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A Review and Assessment of the Ukrainian Financial Sector

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A Review and Assessment of the Ukrainian Financial Sector FINREP A Review and Assessment of the Ukrainian Financial Sector 2010 June 2010 A Review and Assessment of the Ukrainian Financial Sector June 2010 This document is made possible by the support of the American People through the United States Agency for International Development (USAID) under the terms of the Financial Sector Development Project (FINREP, Contract # EEM-I-03-07-00007-00). USAID/FINREP is implemented by a consortium led by Booz Allen Hamilton. Consortium members include Bankworld, Inc., Cardno Emerging Markets, and Financial Markets International, Inc. The contents of this document are the sole responsibility of its authors and do not necessarily reflect the views of USAID or the United States Government. FINREP Financial Sector Development Project U.S. Agency for International Development 7/9 Yaroslavskyi Lane, 2nd Floor Regional Mission to Ukraine, Moldova, and Belarus Kyiv, Ukraine 04071 19 Nyzhniy Val Street Tel: +38 044 379-1375 Kyiv 04071 Ukraine Fax: +38 044 379-1376 Tel.: +38 (044) 537-4600 www.finrep.kiev.ua Fax: +38 (044) 537-4684 www.ukraine.usaid.gov A Review and Assessment of the Ukrainian Financial Sector June 2010 Foreword Although much has already been written about the macroeconomic and financial economy of Ukraine, fast changing events demand frequent reexamination and appraisal of key economic policy issues and institutional arrangements. This is particularly true in a country in which change has been profound and rapid. With this thought in mind, a team comprised of George Gregorash, William Osterberg, and Ruslan Viksich from the Financial Sector Development Project (FINREP), funded by the U.S. Agency for International Development (USAID), produced the following report. Although the authors begin with broad, if familiar, topics such as monetary and exchange rate policy, the ultimate focus of the report is on the more prosaic, but critical, functioning of the financial markets and the financial intermediaries that serve as the “arteries” of finance, and ultimately as conduits of economic growth. This report serves as a helpful primer and an updated base document for various advisors, academics, and observers of the Ukrainian economic system who wish to join the debate. Fundamentally, the document highlights the common purpose and unifying rationale for FINREP’s work on the seemingly disparate topics of residential mortgage modification, deposit insurance development, banker training, consumer financial literacy, and government debt market evolution. The report will be updated periodically to reflect changes in the situation in the financial sector. The authors welcome comments from counterparts. A Review and Assessment of the Ukrainian Financial Sector June 2010 Executive Summary 1. Despite encountering a severe blow to the financial account and negative shocks to prices of critical export commodities, the Ukrainian banking system has performed considerably better than many people had expected. Although its performance might be attributed in part to support from official sources, the authors suggest that it also reflects positively on the structure of the banking system. In particular, a relatively large number of sufficiently large and efficient banks exist. There also is substantial diversification of ownership—private and public, domestic and foreign—that might imply that the impact of the stress was dispersed widely. This strength of diversity has policy ramifications in numerous areas, including “too big to fail” calculations. 2. The Ukrainian economy is heavily dollarized with a high percentage of banking assets and liabilities denominated in foreign currencies, which has had obvious and negative consequences during the crisis. However, other than imposing a wider range of policies restricting currency movements, the central bank has not articulated a view on the way in which it takes account of dollarization in its policy deliberations. If there were a longer list of instruments available to the private sector for managing foreign exchange risk, the transition to a non-dollarized economy probably would be easier. However, the central bank has generally been opposed to such instruments. 3. The banking sector continues to be plagued by high levels of mistrust, which contributed to runs on banks in 2008 and to which the central bank responded initially with moratoriums that were not supported by existing legislation. Even if international donors come through once again with support, restoring the trust of depositors is a sounder strategy with long-run benefits. Authorities need to acknowledge this problem and commit to a series of consistent policies to address it. Depositors’ fear of funds loss or deferred access to accounts, triggering contagion risk, can be more effectively limited by (1) the presence of a reliable, predetermined deposit guarantee scheme that provides immediate availability of depositor funds, and (2) effective and timely central bank communication with the public. A more responsive interest rate policy can mitigate depositor fear of reductions in the real value of deposits. Although statements that support a move toward inflation targeting have been made, little has occurred in the way of supportive changes in operations. 4. Developing a broader array of domestic currency denominated investment instruments can play a crucial role in limiting dollarization and reducing foreign currency denominated lending and its attendant risks. Currently, it is not much of an exaggeration to say that Ukrainians are limited to cash, deposits, and real estate. Although initiatives are under way to more greatly develop a domestic market for government securities, for example, these efforts should be intensified. A worthwhile goal would be for government securities to be viewed as an integral part of bank asset and liquidity management and ultimately as a safe savings vehicle for households. 5. The National Bank of Ukraine (NBU) has moved aggressively with a wide array of regulations to combat adverse movements in currency flows and the exchange rate. Although the overall matrix of policies—which includes support from international financial institutions (IFI) and foreign parent banks—appears to have succeeded in stabilizing the economy, the regulatory apparatus confronting financial institutions is overly complex and inefficient. Authorities should begin reducing reliance on these mechanisms. A Review and Assessment of the Ukrainian Financial Sector June 2010 Contents I. Macroeconomic and Financial Overview .......................................................................... 1 A. Impact of the 2008 Crisis on Ukraine .................................................................................. 1 B. 2009 Through Early 2010..................................................................................................... 3 C. Impact on the Banking Sector .............................................................................................. 4 D. Policy Response ................................................................................................................... 6 1. Monetary Policy, Liquidity Support, and Foreign Exchange............................................ 6 2. Official Support for the Banking Sector............................................................................ 8 E. Current Status With IMF.................................................................................................... 10 II. Financial Sector Overview ................................................................................................ 11 A. Non-Banking Financial Institutions (NBFI)....................................................................... 11 B. Insurance ............................................................................................................................ 12 C. Overview of the Ukrainian Banking Sector ....................................................................... 13 D. Monetary Policy ................................................................................................................. 14 1. Legal Status and Goals of the Central Bank.................................................................... 14 2. Instruments and Operations............................................................................................. 16 3. FX Operations and Currency Controls............................................................................ 17 E. Supervision and Regulation of the Financial Sector .......................................................... 18 1. Banking Supervision ....................................................................................................... 18 2. Temporary Administration, Liquidation, and Rehabilitation.......................................... 20 3. Reporting Requirements.................................................................................................. 22 4. Deposit Insurance............................................................................................................ 23 5. Capital Adequacy ............................................................................................................ 23 F. The Government Securities Market ................................................................................... 24 1. Importance for Financial System Development.............................................................. 24 2. The Role of the NBU in the Market for Government Securities (OVDPs)....................
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