd and 4th their public statements from 2008 to 2013 were groups for the purposes of supervision will be based taken as the input data set. This period was chosen on an assessment of business models and the nature because in crisis and post-crisis years the behavior of operations. The subsequent three-dimensional of domestic banks has undergone significant scale is used to assess the condition of individual changes highlighted above. Statistical data do not banks: include 2014, as, since this period, the activities of - transparency of the ownership structure – the financial institutions were influenced by resource potential of shareholder determines unpredictable factors (occupation of the Crimean the ability of additional capitalization and Peninsula by Russia, war and subsequent occupation liquidity support to financial institutions and of further territories of Ukraine by Russia). allows to identify the bank’s dependence on Additionally, since 2016 Ukrainian banks are obliged related parties; to prepare their financial statement in accordance - the presence of a business model – a way to with IFRS standards. Before this requirement became generate profit in the banking business by legally active, banks in Ukraine could voluntarily use implementing certain strategies and tactics of IFRS as a basis for accounting/reporting, but very behavior in the market; few banks did so, thus the official data starting at - the riskiness of the business model – Jan 1, 2016, is not comparable with the financial concentration on certain industries or data of previous years (NBU, 2015e). The sample enterprises increase credit and investment included banks that were in the 1st and 2nd group risks and may also indicate money laundering according to the NBU classification by Jan 1, 2014. through lending to the related parties. As it can be seen in Figure 5 (see Appendix), during Table 3 (see Appendix) shows the the entire sample period, banks of these groups characteristics of clusters formed by the method of owned more than 80 percent of total assets of the the regulator. banking system, so the sample can be considered Banks that received their equity investments representative. The inclusion of the additional banks from and conduct business with unrelated parties at (namely groups 3 and 4) in the sample, most of market conditions belong to the ‘market’ cluster. which are ‘pocket’ and have no clearly defined ‘Inactive’ banks do not have a clearly defined strategy or power to influence the market, would business strategy since the vast majority of them distort the results of our analysis. were established before the crisis to be subsequently The Basel Committee on Banking Supervision sold to foreign investors and did not have sufficient (2013) defines three main types of concentration of capital to cover unexpected withdrawals of funding serving also as a basis for determining the customers. This cluster also includes active banks risk exposure of Ukrainian Banks: that conducted a large-scale reduction of units and - by currency (foreign currency assets/total activities in times of volatility in financial markets, assets (Afc/A); liabilities in foreign but today a significant change in the structure of currency/total liabilities (Lfc/L)), their balance sheets is not observed so that the - by the instruments (securities/total assets future behavior of these financial intermediaries is (S/A)), particularly uncertain. - by contractors (loans to banks/total assets The structure of assets and liabilities of (Cb/A); loans to individuals/total assets (Ci/A); ‘captive’ banks is determined only by transactions loans to companies/total assets (Ce/A); bank with their shareholders. These institutions do not debt/total liabilities (Lb/L); individuals' perform widespread financial intermediation but deposits/total liabilities (Li/L); deposits of the were established exclusively to manage the financial companies/total liabilities (Le/L)). flows of certain companies. If this model of the Using Viscovery SOMine software, we develop a concentration of transactions with related parties neural network model. Kohonen maps for each of has not changed for three years, it is likely that the the input parameters for all objects throughout the bank will be sold or liquidated. ‘Risky’ banks show study period were built to facilitate interpretation of significant imbalances of the relation of the equity the test. Grytsenko (2012) proposed this method for to their (often heavily concentrated, in other words the analysis of insurance companies. This approach non-diversified) total assets (NBU, 2013). The last allows maximizing the comparability of data. As an cluster is formed by ‘criminal’ banks that performed output of Viscovery SOMine, we get Kohonen map money laundering. The only scenario the NBU sees images, which in this case consist of 10 clusters for such banks is liquidation by law enforcement (patterns) characterized by certain features, which agencies, combined with identification and have to be studied by detailed maps for each indicator. According to the methodology proposed
52 Risk Governance & Control: Financial Markets & Institutions / Volume 9, Issue 3, 2019
by (Zarutska, 2009), the formation of cards was x(t) - the entrance to the t-th iteration. made on every date of the sample. However, with Vector x (t) is chosen from the sample on the t- this approach, the cluster limits do not match, so th iteration randomly. The radius of training h (t) is wi the process of determining the risk profile of the a non-growing function of time (iteration) and bank or group of banks is complicated and increases describes the distance between neuron- ‘winner’ and the likelihood of a false interpretation of the data. neighboring neurons in the network. On the initial But this does not diminish the results received in the stage of mapping, the radius of training is big study, because the usage of Kohonen maps in the enough and decreases proportionally to the aforementioned research was justified by the needs reduction of the response of neurons belonging to it of the banking supervision system, where the use of on the input signal. reactive approaches is justified by the use of At the same time, the function of speed additional tools. training can be described as: The next stage is the construction of a neural network and its training by sorting items and 퐴 푎(푡) = (5) transfers them to the card (the output layer). One of (푡 + 퐵) the neurons is called ‘winner’ if the weight of its relations is the closest to the input image from the where A, B – are constants satisfying the perspective of Euclidean distance. It should be noted condition (0