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)...... 26 III. Enabling Environment ...... 27 A. Perceptions of the Investment Environment in Ukraine ...... 27 B. Corruption ...... 28 C. Corporate Governance...... 29 D. Transparency ...... 29 E. Being a Bank in Ukraine ...... 29 IV. Performance of the Banking Sector ...... 30 A. Concentration, Diversity, and Resilience...... 30 B. The Four Categories of Banks...... 31 C. Loans and Deposits ...... 32 D. Foreign Banks Versus Domestic Banks ...... 33 E. Earnings and Profitability...... 34 Appendix A: A History of the Ukrainian Banking System ...... A-1 Appendix B: Basel Core Principles for Effective Banking Supervision ...... B-1 Appendix C: I. Banks in Temporary Administration and/or Liquidated and II. Supplemental Information on Banks That Have Been in Temporary Administration in the Banks of Ukraine (as of March 26, 2010)...... C-1 Appendix D: References ...... D-1 A Review and Assessment of the Ukrainian Financial Sector June 2010

List of Tables

Table 1: Percentage of Growth Rates of M3 and Components (Not Annualized) ...... 7 Table 2: Banking and Non-Banking Institutions ...... 12 Table 3: NBU Classification of Loans...... 23 Table 4: NBU Loans Classified by Risk Degree ...... 24 Table 5: Licensed Banks by Type of Ownership...... 30 Table 6: Monthly Financial Results, All Banks, June 2009 to February 2010...... 34 Table B-1: Banks With Foreign Ownership ...... B-2 Table C-1: NBU Refinancing of 88 Banks, December 8, 2008...... C-5 Table C-2: Financial Soundness Indicators ...... C-22 Table C-3: Asset Ratios for the Four Categories of Banks; With T-Tests ...... C-24 Table C-4: Liability Ratios for the Four Categories of Banks; With T-Tests ...... C-25

List of Charts

Chart 1: Financial Account and Components ...... C-7 Chart 2: Short-Term External Debt and FX Reserve Measures ...... C-7 Chart 3: Merchandise Trade Balance: 2007–2009...... C-8 Chart 4: Real GDP (year-over-year) Growth Rate, %, Industrial Production Index (year-over- year) Growth %...... C-8 Chart 5: CPI (year-over-year) Rate %, PPI (year-over-year) Rate, %...... C-9 Chart 6: Industrial Producer Price Index Growth From December of the Previous Year, %..... C-9 Chart 7: Consumer Price Index Growth From December of the Previous Year, % ...... C-9 Chart 8: Growth of the Monetary Aggregate (M0, M1, M2, M3)...... C-10 Chart 9: Total Assets, Total Loans, Total Assets Growth Rate (%)...... C-10 Chart 10: Corporate Loans, Retail Loans, Total Loans Growth Rate (%)...... C-11 Chart 11: Dynamics of OVDP Holders for September 2008–March 2010 ...... C-11 Chart 12: LLP and Total Loans; LLP/Total Loans Ratio ...... C-12 Chart 13: Regulatory Capital to Risk-Weighted Assets, Regulatory Tier 1 Capital to Risk- Weighted Assets, and Capital to Assets...... C-12 Chart 14: Currency Composition of Deposits by Resident Sectors...... C-13 Chart 15: Foreign Currency Denominated Deposits and Domestic Currency Denominated Deposits...... C-13 Chart 16: USD Value of Foreign Currency Deposits of Resident Sectors ...... C-13 A Review and Assessment of the Ukrainian Financial Sector June 2010 Chart 17: Currency Composition of Deposits by Non-Financial Corporations...... C-14 Chart 18: Foreign Currency Denominated Deposits and Domestic Currency Denominated Deposits of NFCs...... C-14 Chart 19: USD Value of USD Deposits of Non-Financial Corporations ...... C-14 Chart 20: Currency Composition of Deposits of Households ...... C-15 Chart 21: Foreign Currency Denominated Deposits and Domestic Currency Denominated Deposits Of Households ...... C-15 Chart 22: USD Value of USD Deposits of Households ...... C-15 Chart 23: Currency Composition of Loans to Resident Sectors...... C-16 Chart 24: Foreign Currency Denominated Loans and Domestic Currency Loans to Resident Sectors...... C-16 Chart 25: USD Value of Foreign Currency C Loans to Resident Sectors...... C-16 Chart 26: Currency Composition of Loans to Non-Financial Corporations...... C-17 Chart 27: Domestic Currency Denominated and Foreign Currency Denominated Loans to Non- Financial Corporations...... C-17 Chart 28: USD Value of USD Loans to Non-Financial Corporations...... C-17 Chart 29: Currency Composition of Loans to Households...... C-18 Chart 30: Foreign Currency Denominated Loans and Domestic Currency Loans to Households ...... C-18 Chart 31: USD Value of USD Loans to Households...... C-18 Chart 32: Loan Rates and Deposit Rates (“Integral Rates”)...... C-19 Chart 33: Domestic Currency Loan Rates and Foreign Currency Loan Rates...... C-19 Chart 34 : Deposit Rate Spreads: Domestic Currency and Foreign Currency...... C-20 Chart 35: Term Deposit Rate Spreads: Domestic Currency and Foreign Currency...... C-20 Chart 36: Term Deposit Rate and Deposit Rate: Domestic Currency and Foreign Currency .. C-21 Chart 37: Performance of Individual Deposit Guarantee Fund in 2009 ...... C-21

List of Boxes

Box 1: Sterilized Intervention Versus Unsterilized Intervention...... 1

A Review and Assessment of the Ukrainian Financial Sector June 2010

I. Macroeconomic and Financial Overview

A. Impact of the 2008 Crisis on Ukraine In mid-2008, the worldwide financial crisis struck Ukraine along with many other emerging market countries. Because asset prices generally reflect expectations of future activity, financial markets reacted swiftly and before markets for goods and other services. For Ukraine, this meant that the exchange rate moved sharply and the value of loans to Ukraine was reassessed, relative to alternative investments.1 Prices of key commodities also moved aversely. Ukrainian access (private and official) to international capital markets was slashed quickly. Between the third quarter and fourth quarters of 2008 (2008Q3–2008Q4), foreign direct investment into Ukraine fell sharply along with net debt inflows.2 Chart 1 shows the dynamics of the financial account. Although exports and imports had been rising steadily since 2006, both fell during the 2008Q4, as did the merchandise trade balance (see Chart 2). The sharp deterioration in the financial account implied a decrease in the supply of foreign exchange and hence pressure against the UAH. From October 2008 to December 2008, the value of the UAH against the U.S. dollar fell by more than 50 percent, despite heavy intervention (purchases of the domestic currency with foreign exchange) by the National Bank of Ukraine (NBU). See Box 1. The NBU’s policies in support of the exchange rate ultimately included measures such as deposit withdrawal moratoriums and restrictions on foreign currency lending. Box 1: Sterilized Intervention versus Unsterilized Intervention

The dilemma that NBU faced was similar to that which other central banks in comparable countries had faced, even if the reasons for this global crisis differed from those in our recent past. The sale of domestic currency assets by foreigners or a decision to invest less in the country brings downward pressure on the international value of the currency. This issue can be defended by either increases in short-term interest rates or purchases of the domestic currency (sales from the stock of foreign exchange reserves). The former leads to an increase in the cost of funding for domestic banks, which leads to a decline in lending and a decreased quantity of desired borrowing and spending. On the other hand, the purchase of the domestic currency decreases the amount of currency circulating, which also exerts downward on spending and other economic activities. The impact of sales of dollars (purchases of hryvnia [UAH]) on the domestic money supply, however, could in principle have been neutralized (“sterilized”) by the purchase of an offsetting amount of government debt. Such sterilized intervention would leave the monetary base unchanged but would logically lower the interest rate on government debt, and further stimulate capital outflows.1 Thus, the ability of central banks to defend a fixed exchange rate depends not only on their stock of foreign exchange reserves but also on the ability of the domestic economy to withstand interest rate increases. Currency speculation might have been fueled by knowledge of the special vulnerabilities of the Ukrainian economy.

1 The nature of the global financial crisis and its relevance for emerging market economies is discussed in detail in Global Financial Stability Report, IMF, April 2009. 2 Specifically, the ability of Ukrainian borrowers fell, and the gap between foreign debt repayment and the sale of Ukrainian debt to foreigners rose (e.g., “rollover rate” on foreign debt fell).

1 A Review and Assessment of the Ukrainian Financial Sector June 2010 Relative to other countries (e.g., Latvia, Lithuania, Estonia, and Russia), Ukraine was hit hard by the crisis. Real gross domestic product (GDP) growth fell from 7.9 percent in 2007 to 2.1 percent in 2008 (despite rising in 2008H1), whereas consumer price inflation grew from 16.6 to 22.3 percent. One factor behind the large drop in GDP growth was heavy reliance on exports and on export products with high price volatility. Exports in 2008 accounted for roughly 50 percent of Ukrainian GDP, and about 60 percent of exports were metals, minerals, and chemicals.3 Beginning in August 2008, world commodity prices fell dramatically. The world steel index, after having risen roughly 40 percent during the first half of 2008, was below January levels by the end of December. A second factor was the relatively high proportion of imports by energy, also exposing the Ukrainian economy to commodity price cycles. In this case, lack of diversification among energy producers meant that Ukrainian industrial producers had to try to absorb increases in energy prices, putting them under competitive pressure and reducing foreign sales. From 2006 to 2007, real goods imports increased 30 percent annually, significantly above the growth rate of real goods exports. Not coincidently, during this period the current account deficit increased from 1.5 percent of GDP to 3.7 percent and then 7.2 percent in 2008. Because a current account deficit must be matched by capital inflows, foreign investors would obviously speculate about the Ukraine’s ability to obtain necessary funding, putting pressure on the domestic currency. A third factor behind the drop in GDP growth was that the funding of the current account deficit was heavily reliant on short-term debt. Partly, this was a result of an underdeveloped domestic market for longer term securities and a poorly developed market for government securities in general. As part of a rapid build-up in private foreign debt, the amount of external debt that needed to be paid in less than 1 year has reached roughly in U.S. dollars (USD) 40 billion by mid-2008. With approximately USD 35 billion in foreign exchange reserves, the need to roll over such a large amount of debt in a short time period was bound to put pressure on the UAH. The fourth factor was the condition of the Ukrainian banking system. Although external debt as a percentage of GDP had risen from 50.4 in 2007 to 58.6 in 2007, the growth of banking sector debt had been more rapid than either corporate or public debt. With the decline in GDP in the second half of 2008, the ratio of total external debt to GDP stood at 83.6 percent. The perception that such a ratio was unsustainable must have added to speculative pressure against the UAH. Officially measured non-performing loans as a percentage of total loans also began to grow and reached 14.5 percent in 2008, significantly ahead of peer group countries4 5; however, whether such balance sheet reports had any impact independent of the factors previously mentioned is unclear. As will be discussed in more detail later, the Ukrainian authorities were not in compliance with several international reporting requirements.

3 See “The Impact of the Global Liquidity Crisis on Ukraine and the Road to Recovery,” Dr. Ediberto Segura, SigmaBleyzer, December 2009, p.6. 4 The NBU classification treats “doubtful” and “loss loans” as non-performing. See Table 3 – below. 5 See Global Financial Stability Report, IMF, April 2009.

2 A Review and Assessment of the Ukrainian Financial Sector June 2010 Although such uncertainty is often associated with risk, requiring a higher rate of return, it also sometimes calls for lower asset prices.

B. 2009 Through Early 2010 2009 was a difficult year for Ukrainians. Although consumer price inflation fell to about 12 percent, real wages fell by roughly 9 percent. Although the official unemployment rate was about 2 percent, the International Labor Organization estimates that it was closer to 10 percent. Ukrainians had also become worried about the safety of their savings, which are generally limited to cash, deposits, and real estate. News of the difficulties in rolling over Ukrainian external debt, the decline of the UAH, and the purportedly poor condition of many Ukrainian banks might well have led to a run on the banks, a surge in demand for withdrawals based on fears of insolvency. To make matters worse, official statements about the banking sector might have signaled a lack of confidence and triggered a pre- existing Ukrainian mistrust of banks. Beginning in fall 2008 and intensifying in the first quarter of 2009, many Ukrainians sought to draw down their foreign currency deposits. This further exacerbated the pressure on the domestic currency because to meet such demands, commercial banks would need to draw on their reserves at NBU. As one of many measures taken to support the exchange rate, NBU prohibited early withdrawals of terms deposits from October 2008 through May 2009. Although such a policy might well have reduced the total amount of foreign currency withdrawn, it certainly did not provide a good signal about the health of the banking system.6 A main driver of real economic activity, exports fell sharply in 2009, fueling a drop of 15.0 percent in GDP. Steel and chemical exports fell almost 50 percent in real terms. Over the year starting mid-2008, world carbon steel prices fell about 50 percent, making clear the cost of poor export diversification; however, imports fell even more rapidly as a result of currency depreciation, declining real incomes, and an inability of importers to obtain funding. Not surprisingly, the fiscal year 2009 worsened as “consolidated” government revenues fell by roughly 8 percent. Expenditures hardly changed. On the revenue side, import duties, profit tax, and value added tax (VAT) were hit hardest, although excise taxes on tobacco and alcohol were introduced along with a temporary markup on import duties.7 Although authorities significantly cut expenditures relative to the plan (particularly, capital expenditures), social spending was maintained in the face of the upcoming election in early 2010. Four special factors must be considered in assessing the overall or “true” consolidated budget performance:

6 Technically, this actual was illegal. Eventually, legislation made such moratoriums legal under certain conditions. 7 Advanced collection of taxes and accumulation of VAT arrears were among the methods used to mask the extent of revenue decline. See ‘Ukraine Macroeconomic Situation,” Sigma Bleyzer, February 2010.

3 A Review and Assessment of the Ukrainian Financial Sector June 2010 The deficit of the Pension Fund, which legally must be covered by state budget funds, was budgeted to be roughly 1.5 percent of GDP.8 However, the actual deficit appears to have been higher, and funds were received from a “Treasury Account,” amounting to almost 2 percent of GDP. The poor condition of the state-owned Naftogaz required a loan from the Treasury of roughly 2 percent of 2009 GDP.9 The mechanism through which this loan was made is unclear and is a cause of concern to bankers. Government expenditures in support of insolvent or illiquid banks, although of uncertain magnitude from the perspective of outside observers, are measured at 2 percent of GDP. Support from the International Monetary Fund (IMF) in the form of a Special Drawing Rights (SDR) allocation was counted as revenue in late 2009 and amounted to another 1.7 percent of GDP. Taking into account all these factors, the “overall budget deficit” is seen to be 11 percent of GDP, compared with the official 2.3 percent. The linkage between the fiscal situation and the external account became a focal point during 2009. In dollar terms, the total amount of state debt (external + internal + guaranteed) increased from 24.6 billion in December 2008 to 37.7 billion 1 year later. As a percentage of GDP, public debt reached 33 percent, which is not high relative to other similar countries. However, as of mid-March 2010, it is unclear when external funding would return to significant levels. During 2008, the Financial Account had registered a surplus of $9.6 billion; for 2009, the number was minus $11.8 billion. Foreign direct investment (FDI) was cut by more than half, and net foreign debt borrowing was minus $9 billion. The net position with respect to cash foreign exchange deteriorated. Although external debt markets have remained closed to Ukraine, it appears that support was provided to corporate groups from offshore resources, and the exchange rate has stabilized. As of early April 2010, some preliminary indications from financial markets are signaling that private financial flows into Ukraine are likely to resume in the short term. There also are positive indications of improvement in the health of the real economy: based on preliminary data, industrial production grew by 11.8 percent year-over-year in January, exports of goods grew by 23.5 percent, and the current account showed a small surplus with a narrowing of the financial deficit.

C. Impact on the Banking Sector As of the end of 2009, 182 banks were operating in Ukraine, only two less than 1 year prior, despite significant deposit withdrawals and mounting non-performing loans (NPL). Neither the number of banks with foreign capital nor the share of foreign owned banks in total banking assets changed significantly. Thus, contrary to expectations, the financial

8 Assessing the financial condition of the Pension Fund would quite possibly imply huge implicit guarantees. 9 The holdings of OVDP by Naftogaz fall into the “other” category in Ministry of Finance data for the structure of OVDP by holder type. See Renaissance Capital, “Ukraine: Default-defiance, Ukrainian style,” December 2009.

4 A Review and Assessment of the Ukrainian Financial Sector June 2010 crisis has neither consolidated the banking sector nor led to major inroads by foreign banks.10 The only significant shift within the banking sector has been the strong expansion of state influence in banking: the state-owned banks lent actively, and several large banks were nationalized.11 The market share of state-owned banks jumped from 11 percent to 17 percent. After dropping in the first quarter of 2009, total banking system assets (domestic currency book value) have recovered somewhat and stand well above 2008Q3 levels. The top 10 banks, mid-sized foreign banks, small foreign banks, and “problem banks” experienced declines in assets.12 The remaining “domestic banks” experienced modest increases in total assets. At the end of 2009, gross loans stand only slightly below the level of 1 year ago. Corporate loans have actually increased with retail loans still declining in 2009Q4. Foreign currency lending, particularly to households, remains high in domestic currency terms, while lending in U.S. dollars has fallen in U.S. dollar terms to households, residents sectors, and nonfinancial corporations. This is in spite of measures introduced by the NBU to restrict foreign currency loans to borrowers without foreign currency revenue, which seemed to have been intended to restrict foreign currency lending to households.13 Domestic currency lending numbers are distorted by strong domestic currency lending at the state bank Oschadbank, whose corporate lending was bolstered by directed lending to Naftogaz. Nonetheless, domestic currency lending also has fallen off significantly. Despite having received significant capital injections from foreign parents, assets fell sharply during 2009 at foreign banks, while increasing modestly at domestic banks, excluding banks in NBU temporary. However, such calculations are affected by the sale of Prominvestbank (currently, the largest Ukrainian bank based on total assets) to a Russian bank, five new domestic banks, and banks entering liquidation. Although there is some doubt about the willingness of foreign parent banks to provide additional capital to their Ukrainian subsidiaries (correct term), attention has been focused on the impending decision of the IMF regarding additional financial support. The asset quality of Ukrainian banks has dropped sharply during the crisis. Economic factors mentioned previously are partly to blame: exposure to cyclical sectors and the huge drop in the exchange rate. However, observers also view the sharp increase in lending during 2008 as not having been supported by adequate risk management. In hindsight, the stress testing performed during 2007 also must be seen as having been deficient.

10 Foreign-owned banks did increase market share in the “personal” deposits segments. However, this statistic might be distorted by the purchase of a domestic bank by the Russian bank. 11 Roughly one-half of Oschadbank’s book concerns lending to Naftogaz, and it might have been required to provide additional credit against receivables. 12 The categorization of banks as either “top 10, small foreign, mid foreign, or problem” comes from Unicredit Group’s UniMonitor. See “Ukrainian Banking System in 2009,” Unicredit Group, March 7, 2010. 13 Since 2008, all such loans would need to be provisioned at 50 percent if they were “standard” or 100 percent for other categories (Fitch Reports, 4 February 2010).

5 A Review and Assessment of the Ukrainian Financial Sector June 2010 Considerable discussion in Ukraine has focused on measuring NPLs and assessing capital adequacy. Arriving at a consensus view that will be viewed as reasonable from the perspective of international financial markets might be an important factor influencing the recovery of the Ukrainian economy. Once such a consensus has been reached, observers can better calculate the amount of private or official capital support that will be needed and then assess the cost. This would logically influence the risk premium demanded, and the prices that would be paid for investments in Ukraine. The level of NPLs that the NBU reported is widely seen as significantly understating the amount that would be reported under international best practices. IMF and Fitch estimates had the percent of loans that were “non-performing” as about 30 percent in mid-2009. These numbers are roughly double the official ones that the NBU published along with other Financial Soundness Indicators. A clear reason for the differences is that NBU guidelines stipulate that only loans in the worst two of the problem loan categories, rather than the worst three, should be included as non-performing,. NBU forbearance also has influenced the reported loan quality data; banks have been permitted to restructure loans without regulatory consequence. In particular, since February 2009, banks were allowed to restructure or extend certain past due loans made before October 2008 without the requirement for reclassification. The usual problems with forbearance must be noted; although such a policy might make it more likely that borrowers would make full payment, it might simply postpone the time when losses hit bank capital and thus make the reported data less informative. Interpreters of data on loan quality also must consider the actions that have been taken in the private sector. According to Fitch, banks have restructured loans without explicit official guidance. This has included extending loan terms, granting holidays on principal repayment, and reducing the size or frequency of front-end loan payments. According to reports, some banks have been able to sell off relatively large problem loan portfolios. However, the size of this latter effect is unclear.

D. Policy Response 1. Monetary Policy, Liquidity Support, and Foreign Exchange As mentioned, the NBU has actively intervened in support of the domestic currency during 2008 and 2009. This was consistent with the stated goal for monetary policy for 2008, although some observers have been confused by the NBU’s sometimes having been on both sides of the market. It is also unclear whether foreign currency interventions were sterilized. Unsterilized purchases of UAH would exert downward pressure on the monetary base. Monetary stimulus, on the other hand, was achieved through the monetization of government bonds issued to state-owned banks as capital support. Table 1 shows the growth in the monetary aggregates M0, M1, M2, and M3. Despite having bumped up against IMF targets for the monetary base at the end of 2008 and in the 2009 H1 (not depicted), tighter monetary policy in 2009 has meant that Ukraine met the IMF target for the monetary base for 2009 as a whole. As would be expected, the general trend of deposit and loan interest rates during 2009 H1 was upward.

6 A Review and Assessment of the Ukrainian Financial Sector June 2010 Table 1: Percentage of Growth Rates of M3 and Components (Not Annualized) 12/06–12/07 12/07–6/08 6/08–12/08 12/08–6/09 6/09–12/09

M0 48.19 49.25 24.06 -1.04 2.53

M1–M0 46.08 42.35 -7.87 4.82 4.01

M2–M1 53.97 56.48 17.21 -15.42 -8.36

M3 51.75 52.73 14.46 -8.33 2.53 Source: National Bank of Ukraine, and FINREP, March 2010. M3–M2 is omitted because of its extremely small magnitude.

NBU Resolution No. 319, issued October 11, 2008, provided a wide range of liquidity support: Early withdrawals of term deposits were prohibited. The NBU agreed to provide credit facilities (“refinancing”) to banks with maturities up to 1 year with at least a 15-percent fixed interest rate level, for up to 60 percent of the banks’ regulatory capital, but not exceeding 90 percent of the collateral value. Fitch indicates that the acceptable collateral was at the NBU’s discretion and that the size limit was removed in 2009Q2. The 20-percent reserve requirement on short-term foreign loans with maturity up to 183 days and attracted by Ukrainian banks was suspended. NBU Resolution No. 319 also provided more explicit support for the exchange rate: The exchange of foreign currencies was limited to those within the same group under the NBU classification system. The maximum deviation between the purchase and sale price was limited to 5 percent.14 The Ukrainian banks should not honor claims of counterparties under “all types of agreements comprising attraction of funds in any currency” for accelerated repayment. “Attraction of funds” may have referred to lenders and bondholders, as well as depositors. In any case, in response to controversy over this aspect of the regulation, it was revised by NBU Resolution No. 328 on October 16.15 Although the purpose of many recent NBU resolutions appears to be support for the currency, there are other impacts. For example, NBU Resolution No. 217, issued July 28, 2008, includes the following, which might be seen as support for the exchange rate or the banking system, or both:

14 However, NBU Resolution No. 353 of November 5, 2008, stipulated that as of that date, the difference was limited to 3 percent. NBU Resolution No. 356 of November 7, 2008, changed the maximum difference to 1.5 percent as of November 8. NBU Resolution No. 408 of December 1, 2008, cancelled these requirements. 15 See “On Cancellation of certain restrictions set forth by the Resolution of the National Bank of Ukraine No. 319 dated October 11, 2008,” Kyiv Banking and Finance Department, Gide Loyrette Nouel, Kiev, October 17, 2008.

7 A Review and Assessment of the Ukrainian Financial Sector June 2010 Disbursements of loans to foreign contractors without crediting the loan proceeds to the accounts of Ukrainian borrowers, was disallowed. The aggregate amount of payments for use of a loan disbursed in tranches under a general credit facility agreement was restricted based on the maximum interest rate for a comparable foreign loan. Following the huge drop in lending volume into Ukraine, NBU Resolution No. 294 was adopted on September 25, 2008, effective October 27, 2008. This resolution abolished the existing maximum interest rates on fixed rate foreign currency loans; up to 1 year in maturity—up to 9.8 percent; 1 to 3 years—up to 10 %; more than 3 years—up to 11 percent; floating rate loans—up to 3-month London Interbank Offered Rate (LIBOR), plus 750 basis points. Instead, loans for up to 1 year were limited to 11 percent.16 About 1 year later, NBU Resolution No. 614 of October 15, 2009, cancelled Resolution No. 294 and reintroduced the caps originally established in 2004. The banking community claimed at the time that the old ceilings being restored did not accurately reflect the market, and it was too early for such a move. In April 2008, the NBU eliminated its already low reserve requirements on both demand deposits and time deposits denominated in the domestic currency. Then, in May 2009, reserve requirements on deposits denominated in foreign currencies were increased. Unless banks are voluntarily holding significant excess reserves, lowering requirements frees up cash, improving liquidity. Alternatively, unless interest is paid on reserves, banks could choose to offer higher deposit interest rates to attract funding. In the case of increases in the requirements on foreign currency deposits, the policy might have been intended to lower interest rates offered on such deposits and to thus reduce dollarization. NBU Resolutions No. 414 (July 21) and No. 514 (August 31) appear to be consistent with the view that during this time frame the NBU was fighting dollarization. Number 414 required banks to keep 40 percent of obligatory reserves in a separate nostro account.17 Number 514, effective September 10, increased the percentage to 50. Note that this is not the same as increasing “reserve requirements”; rather, it implies that existing reserve requirements were split onto two accounts. Nostro accounts may have accrued interest, which would have the practical effect of making it easier for banks to lower interest rates on loans. Under normal circumstances, reserves are non-interest bearing; consequently, they are viewed as a tax that the borrower must pay with higher interest rates. 2. Official Support for the Banking Sector

16 Interest rate caps for loans with maturities exceeding 1 year were simply not “set forth.” See “Brief review of recent changes in Ukrainian legislation related to Foreign Borrowings by Residents,” Kyiv Banking and Finance Department, Gide Loyrette Nouel, Kiev, October 6, 2008. This resolution changed NBU Resolution No. 363 of August 3, 2004, which was effective September 3, 2004. 17 The general procedure for determining bank reserves is described by NBU Regulation No. 91.

8 A Review and Assessment of the Ukrainian Financial Sector June 2010 NBU Resolution No. 319 of October 11, 2008, also provided support other than directly through liquidity: Assets at banks were capped at their October 13 level (as were their lending operations) level (although this repealed with Resolution No. 328 on October 16). Banks were required to limit their loans to borrowers who did not generate foreign currency revenue to the amount of indebtedness under such loans existing as of October 13, 2008. However, other loans (i.e., in domestic currency) are permitted if the bank has sufficient funds to service these loans.18 As mentioned above, the NBU has practiced forbearance regarding the regulatory classification of problem loans. Fitch lists other measures that the NBU has taken to support regulatory capital: Inclusion of pre-paid (but not yet registered) equity injections. Suspension of capital deductions for certain breaches of prudential limits if caused by the impact of the depreciation on foreign currency loans. More frequent revaluation of foreign currency subordinated debt. Relaxation of the limit on the inclusion of subordinated debt. The NBU also has implemented procedures for moving banks into temporary (provisional) administration or straight into liquidation. Appendix C contains a list of banks that have entered temporary administration and liquidation and discusses details of these policies and procedures. Overall, the government’s efforts in handling the crisis have been viewed favorably. However, NBU Resolution No. 47 of February 4, 2010, raised serious enough concerns that the IMF and The World Bank jointly wrote to the Governor of the NBU, asking that the registration of the resolution be delayed. A major concern is that the resolution explicitly introduces a “stimulus loan” that is granted to “resume lending to the national commodity producers that are important for Ukraine economy achieving the pre-crisis parameters.”19 Note that confusion between developmental lending and lender-of last resort function already existed, but the difference between the two has been clarified to some extent. The NBU has also injected capital into the following: State-owned banks: Oschadbank (UAH 12.8 ban) and Ukreximbank UAH 6.3 ban Based on a decree of June 10, 2009, three non-state banks were capitalized in July 2009: Rodovid (UAH 2.8 ban in July 2009 and UAH 5.6 ban in November 2009); Bank Kyiv (UAH 3.57 ban); and Ukrgazbank (UAH 3.1 ban).

18 See “NBU Amends Its Resolution No. 319,” Banking and Finance Legal Alert, Baker & McKenzie, Kyiv, October 2008. 19 See “On Approval of Provisions on Refinancing and Granting Loans by the NBU to Banks of Ukraine in Order to Promote Lending to the Ukraine Economy Until Achieving the Pre-Crises Parameters,” NBU Resolution No. 47, February 4, 2010, informal translation.

9 A Review and Assessment of the Ukrainian Financial Sector June 2010 According to one report, about two-thirds of government securities provided for bank recapitalization was sold to the NBU and monetized.20

E. Current Status With IMF The reversal of negative economic performance and reduction of stresses on the financial system is dependent on resumption of economic growth and near-term resumption of IMF lending. The IMF in autumn 2008 agreed to disburse about $17 billion to Ukraine. Ukraine received three tranches worth almost $11 billion. The allocation of the fourth tranche, worth $3.8 billion, was scheduled for November 2009 but was withheld as social spending increases were passed into law. As of late May 2010, the IMF announced that it had yet to fix a date for starting its mission in Kyiv, which observers take as confirmation that it does not agree with the declared budget parameters. Apparently, the IMF suspects a hidden budget deficit larger than declared, which may imperil lending frozen last year over similar concerns. Ukraine’s government already took meaningful steps to reduce the budget deficit when it negotiated a 30-percent reduction in the price that Ukraine paid for imported Russian gas, in exchange for a 25-year extension of the lease for the Russian Black Sea fleet naval base in Sevastopol, due to expire in 2017. The controversial agreement was signed in Kharkiv by President Viktor Yanukovych and Russian President Dmitry Medvedev on April 21, 2010, and ratified on the same day as the budget was passed, on April 27. The government is hoping to secure a $19 billion lending program from the IMF. The government has penciled in roughly $2 billion of IMF money to fund the deficit. An IMF agreement would serve as a clean bill of health for markets and for other international financial institutions, making other borrowing such as a planned $1.3 billion Eurobond cheaper. The government designed the budget to comply with the IMF’s requirement for a maximum deficit of 6 percent of gross domestic product. But the government did so by avoiding any social spending cuts that could undermine the government’s populist rhetoric. The official budget deficit in the budget law passed by parliament April 27 is 5.3 percent of GDP. But skeptics argued that the government’s revenue forecasts were over-optimistic and spending forecasts understated. The main areas of contention are the government’s plan to issue bonds to compensate business owners who have not received VAT refunds, which the IMF sees as indirect budget deficit and the refusal to raise gas tariffs for households. Analysts see the real consolidated budget deficit, including bank recapitalization, at closer to 10 percent. This includes 5.3-percent primary revenue deficit, 3 percent for gas distribution monopoly Naftogaz, if there is no increase in utility tariffs, 1.5 percent for the pension fund deficit, and 2.8 percent for bank recapitalization.

20 See Renaissance Capital, “Ukraine: Default-defiance, Ukrainian style,” p. 12.

10 A Review and Assessment of the Ukrainian Financial Sector June 2010 On the revenue side, analysts are skeptical about the government’s targets. The budget is based heavily on a surge in revenues (19 percent on the year) on the back of higher tax collections (36 percent on the year) to finance inflated social expenditures and rising public sector wages. However, for the first 4 months of 2010, tax revenue growth on the year reached only 10 percent instead of the forecast 40 percent, taking into account the practice in 2009 of not refunding VAT. For the government forecasts for VAT revenue to come true, imports would need to increase by 40 percent, instead of the 25 percent that is likely, leaving 11 percent of the predicted VAT revenues unaccounted for. To rectify the situation, the IMF will demand that Ukraine hike utility tariffs to mitigate the Naftogaz deficit and reform the pension system by raising the average pension age, in particular by abolishing privileges such as early pensions for specific groups. The government is likely to resist such demands, which would be deeply unpopular in the short term but crucial over the long term. With export-led economic growth surging in the first quarter to 5 percent on the year, and reaching 8 percent on the year in April, Ukraine’s government has a basis for talks with the IMF regarding budget revenue forecasts. The budget is based on a modest growth forecast of 3.7 percent. The dynamics in April and May indicate that the figures potentially may be achieved. II. Financial Sector Overview

A. Non-Banking Financial Institutions (NBFI) The banking sector is considered to be the financial sector in Ukraine. This situation is detrimental to not only banks but also individual investors. According to a 2006 World Bank report, “the development of the NBFI sector in Ukraine lags far behind that of recent accession countries in Central Europe.”21 Far from ensuring the health of Ukrainian banks, without competition for depositors and investors, banks are less likely to develop a wider range of products. As long as the banking sector is viewed as providing the primary mechanism for channeling savings into investment, banks are more likely to be subjected to various measures of state control and influence to benefit specific sectors.22 Obviously, the situation is detrimental to individual depositors because fewer opportunities exist for investment and retirement income. The development of a sound and diversified NBFI sector will broaden access to finance by enterprises, potentially broaden access to residential housing finance by households, provide a foundation for the successful introduction of private pensions, and provide access by households and enterprises to insurance products.

21 “The Development of Non-bank Financial Institutions in Ukraine: Policy Reform and Action Plan,” World Bank Working Paper No. 81, The World Bank, Washington, DC, 2006. 22 In instances in which state-owned banks have borrowed and hold government debt, they might be asked to simply extend maturities.

11 A Review and Assessment of the Ukrainian Financial Sector June 2010 The non-bank financial sector in Ukraine is growing rapidly, making regulatory reform urgent. The number of joint investment institutions grew from 29 in 2003 to 519 in 2006. Net assets under management were estimated at UAH 14 billion in 2006, 90 of which were venture funds. There were 79 non-state pension funds operating in 2006, with total net assets under management of UAH at 137 million. The number of insurance companies increased to 411, and insurance premiums grew to 2.5 percent of GDP from only 1.3 percent of GDP in 2000. Table 2 lists banking and non-banking institutions. Table 2: Banking and Non-Banking Institutions Insurance Non-State Credit Pawn Banks (Life Pension Leasing Factoring Unions Shops Insurance) Funds Number of 179 23 475 (73) 104 819 312 90 43 Institutions Assets, UAH bn 873.5 37.3 0.55 6.3 0.48 1.9 0.27 Assets as % of 95.7 24 4.09 0.06 0.69 0.05 0.21 0.03 GDP Data for non-banks from “Financial Sector Resolution Framework,” March 11, 2009. Sources: NBU, State Commission for Regulation of Financial Services Market.

Under 2007 legislation, NBFI regulators do not have the power to trace the ultimate controllers of NBFIs or to check criminal, economic, and fiscal records of these entities. Not only does this lack of power make it difficult to keep violators out of the market, but also this deficiency hinders the evaluation of compliance with capital and solvency requirements on a consolidated basis. A 2007 paper by The World Bank and USAID emphasizes key policy initiatives necessary for stimulating the growth of NBFIs. These initiatives include the empowerment of regulators to “trace the ultimate controllers of NBFIs” and carry out background checks on them; taking regulators out of the executive branch; and establishing twinning programs with counterpart agencies. Recommendations also were made to support the development of investment funds by furthering the participation of retail investors and the relicensing of such funds, which would include checking their ultimate controllers.

B. Insurance The regulator for NBFIs is the State Commission for Regulation of Financial Services Markets (SCFM), established by the Law of Ukraine on Financial Services and State Regulation of Financial Markets. By law, insurers must acquire special licenses for performing insurance activity, issued by the SCFM. Despite having made progress since taking on responsibility for insurance supervision in April 2003, the SCFM still lacks financial autonomy and enforcement measures, according to the 2006 study by Noel,

23 Number of banks and assets are based on NBU data for YE2009. 24 Nominal GDP is for 2009 from NBU website.

12 A Review and Assessment of the Ukrainian Financial Sector June 2010 et.al. A Joint Evaluation Report by the European Commission (EC) in 2008 determined that progress had been achieved via adoption of insurance legislation. By law, an insurance company must have minimum capital of EUR 1 million, and a life insurance company must have minimum capital of EUR 1.5 million. Subscriptions to the authorized capital of insurance companies may be made only in cash, except for government securities, which may not exceed 25 percent of authorized capital A 2004 USAID Financial Sector Review determined that most insurance firms were severely undercapitalized, and the sector suffered from low liquidity, low creditworthiness, and issues of solvency and governance. A 2006 report cites low levels of transparency, weak consumer protection, and tax avoidance schemes. Despite the Cabinet of Ministers’ August 2005 promulgation of an Instruction on Approval of the Concept of the Development of the Insurance Market in Ukraine until the Year 2010, the Financial Standards Forum indicates that insufficient information exists to assess the adherence to any of the 28 insurance core principles.

C. Overview of the Ukrainian Banking Sector The modern Ukrainian banking system was initially based on the old soviet system of specialized state-own banks. A large number of privately owned institutions have been added, mostly very small in terms of assets and capital. Only in the mid-2000s did international banking groups begin settling in Ukraine. The legal framework pertinent to banking includes the Law of Ukraine “On Banks and Banking,” dated December 7, 2000; the Law of Ukraine “On the National Bank of Ukraine,” dated May 20, 1999; the Civil Code of Ukraine, dated January 16, 2003; and corporate legislation. To obtain the status of a bank, entities must be registered with the NBU, must obtain a banking license, and must have minimum capital of UAH 75 million at the time of registration. Foreign bank affiliates must have assigned capital of at least EUR 10 million. The Ukrainian banking system is composed of the NBU, commercial banks, and subsidiaries of foreign banks. However, the government owns five commercial banks: (1) Open Joint Stock Company (OJSC) Oshchadbank (100 percent), (2) Public Joint Stock Company (PJSC) Ukreximbank (100 percent), (3) PJSC Rodovid Bank (99.7 percent), (4) PJSC Ukrgazbank (81.58 percent), and (5) PJSC Joint Stock Commercial Bank Kyiv (99.94 percent). With the nationalization of some of these as part of the authorities’ efforts to cope with the crisis, the share of total banking assets that is explicitly in public hands has reached 17 percent. Ukrainian banks are either universal banks or specialized banks. If the latter, a bank can be a savings bank, an investment bank, a mortgage bank, or a settlement bank. Banks are free to determine their specialization and scope of activities. If more than half of a bank’s assets are deposits from individuals, a bank must obtain the status of a specialized savings bank. Savings banks are subject to more conservative prudential requirements regarding solvency and liquidity. In practice, many banks have been classified as savings banks as a

13 A Review and Assessment of the Ukrainian Financial Sector June 2010 result of a large increase in corporate deposits or capital. “Investment bank” is not a clearly defined term. Banks cannot invest more than 60 percent of regulatory capital in equities, and an investment bank cannot attract more than 5 percent of its authorized capital in the form of individual deposits. A “mortgage bank” has more than 50 percent of its assets in mortgages, but there is no limitation on the amount of mortgage investments for a mortgage bank so that such an entity can be very poorly diversified. Mortgage banks and settlement banks also are limited to having no more than 5 percent of authorized capital as individual deposits. There is no publicly available information about the number of investment, mortgage, or savings banks in Ukraine. A November 2006 amendment to the Banking Law authorized foreign banks to operate branch offices in Ukraine and to conduct the same activities as domestic banks as long as they complied with certain regulatory requirements in the Banking Law. Branches of foreign banks must register with the State Registry of Banks and receive a banking license. However, foreign banks have opted instead to purchase control of Ukrainian banks. The extent of foreign ownership is difficult to measure because foreign capital partially controls many banks. The NBU reports that as of March 1, 2010, the share of foreign capital in the statutory capital of Ukrainian banks is 35.2 percent. Using a narrower measure, banks with 100-percent foreign ownership operating in Ukraine accounted for 10.7 percent of total banking system assets at the end of 2009. Penetration of banking services is difficult to measure. One indicator is the number of bank offices and branches. As of October 1, 2009, there were 1,145 bank branches in Ukraine.25 Banks are free to judge whether to treat an office as a stand-alone branch. Because it is common for Ukrainian banks to use “remote sites” without reporting them to the NBU as a branch, the actual number of “bank points of sale” might be larger. In most instances though, such remote sites provide only retail services (e.g., bank cards and money transfers) and operate as “document windows” for more sophisticated transactions.

D. Monetary Policy 1. Legal Status and Goals of the Central Bank The NBU was established in 1991. The principles of organization and activities are determined by the Constitution of Ukraine and the Law of Ukraine, “On the National Bank of Ukraine.” The NBI is a legal entity with separate property. Authorized capital of the NBU is UAH 10 million, and the NBU is responsible for changes in the value of this capital. The main function of the NBU is said to be to ensure the stability of the monetary unit: UAH. To accomplish this effort, the NBU is expected to foster banking stability and price stability. Although formally independent, the NBU pursues “common state policy” regarding movements in the amounts of currency in circulation and credit.

25 Source: NBU official website [http://www.bank.gov.ua/Publication/bank_sup/Results/2009/01102009.htm]

14 A Review and Assessment of the Ukrainian Financial Sector June 2010 The NBU also determines the characteristics of notes and coins, assures the accumulation and custody of gold, currency reserves, and banking metals. It further sets a discount rate and other interest rates, manages commercial bank registration, provides licenses and permits for bank business, and determines lender of last resort policies for commercial banks and other financial institutions. The NBU’s Monetary Policy Fundamentals for 2008 specified that the UAH/USD would be kept between 4.95 and 5.25. To achieve this end, in mid-2008, the NBU began increasing its unsterilized intervention in the foreign exchange market, increasing the supply of UAH in circulation and contributing to higher inflation. Despite the obvious obstacles that arose to keeping the UAH/USD within the bands, the Monetary Policy Fundamentals for 2009, approved in September 2008, announced the continuation of a “managed float” with the rate to be kept at 4.85 plus or minus 5 percent. Speculative capital flows represented successful bets against the policy, and the peg was abandoned. Limited progress has been made toward a consensus view among experts that monetary policy should move away from a fixed exchange rate system and toward inflation targeting. The 2009 Fundamentals specified measures to be taken to enable the transition to such a regime: macro and financial stability, development of domestic capital markets, and development of a new statistical modeling and forecasting apparatus. A bank law amendment is supposed to provide the NBU with a clear mandate to pursue price stability and grant operational independence. In January 2008, a Green Book on Strengthening NBU’s Role in Attaining Price Stability was published, outlining various scenarios and options and solicited input from business and academic communities. However, the need to address dollarization through a sequence of clear policies and operations is growing. According to the Financial Standards Forum’s report on Ukrainian Code of Good Practices on Transparency in Monetary Policy, there is insufficient publicly available information to determine compliance with any of four principles: clarity of roles, responsibilities, and objectives; open process for formulating and reporting monetary policy decisions; public availability of information on monetary policy; and accountability and assurances of integrity by the NBU. This information was based on the 2003 financial sector analysis conducted by the IMF. NBU announcements explaining monetary policy have remained vague and inconsistent, which is particularly true regarding exchange rate stability and inflation. Announcements to continue exchange rate targeting were not followed with interventions when the currency was depreciating. Financial market participants and other informed observers consistently state that, from their perspective, it is unclear whether the NBU is focusing on prices (e.g., exchange rates, consumer prices, export prices) or quantities (e.g., monetary base, other monetary aggregates, total credit). In practice, the NBU uses moral suasion on the issue of interest rates (“prices”) and auctions quantities of various types of securities and certificates. The NBU also has

15 A Review and Assessment of the Ukrainian Financial Sector June 2010 intervened to influence the exchange rate (a “price”) and has shown concern for the availability of quantity to specific sectors.26 The only published yardstick for NBU performance comes in the form of targets given by the IMF for monetary base and net international reserves. Multiple targets for measures of the deficit of the central government also exist. The cash deficit measure is adjusted for 100 percent of the cost of bank recapitalization and any bonds issued for capitalization of Naftogaz. Thus, along with a ceiling on an “underlying cash deficit,” the IMF implies goals for bank recapitalization and Naftogaz. The IMF also has made clear its wish that the NBU limit its interference in the market for foreign exchange. Clearly, foreign currency controls interfere with the discipline implied by the net international reserves target. 2. Instruments and Operations There appear to be no consistent intermediate or operating targets for monetary policy. Such targets are perhaps not important when the NBU is pegging the exchange rate. However, during time periods between statements about the value of a peg, they take on increased importance. In these instances, the only candidate targets would be the discount rate and refinancing rates. However, no transactions have been carried out at the “discount window.” Any signal supplied by the refinancing rate, on the other hand, is muddled by lack of clarity about the refinancing facility. The main monetary policy instrument appears to be the issuance of certificates of deposits (CD) to commercial banks. This is presumably intended to absorb excess liquidity in the system based on either the current level of the monetary base relative to IMF targets or on a judgment about the extent to which excess reserves of the domestic currency might be sold for foreign currency, endangering the exchange rate band. These CDs can be sold on the interbank market and can be used as collateral in interbank lending. The NBU also sets reserve requirements on deposits, differentiating between maturity and currency denomination. Although these rates have not been changed frequently, this instrument was employed during the most recent crisis to support banking liquidity. In its 2003 report, the IMF noted that the NBU was regularly offering three maturities of “refinancing” loans to commercial banks: overnight, up to 14 days, and up to 270 days. However, more recently, Fitch has described the “liquidity regulation” facilities of the NBU as including unsecured overnight lending available once per week, overnight lending available 15 times per month secured by government securities or NBU CDs, “repos” in which collateral is either government securities or precious metals, and loans of 14 or 90 days on an auction basis with collateral defined for each auction. A more recent examination of NBU data shows that the term for “tender on allocation of NBU deposit certificates” varies from 2, 3, 4, 5, 7, 14, and 29 days.

26 On April 2, 2010, the head of the group of advisors to the governor of the NBU announced that not only would the UAH/USD fluctuate during 2010 within the range of 2009 fluctuations but also that it would be better to promote appreciation to 7.80, while referencing the level of the discount rate. [Source: Interfax-Ukraine.]

16 A Review and Assessment of the Ukrainian Financial Sector June 2010 Use of the term “refinancing,” including operations as described above, is bound to lead to confusion. What is more properly referred to as “refinancing” was a support facility mentioned in the 2003 IMF report that initially appears to have been for developmental purposes. More recently, however, “refinancing” has taken the form of “stabilization” lending to banks being rehabilitated. Other than in these instances, refinancing would require that the bank meet conditions regarding capital, solvency, and payment record on previous such loans. Since at least the beginning of 2009, refinancing—at least in the views of many informed observers—seems to have combined developmental needs with the lender of last resort function. One recent analysis of the situation has stated— “There is no sound refinancing system in Ukraine provided by the monetary authorities. The terms of refinancing provided by the NBU are non-transparent and usually negotiated with banks on an individual basis.”27 Relative to the actions of other central banks since 2008, NBU discretionary monetary policy in the form of new lending facilities with broader ranges of collateral and maturity might be unexceptional. However, given historical levels of mistrust within the Ukrainian financial sector broadly, such policy and operational changes continue to undermine the financial sector’s limited trust in the monetary authorities.28 3. FX Operations and Currency Controls Until recently, the NBU has stated its intentions to keep the exchange rate within an announced band. However, observers note that sometimes such announcements were not followed with the implied operations (e.g., selling foreign currency when the domestic currency was depreciating). Note also that a wide range of laws and regulations indirectly influence exchange rates. These laws and regulations include limits on interest rates on foreign currency lending and various other measures that are usually seen as intended to protect the currency from depreciating. Although Article 47 of “On Banks and Banking” states that banks are entitled to carry out foreign currency transactions, it is only with special authorization that they may transact on their own behalf with instruments based on currency exchange rates and interests (i.e., currency or interest rate derivatives) or with financial futures and options. Since January 1, 2008, long- and short-term loans needed to be registered with the NBU. Registration of short-term loans, however, is a relatively simple procedure. The authorized bank notifies the NBU with specialized software, the NBU registers the loan, and then the NBU sends a confirmation to the bank. However, interest rates on such loans are subject to ceilings that the NBU sets as a means to prevent banks from raising funds that will soon leave Ukraine.

27 Renaissance Capital, p. 11. 28 See 2003 IMF report.

17 A Review and Assessment of the Ukrainian Financial Sector June 2010 Currency regulation in Ukraine is governed by a currency decree; “On the System of Currency Regulation and Currency Control” initiated February 19, 1993. Generally, any use of foreign currency in Ukraine, as a means of payment or as an object of pledge, requires an individual license from the NBU. This does not apply to foreign currency transfers conducted in Ukraine by a domestic commercial bank or financial institution already having a license from the NBU for currency transactions. Generally, it also is true that any transfer abroad of foreign currency from Ukraine requires an individual license of the NBU. However, the list of exemptions is lengthy. An individual license is required for repatriation and transfer of UAH funds into Ukraine if in excess of the amounts that have been legally transferred abroad; depositing funds in foreign currency (and also securities) in an account or on deposit outside Ukraine (with exceptions noted for certain banking operations); and investing abroad, which includes transferring foreign currency to acquire assets.29 Receipt of foreign currency by a Ukrainian resident, or even a Ukrainian commercial bank from a non-resident in the form of a loan, must be registered with the NBU.30 Purchases of foreign currency are regulated. If a resident Ukrainian individual’s business or corporation wishes to acquire non-cash foreign currency, he or she must use a licensed Ukrainian commercial bank or a licensed NBFI. Documents supporting the legitimacy of the purchase are required. Permitted transactions include repayment of loans and interest and payments of dividends or other income resulting from the investment. On September 9, 2009, NBU Resolution No. 538 was introduced to amend NBU Resolution No. 502 from 2002. This resolution required that currency exchange transactions exceeding UAH 15,000 must be at the cash desk of financial institutions. Banks also were prohibited from selling foreign exchange in amounts exceeding UAH 79,000 to one person in one day to prevent money laundering. Commissions for certain foreign currency transactions were required to be paid in domestic currency. These requirements can be seen as efforts to protect the international value of the UAH.

E. Supervision and Regulation of the Financial Sector 1. Banking Supervision The legal framework for banking supervision is based mainly on the Law of the National Bank of Ukraine and the Law on Banks and Banking. Both laws have been updated within the last few years. These laws define the general principles of banking activity and give the NBU broad powers to license banks, conduct oversight, determine reporting requirements, supervise, and carry out enforcement actions for violations of banking legislation and regulations to protect the stability of the banking

29 See Cabinet of Ministers Decree No. 15-93 of February 19, 1993, “On the System of Currency Regulation and Currency Control.” Article 5, item 4, defines the list of individual licenses issued by the NBU. 30 See NBU Resolution No. 270 of June 17, 2004, “On Approval of the Procedure of the Obtainment of Foreign Currency Credits and Loans by Residents From Non-residents and the Provision of Foreign Currency Loans by Residents to Non-residents.”

18 A Review and Assessment of the Ukrainian Financial Sector June 2010 sector and the interests of depositors. The NBU staff has the legal protection of civil servants in carrying out their duties, but there has been potential for legal harassment of supervisors noted (IMF2003). Based on recommendations made by the Basel Committee in early 2005, the NBU conducted a self-assessment and described the results in the 2006 Annual Report. According to the NBU, progress had been made with regard to Basel Core Principles (BCP) 10, 15, and 17 (see Basle Core Principles in Appendix B), which were assessed as non-compliant in a study conducted by the IMF in 2002. Compliance with BCPs 4, 10, 19, 20, and 21 was to be enhanced by prospective amendments to the banking laws. The 2006 Annual Report also noted challenges such as training and improving the skills of banking supervision specialists and organizing preparatory work for the introduction of Basel II. In its Annual Report on Banking Supervision in Ukraine in 2007, the NBU reported that a June–July 2007 joint IMF/The World Bank mission assessed performance in Ukraine regarding BCPs for banking supervision under the Financial Sector Assessment Program (FSAP). According to this report, the mission concluded that Ukraine complied either completely or mostly with 25 of the 30 BCPs.31 Progress was said to have been notable in strengthening adherence to principles 6–17 (regarding the legislative and regulatory framework for prudential regulation), improving compliance with principles 7–16, 19, and 20 (regarding communication and the implementation of risk assessment and management), and adhering to principle 18 (regarding money laundering and combating the financing of terrorism).32 Regarding the assessment of foreign exchange (FX) risk, it is unclear whether the most appropriate stress tests were conducted. In a heavily dollarized economy, the best FX stress tests are quite possibly different from those that would be conducted in other circumstances. Consider the following excerpt from the 2007 Annual Report of Banking Supervision, released in early 2008: “Stress testing of the impact of foreign exchange fluctuations upon the banking activities, which presents an opportunity to trace and forecast direct FX risks, should be exercised with the help of a net open position in the foreign currency. At the same time, the National Bank of Ukraine carries out an analysis of data of FX transactions both in the context of banks and the banking system in general and calculates an impact of exchange rate fluctuations (US dollar and Euro) upon the regulatory capital adequacy. As of 01.01.2008, stress-testing results showed that a fluctuation of Exchange rates by 10% may change a volume of the regulatory capital in the banking system by 0.03%. This shows an insignificant impact of the direct FX risk upon the banking system. Impact of exchange rate fluctuations upon the volume of the regulatory capital is insignificant (both when the UAH is revalued and devalued).”

31 BCP Number 1 has six components that might be assessed individually. 32 See NBU, Annual Report on Banking Supervision in Ukraine in 2007, informal translation, FINREP, April 2007.

19 A Review and Assessment of the Ukrainian Financial Sector June 2010 Although the report implies that “the context of banks and the banking system in general” was considered, it seems that too narrow an assessment of FX risk might have been conducted, even if the net open position was nil at the time of the test. A focus exclusively on direct FX risk (translation risk) would explain the apparent misread of the situation. However, the report implies that an impact on the banks and the banking system should have been considered.33 Unfortunately, despite NBU and (indirectly) IMF reports regarding improvements in adherence to BCPs for banking, there is little in the way of publicly available information directly assessing the issue. In fact, according to the Financial Standards Forum, there is “insufficient information” regarding adherence to each of the 25 BCPs for effective banking supervision. 2. Temporary Administration, Liquidation, and Rehabilitation According to an IMF study in September 2009, resolution strategies for the five systemic banks had been finalized, diagnostic studies for the other banks had been completed, and legislative changes to “ensure effective bank resolution” had been prepared. The NBU, as of September 2009, had formed a specific unit to implement an “enhanced monitoring” of several banks whose activities it had restricted and to follow up on promises from shareholders of several banks to inject capital. A small number of banks entered temporary provisional administration (PA) in 2001 and 2002; however, the policies and practices regarding both PA and liquidation of problem banks evolved greatly during 2008. Both mandatory and optional triggers have been established for putting banks into either PA or liquidation. A bank that has entered PA will move into either rehabilitation or liquidation (if the provisional administrator determines rehabilitation is not possible or the NBU decides that the administrator has failed). A bank that has reached rehabilitation will either be recapitalized, merged (if recapitalization is not possible; however, this would be viewed as a failure of the rehabilitative process), or liquidated (if the merger is deemed a failure). The mandatory trigger for PA is if the risk-weighted capital adequacy ratio falls to 7 percent or lower. This and other ratios are evaluated on the 1st, 11th, and 21st of each month. Optional triggers include— Two or more precedents of non-compliance with lawful NBU requirements A decline in regulatory capital of at least 30 percent over the last 6 months Failure to pay off 10 percent or more of due liabilities within 5 working days Bank managers being arrested or declared guilty by court for any wrongdoing Bank hiding accounts, assets, registries, reports, or other documents Bank refusing to provide requested documents to NBU or its representatives Public conflict in bank management Bank soliciting application for introduction of PA

33 The focus of the stress tests on translation risk is clarified in the Ukrainian version of the 2007 Annual Report for Bank Supervision.

20 A Review and Assessment of the Ukrainian Financial Sector June 2010 Bank engaging in highly risky operations that have already led or might lead to losses in assets or earnings Breach of anti-money laundering rules. The NBU thus has a significant amount of discretion in implementing PA. The third optional trigger in the list above is the most common criterion employed to send a bank into PA. Formally, banks are subjected to moratoriums during PA for up to 3 months, although this period can be extended.34 Appendix C provides some details of these extensions. The mandatory trigger for liquidation is failure to settle due liabilities 6 months from a court order, provided no deposit withdrawal moratoriums have been in place. There also are a wide range of optional triggers in this circumstance: Fraudulent licensing requirements Bank being dormant for 1 year Breach of laws causing asset loss of capital depletion, including lack of cash to meet claims; risk-weighted capital asset ratio less than one-third of required; adversely classified assets reaching 60 percent of regulatory capital; loss in current year of 50 percent of authorized capital; loss of at least 10 percent of authorized capital 3 years in a row Issuance of an opinion by PA authorities that it is not feasible to restore bank capital norms to comply with prudential minimums; absence of acceptable proposals from existing shareholders or new investors to restore the bank’s financial condition; impossibility of rehabilitation because shareholders or investors have failed to restore the bank It is infeasible to continue with the merger; NBU refused the reorganization proposals submitted by the PA authorities after review, and there are no other proposals from shareholders or investors to restore the bank’s condition; NBU refused to allow holders of essential participation who applied to the PA authorities with a reorganization proposal to purchase or increase essential participation in a new bank; and termination or early withdrawal and payoff of liabilities of new bank after reorganization would either threaten its solvency or not be possible. Here also the NBU has a significant amount of discretion. Generally, the industry and observers feel the utilizations of PA and liquidation procedures have been conducted well; however, greater transparency would be welcome.35 The best estimate of the cost of PA to the government is the total recapitalization of banks under PA contributed in the form of government bonds sold to the NBU. This total was UAH 17 billion as of early February 2010.36

34 Before August 2009, the period was 6 months. 35 See also NBU Resolution No. 421, dated July 22, 2009, “On Specific Issues of Banks Operation Under the Financial and Economic Crisis.” 36 See “Ukrainian Banking Sector: Looking Beyond the Elections,” Fitch Ratings, February 4, 2010, p.6.

21 A Review and Assessment of the Ukrainian Financial Sector June 2010 NBU Resolution No. 47 of February 4, 2010, mentioned above, explicitly discusses two types of NBU loans: stabilization (or rehabilitation) loans and stimulus loans. Stimulus loans are developmental in nature and inconsistent with the best practices of central banks. Stabilization loans appear intended to support liquidity, but there is no clear distinction made between liquidity support and solvency support. To apply for such a loan, the bank must submit a set of documents, including a financial rehabilitation plan. A bank in this state is not exactly the same thing as a “problem bank” because such plans can be proposed without PA. So, the purpose of stabilization lending vis-à-vis PA is unclear. However, more importantly, there is an apparent breach of firewalls between regulatory and monetary policy functions because all loans made by the NBU (stimulus and stabilization) are in the hands of the department within Bank Supervision that handles provisional administration. 3. Reporting Requirements BCP 21 requires “consistent accounting policies and practices that provide a true and fair value of the financial condition of the bank.” According to an assessment published by the Ukrainian Association of Certified Accountants and Auditors in November 2008, the NBU requires banks to file audited annual financial statements and publish quarterly and annual balance sheets and income statements. Banks are required to maintain accounts and prepare financial statements in accordance with International Financial Reporting Standards (IFRS). According to a 2007 “Doing Business Guide” by PricewaterhouseCoopers, all entities in Ukraine must prepare financial statements in accordance with the National Accounting Standards (NAS), which, in practice, differ from the IFRS, in spite of the fact that the Law on Accounting and Financial Reporting stipulates that the NASs should not contradict the IFRS. However, although the NAS in effect in 2007 provide less interpretative guidance, explanations, and illustrations than do the IFRS, the NBU has developed its own reporting requirements for banks, which in some ways are more comprehensive than reports based strictly on IFRS. At the same time, banks that prepare IFRS-compliant reports are also required to supply these to the NBU. The quarterly balance sheet information on banks supplied by the NBU on its website is based on the Ukrainian standards, not strictly those of the IFRS. Banks must meet mandatory loan provisioning requirements to cover net loan risks and review these requirements each month. There are several exceptions to this requirement, including real estate-backed leasing transactions and subordinated loans.37 As of January 2010, provisioning is determined as indicated in Table 3:

37 See Baker and McKenzie, “Conducting Business in Ukraine,” Baker and McKenzie—CIS Limited, Kiev, May 2009.

22 A Review and Assessment of the Ukrainian Financial Sector June 2010 Table 3: NBU Classification of Loans Calendar days past due Category of debt Provisioning ratio for homogeneous consumer loans UAH In foreign currency 0 “standard” 2% 50% Up to 30 “watch” 10% 100% 31-60 “sub-standard” 40% 100% 61-90 “doubtful” 80% 100% 91 and over “loss” 100% 100%

4. Deposit Insurance Deposit insurance schemes are of possible relevance to a financial sector assessment for several reasons. First, deposit insurance might sometimes prevent bank runs, assuming depositors believe their deposits will be protected. Alternatively, the presence of deposit insurance might be a hazard because depositors might not examine the safety of their bank and bank managers might assume they will not have to bear the consequences of poor investment decisions. Consequently, the reserves of a deposit insurance fund might be inadequate for a significant wave of failures, meaning public monies might need to be used to honor the deposit guarantee. The Individual Deposit Guarantee Fund (IDGF) was established in Ukraine in 1998 and upgraded in 2001. It covers deposits (including any accrued interest) up to UAH 150,000 for a single person (irrespective of the number of accounts) in a domestic bank or branch of foreign bank. All deposits are fully covered directly by the government. Membership is not mandatory and there are two types of membership: full membership in which the fund covers any deposit of any person up to the threshold,38 and temporary membership in which the fund covers only those persons who placed their deposit before the change in membership day and only the balances as of that day (or up to threshold, whichever is lower). Banks pay initial fee of 1 percent of authorized capital and a regular fee of 0.25 percent of outstanding individual deposits as of December 31 and June 30 (this payment is split into four quarterly tranches of 0.25 percent each). The IDGF has no authority to initiate bank liquidation or provisional administration and essentially operates as a “paybox.” According to official statements, the fund paid more than UAH 1 billion to depositors in 2009, although it is not clear how many banks were covered. 5. Capital Adequacy Identifying problem assets has always been an issue for Ukrainian banks. NBU Regulation No. 279, dated July 6, 2000, sets forth five loan classification categories: “standard,” “watch,” “substandard,” “doubtful,” and “loss.” The NBU only included

38 Bank owners, insiders, and external auditors are not covered.

23 A Review and Assessment of the Ukrainian Financial Sector June 2010 “doubtful” and “loss” as “non-performing” for the purposes of IMF Financial Stability Indicators. However, international standards imply that “substandard,” “doubtful,” and “loss” should be counted. Although loan classification is supposed to be based on both character and performance, banks have tended to put loans into problem categories based on arrears, not on borrower character. Specifically, the criteria listed in Chapters 4 and 5 of the NBU’s loan loss provisioning policy reads as shown in Table 4, with loan portfolio classified by risk degree.39 Table 4: NBU Loans Classified by Risk Degree Financial condition of the Debt servicing by the borrower (group) borrower (class) “good” “weak” “unsatisfactory” “A” “standard” “watch” “substandard” “B” “watch” “substandard’ “substandard” “C” “substandard” “substandard” “doubtful” “D” “doubtful” “doubtful” “loss” “E” “doubtful” “loss” “loss”

Asset quality data lag economic and financial developments. This is partly because reliable data is only available at the end of the quarter. If a borrower stops paying today, the loan might classify as a problem loan after 90 days. For reporting purposes, gross loans include accrued, not received, interest. At the same time, accrued interest is part of the capital earnings of the current year. When a borrower becomes past due on a loan, the bank continues to accrue interest, and such interest might be considered current for certain time. This interest distorts the reported loan-to-capital ratio.40 The two Financial Soundness Indicators for NPLs shown in Table 25 show a sharp drop in early 2008 as the NBU changed its measurement of NPL from including the bottom four borrower categories to the bottom three. The NBU has not provided a consistent time series covering the full period, although it has the information to do so. Official NBU data on loan quality is also distorted as a result of official sanctioning of banks’ loan restructuring without regulatory consequence (forbearance). In particular, since February 2009, banks have been allowed to restructure or extend certain past-due loans made before October 2008 without the requirement for reclassification. This forbearance could make it more likely that borrowers would make full payment, or it could delay banks adding to capital.

F. The Government Securities Market 1. Importance for Financial System Development

39 Informal translation by FINREP of NBU Regulation No. 279, effective January 2010. 40 According to NBU Loan Accounting Policy, in Ukrainian banks doubtful accrued interest is provisioned, not reversed. This has same net accounting effect as reversal, but analyses might be distorted.

24 A Review and Assessment of the Ukrainian Financial Sector June 2010 In many countries, a well-developed market for government securities plays a crucial role in liquidity management and efficient pricing for commercial banks. Next to cash, government securities are often the most liquid assets and can be sold easily at close to their true value, which is calculated using agreed-upon formulas for asset prices. However, it is not uncommon for government securities markets in underdeveloped economies to lack these characteristics. A key element in the development of modern fixed-income markets is the repurchase agreement. “Repos” are widely misunderstood, largely because of ignorance about master agreements and accounting treatments.41 The volume of treasury securities trading in advanced economies via repos is far greater than the volume of government securities trading without repos. In a “true” repo, legal title changes hands, as in a “true” or “outright” sale. At the same time, under a proper legal framework such as the Global Master Repurchase Agreement (GMRA), there is a simultaneous agreement to buy back an equivalent (but not necessarily identical) security. The fact that only an equivalent security must be returned in the future allows securities dealers to use the repo structure to sell securities that they do not actually have in inventory, obtaining them instead via a “reverse repo.” Alternatively, the bank can use the repo structure to borrow cash by selling the collateral.42 Often, however, collateralized interbank lending is conducted without the proper legal framework. These transactions are called repos. In a liquid market for government securities, players can easily ascertain the current market value for a given security while only needing to know the cash flow characteristics, the coupons to be received, the date coupons will be received, and the amount and date of principal. However, to be able to value such cash flows, a player needs to be able to identify the best alternative rate of return. Unfortunately, in developing government securities markets, players often wish to know what the market rate of return is at any given point in time before they will engage in repos. Ironically, such a market return can only be discovered if players are willing to initially take on a certain amount of risk. Initially, there might be market risk, counterparty risk, or other risks. However, ultimately the risks associated with buying and selling government securities are the lowest among all of the non-cash asset classes. Where there is a liquid market for government securities, it is easier for banks to meet cash requirements because they can easily sell treasury bills or notes or, more likely, raise cash through a repo. Like the chicken and the egg, once the market for government securities is liquid, it is easy to value the security used in the repo; the

41 A recent proposal in the U.S. Congress to treat the repo security on the books of the security seller as collateral, which would be available to the claimants of a failed bank, was seen as a threat to the underpinning of the U.S. Treasury market and was withdrawn. 42 Under proper accounting treatment, the security sold in the repo stays on the books of the seller, and the seller ultimately receives any coupon paid during the term of the repo. A rationale offered for keeping a security for which title has changed hands on the books of the seller is that by having agreed to buy back an equivalent security in the future, the seller retains economic exposure to changes in the security’s value.

25 A Review and Assessment of the Ukrainian Financial Sector June 2010 government security market becomes more liquid as government securities are the primary securities used in repos. Once a liquid market for government securities is established, the market yields on instruments of varying maturities become the “riskless” rates of return used as the foundation for pricing other asset classes. However, for this to take place, it is also necessary for the government to sell government securities varying by maturity. In practice, perhaps five to maturities need to be auctioned on a regular and fairly reliable schedule.43 Several advances have been made in the development of the market for Ukrainian government securities (OVDPs). Banks have signed the GMRA and conduct repos among each other on this basis. However, this market is limited largely because of mistrust and perhaps also because the GMRA has never been tested in court. There has also been some secondary market trading. However, this trading has not yet been consistent or deep enough for the development of an accepted yield curve to occur. Consequently, the benefits of a well-developed government securities market have not yet been seen in Ukraine despite the fact that the Ukrainian government now issues bonds of maturities up to 5 years and at attractive yields. The lack of benefits might be related to the fact that the UAH is not a convertible currency, so such bonds have substantial currency risk. 2. The Role of the NBU in the Market for Government Securities (OVDPs) A significant influence on the amount of liquidity in the system is the inability of the Ministry of Finance to conduct repos or otherwise earn interest on the cash balance it builds during the year. This balance, as a liability of the NBU, is a source of funds used to back asset purchases. Because no interest is paid on these balances, they supplement NBU profits. A more efficient setup would be for the Ministry of Finance to earn interest on these funds through either repos or other placements in the market. However, the NBU seems opposed such proposals. As clearly depicted in Chart 11, the NBU has ratcheted up its holdings of OVDPs, increasing its holding more than ten-fold between November 2008 and March 2010. During the same period of time, the total outstanding volume of OVDPs held increased more than five-fold. Most OVDPs issued in 2008 Q4 and 2009 were used to recapitalize state-owned banks, recapitalize and take over troubled banks, and recapitalize Naftogaz (UAH 18.4 billion). At the end of 2009, central government external debt-to-GDP ratio was said to be at 14 percent, compared to the median indicator of 33 percent for B-rated countries. 2010 shows a very light external debt servicing schedule, with no sovereign Eurobond redemptions until December. As of the end of 2009, the Ukrainian segment was one of the few fixed-income markets in the world where Eurobond yields were still at significantly higher levels than in the pre-crisis period.

43 The regular and structured issuance of government securities varying by maturity is referred to as “benchmarking.” This and other issues are discussed in World Bank and IMF “Developing Government Securities Markets.”

26 A Review and Assessment of the Ukrainian Financial Sector June 2010 The failure of the Ukrainian railway system to repay its loan on time has stimulated interest in the contingent liabilities of the government. By one estimate, the true magnitude of commercial third-party guarantees was $1.5 billion as of the end of 2009. This estimate took into account that the bulk of outstanding government guarantees as of the first half of 2009 were against the IMF money that went to the NBU. There might also be approximately $1 billion of domestic government liabilities where Oschadbank and Ukreximbank are beneficiaries. Although the public nature of these liabilities was not disclosed, they appeared on the books of the state’s debt in February 2009 and June 2009. They might be related to loans to Naftogaz, where Oschadbank has heavy exposure. Despite prodding by the IMF, the financial position of Naftogaz and hence Oschadbank is opaque. III. Enabling Environment

A. Perceptions of the Investment Environment in Ukraine The overall business and investment climate remains poor in Ukraine, as shown by its ranking of 142 out of 183 countries in The World Bank’s Doing Business Report for 2010. Although this report found that significant improvement had been made in protecting investors, Ukraine’s ranking dropped. The country’s low ranking indicates the strides other countries are making. The International Financial Corporation (IFC) conducted a survey from December 2008 through March 2009 to assess the progress made on 2007 recommendations. One of the major findings was that the implementation of key 2005 and 2007 laws on permits and inspections was limited but, when accomplished, effective. The survey stated that “a burdensome and overly prescriptive regulatory system remains a problem for Ukrainian businesses” (p. 18). Disappointingly, Ukraine’s accession to the World Trade Organization (WTO) appears to not have generated much momentum for reforms. Regulatory frameworks in general have not been harmonized with WTO requirements. A March 2009 Business Index prepared by the Financial Standards Foundation found Ukraine below standard in terms of its composite business index of economic, legal, and political factors. The Heritage Foundation’s 2010 Index of Economic Freedom ranks Ukraine 162 out of 179 countries. A 2008 Background Note on Ukraine by the U.S. Department of State refers to the inconsistent and complex legal framework, inadequate corporate governance, poor contract enforcement, and corruption as huge deterrents for investors. In a 2009 report by the U.S. Department of Commerce, Ukraine was said to impose discriminatory fees, certification requirements, and several other import impediments on imports, including non-transparent standards. However, to accede to the WTO, trade barriers are progressively being removed. In addition, the Law of Ukraine, “On the Regime of Foreign Investment,” adopted on March 19, 1996, includes protection against changes in legislation, protection against nationalization, guarantee for compensation and reimbursement for losses, and guarantee for repatriation of profits.

27 A Review and Assessment of the Ukrainian Financial Sector June 2010 Despite all of these concerns, it must be noted that investors are finding opportunities in Ukraine. Ukrainian legislation generally provides that foreign investors are authorized to carry out investment activities in Ukraine on the same basis as Ukrainian domestic investors, a principle that was firmly acknowledged upon Ukraine’s May 2008 accession to the WTO. Ukraine’s WTO accession and ongoing Free Trade Agreement negotiations with the European Union are seen as, over time, pushing Ukraine to be more open. On December 23, 2009, a new legal framework was introduced regarding technical procedures for the registration of foreign investments: NBU regulation No. 762. This framework might reduce uncertainty and risk among the international investment community.

B. Corruption Transparency International’s 2009 Global Corruption Barometer International placed Ukraine last among the New Independent States (NIS). The publication reports that Ukrainians feel public officials and civil servants represent the most corrupt sector of society—worse than political parties, legislature, the private sector, or the judiciary. It must be noted that the NIS, which includes Ukraine, is the second most likely group of states where people would report having paid a bribe in the last 12 months. Fewer than 1 in 20 respondents considered government anti-corruption efforts effective. A study co-funded by the European Union and the United Nations Development Program and published in April 2009 found that few recommendations made in 2007 for legal action against corruption had been fully adopted. In particular, Ukraine failed to follow recommendations to develop a detailed plan for implementing a national anti-corruption strategy and establish a body separate from law enforcement functions in order to implement such a strategy. Ukraine had taken partial steps toward this recommendation, but a proposal for a new agency was seen as inadequate. The following recommendations had been partially implemented: strengthening coordination between law enforcement authorities involved in corruption investigations, enhancing the independence of the Chief Prosecutor, reviewing public procurement legislation, approving special investigative techniques, introducing regulations regarding the confiscation and seize of proceeds from crime, and adopting a clear set of rules governing the administrative process and decision making.44 Ukraine’s anti-money laundering regime (AML) is based on the Law on Prevention and Counteraction to Legalization (Laundering) of the Proceeds of Crime or Terrorism Financing. The primary monitoring function is assigned to the State Committee for Financial Monitoring. In the 2007–2008 Annual Report of the Financial Action Task Force (FATF), Ukraine is named as one of the jurisdictions that has undertaken to implement FATF’s “40+9” recommendations. MONEYVAL, in a March 2009 report, detailed deficiencies in Ukraine’s performance in regard to the 40+9 recommendations of FATF. Specifically addressing preventative measures regarding financial institutions, it was noted that Ukraine has introduced some

44 See also “Strengthening Capacity for Investigation and Prosecution of Corruption in Ukraine, “ Organization for Economic Co-operation and Development, www.oecd.org/document/32/0,3343,3n_36595778_36595918_41420320_1_1_1_1,00.html.

28 A Review and Assessment of the Ukrainian Financial Sector June 2010 of the basic elements of customer due diligence, but gaps exist regarding beneficial ownership for customers, a definition of politically exposed persons does not exist, more information should be gathered about correspondent relationships, and no specific requirements exist for financial institutions to have policies and procedures in place to address risks associated with non-face-to-face transactions (among other issues). Ukraine was non-compliant regarding 5 of the 40 recommendations, largely compliant with 12, and partly compliant with 19.

C. Corporate Governance Various reports published between 2003 and 2007 found that Ukraine’s corporate governance was in low compliance with international standards. Areas of concern included financial transparency, ownership structure disclosure, shareholder rights, minority shareholders’ protection, and enforcement and institutional capacity. Significant progress has been made, including the introduction of a voluntary corporate governance code in 2003, the passage of a new securities law in 2006, and, perhaps most importantly, a new Law on Joint Stock Companies that became effective in October 2008. The deadline for new companies to comply with the law was moved up 3 years and is now October 2010. The 2009 report by the U.S. Department of Commerce concludes that the new law is in line with OECD principles and largely compliant with European Union Directives.

D. Transparency Joint research by Standard & Poor and the Financial Initiatives Agency provide the most recent assessments of Ukrainian bank transparency and disclosure. In a study of the 30 largest banks, 16 banks showed greater transparency compared to 2008, and 12 showed less. The greatest disclosure related to ownership structure and shareholder rights, and improvement in financial and operational transparency was the weakest area. Disclosure of the supervisory board and management structure was a weak area, but it showed the greatest improvement. However, the study notes that regulatory filings are the most meaningful source of information and speculates that this weakness might be related to developments during the financial crisis. In particular, as credit default swap quotes rose sharply for Ukrainian issuers in mid-2009, banks may not have thought it wise to reveal their deteriorating financial condition. Unfortunately, various measures adopted by the NBU to control the crisis had the side effect of making disclosure unnecessary, thus reducing transparency.

E. Being a Bank in Ukraine For many years, Ukraine had no specific limitations on the forms of bank ownership. As a result, many operating banks were registered as LLCs, impeding the disclosure of true ownership. LLCs are not subject to the disclosure requirements of the Ukrainian equivalent to the U.S. Securities and Exchange Commission (SEC).45

45 However, if a LLC-type bank opts for issuing publicly traded bonds, it appears to be within SEC jurisdiction.

29 A Review and Assessment of the Ukrainian Financial Sector June 2010 Before the adoption of the Law on Joint Stock Companies, effective April 30, 2009, banks were incorporated as public joint stock companies or limited liability companies (LLC) (see Table 5). However, under the new law, all existing banks must be organized into public joint stock companies within 2 years. Table 5: Licensed Banks by Type of Ownership End of Year 2002 2003 2004 2005 2006 2007 2008 2009 Join Stock 136 133 132 133 135 143 155 176 Companies Open-End 9 94 92 92 91 101 116 76 Joint Stock Close-End 42 39 40 41 44 42 39 1 Joint Stock Public n/a n/ n/a n/a n/a n/a 0 99 LLCs 20 25 28 32 35 32 29 6 Cooperative 1 0 0 0 0 0 0 0 Banks Total 157 158 160 165 170 175 184 182 Source: NBU.

The NBU requires all banks to identify and present in the notes of quarterly financial statements a list of owners of essential participation. The NBU even has an up-to-date list of such owners on its official website. However, the identification and disclosure of true bank ownership remains poor; most banks report immediate “shell” owners and effectively hide real ones. This situation improved slightly from 2005 to 2007 when Ukrainian banks were actively seeking international buying partners and had to provide greater details about ownership. However, this was only true for larger institutions; most small banks are still not transparent in this regard. In 2006, an amendment to the Economic Code passed requiring all operating banks to be re-registered as open-end joint stock companies. In 2008, a new Joint Stock Companies Law was adopted that provided for public joint stock companies (previously known as open-end companies) and private joint stock companies (previously referred to as close- end companies). The law now requires all operating banks to convert into either public companies or cooperative banks (Article 6, Banks and Banking Law) that will be subject to disclosure requirements of the Ukrainian equivalent to the SEC. These relatively new legal requirements are expected to improve transparency, including true ownership. IV. Performance of the Banking Sector

A. Concentration, Diversity, and Resilience

30 A Review and Assessment of the Ukrainian Financial Sector June 2010 The aggregate Herfindahl-Hirschman Index (HHI) concentration ratio for Ukraine is 375, indicating that concentration is quite low.46 The HHI takes into account the relative size and distribution of the firms in a market and approaches zero when a market consists of a large number of firms of relatively equal size. The HHI increases both as the number of firms in the market decreases and as the disparity in size between those firms increases. A highly concentrated market would show a HHI score of 1800 or greater and a moderately concentrated market would have an HHI of 1000. With no bank having more than 10 percent of market share, Ukrainian banking is well diversified. Diversification demonstrates significant potential strength (as there are many unrelated sources of potential additional bank capital if needed) and potential efficiency through competition. Of further note are the significant presence of foreign-owned banks and the wide geographic diversity of the parents. Ukraine can benefit from external capital financing for banks, and those sources are highly disbursed, thus reducing a correlation risk of capital shortfall both in the mother bank and its Ukrainian subsidiary. The diversity and low concentration in the Ukrainian banking market partially explains the reduced damage and enhanced recapitalization capacity of the banking system in the face of the huge 14- percent GDP decline in Ukraine in 2009. Other countries (such as the Scandinavian nations in the 1990s) had much more damaged banking systems despite less GDP decline because of their banking systems’ concentration. The lack of banking concentration also diminishes the necessity for “too big to fail” banks and their associated rescue costs. Scale economies, along with competition, positively influence efficiency. A bank needs to be large enough (i.e., have enough customers, transactions, and diversified investments) to justify the specialization of labor and efficient use of capital equipment and to benefit from the fractional reserve investment method that makes banking profitable. Academic studies of the size a bank must be to meet essential scale economies use asset size as a rough proxy for transaction volume and asset and deposit diversification. Those studies indicate a scale break at USD 2–10 billion47 for the United States. If the same calculation was made for Ukraine,48 adjusting the transaction proxy by the difference in GDP per capita (50,000 United States versus 5000 Ukraine at PPP), a Ukrainian bank would need to hold assets of USD 200 million to 1 billion or UAH 1.6 to 8 billion. The top 25 banks have more than UAH 8 billion in assets and thus 77.11 percent of market share. Using the more liberal efficiency delimiter of UAH 1.6 billion, an absolute majority of Ukrainian banks (97 percent by share of the market) have at least that amount.

B. The Four Categories of Banks

46 For example, for a market consisting of four firms with shares of 30, 30, 20 and 20 percent, the HHI is 2600 (302 + 302 + 202 + 202 = 2600). 47 See Hunter and Timme (1986), Noulas, et al. (1990), Hunter, et al. (1990). 48 Evidence shows that scale economies measures are similarly applicable in developing countries. See “An International Comparison of Scale Economies in Banking: Evidence from Turkey,” Journal of Financial Services Research 7:111-125 (1993), Joseph A. Fields, Department of Finance, University of Connecticut; Neil B. Murphy, Department of Finance, Virginia Commonwealth University; Dogan Tirtiroglu, Department of Finance, Salisbury State University.

31 A Review and Assessment of the Ukrainian Financial Sector June 2010 The NBU publishes quarterly “call report” data on all banks detailing their assets, liabilities, equity, and financial results. For the purposes of these reports, the NBU divides the banks into four groups based on net total assets at year end. There is one consequence of group assignment: banks in the first two groups are within the NBU Head Office Bank Supervision’s jurisdiction; NBU Regional Branches supervise the others. Obviously, larger banks will tend to have more loans and more deposits on their balance sheets. However, Table - presents group averages for 11 asset ratios of interest based on 2009 year-end call report data. They are tested to illustrate whether the groups are different in terms of these ratios. In particular, Tables C3 and C4 reports the results of T- tests for whether a particular ratio is the same between groups 1 and 2, between groups 2 and 3, and between groups 3 and 4. Of the 33 tests conducted, there are only 7 significant results based on the standard 5-percent level.49 Roughly, speaking, this implies that (at least in terms of the ratios examined) there is not much difference between adjacent groups. The banks in the first group (largest) tend to hold a smaller proportion of their assets in cash and equivalents than banks in the second group; tend to do less interbank lending; and tend to have a higher total loan to total asset ratio. The banks in the fourth group, which includes many so-called “pocket banks,” rely less on interbank lending as a type of asset and less on foreign currency lending to either retail clients or legal clients, as compared to banks in the third group. The latter finding seems supportive of the hypothesis that diversification has allowed the Ukrainian banking system to absorb the shock of the currency devaluation. With a smaller share of their lending in foreign currency, the smallest banks would logically be affected less by the increasing burden imposed on their borrowers. In terms of liability ratios (see Table 6), we find even fewer differences between adjacent categories of banks.50 Banks in Group 4 (the smallest banks) rely less on bank deposits as a source of funding. The largest banks (Group 1) rely more on “other liabilities,” a perhaps unsurprising indication that such banks have more diversified types of funding. We note that this finding is in apparent contrast to discussions that compare “small foreign banks,” “medium-sized foreign banks,” and “domestic banks.” However, the comparison is inexact. Nonetheless, the difference in dispersion between foreign currency lending and foreign currency borrowing is interesting.

C. Loans and Deposits Both total loans and total deposits fell dramatically from 2008 Q4 to 2009 Q1, before rebounding somewhat in the middle half of 2009 and falling again in the Q4. Data for March 2010 shows that Ukrainian businesses deposited UAH 9 billion, the highest amount since the beginning of the global crisis. This news is encouraging to those concerned about the lack of a domestic currency market and a threat posed by high levels of dollarization.

49 The test is a standard test for the equality of means between groups when the variances and number of observations differ between the groups. This test was done with Microsoft Excel’s “ttest” command. 50 Of course, not surprisingly, more significant differences are found if comparing groups 1 and 4, groups 1 and 3, or groups 2 and 4.

32 A Review and Assessment of the Ukrainian Financial Sector June 2010 Although many analysts discuss deposits and lending for “legal entities” and “natural persons” based on NBU monthly reports, we examine monthly data from the Monetary Statistics charts, which allow a further breakdown. Charts 14, 17, and 20 depict the dynamics of deposits of three sectors—residents, non-financial corporations (NFC), and households—in UAH terms for UAH deposits and foreign currency deposits. Total deposits clearly declined during 2009 only for NFCs. Although domestic currency deposits fell for all three groups, foreign currency deposits declined during 2009 only for NFCs. In UAH terms, households held approximately 53 percent of their deposits in foreign currency in January 2010—the highest of the three sectors and roughly 2.5 percent above the start of 2009. In USD terms foreign currency deposits fell during 2009 for all of these groups but not as sharply as they increased during the previous year. In domestic currency terms, the proportion of deposits in foreign currency stood well above the levels of January 2008. Depending on where one thinks the optimal mix of foreign and domestic currency deposits lies, these considerations might imply that further adjustment in these ratios will be necessary. Data on loans from deposit-taking corporations, indicate that it was only for households that total loans fell during 2009 in UAH terms. Although the UAH value of foreign currency loans fell in all three sectors, it was only for households that domestic currency loans fell, though the decline was modest. As was the case for deposits, when looking at the charts for USD lending to each of these sectors, it is clear that while the levels have decreased and do not show the large spike associated with the devaluation, loans have not fallen as much as they rose in 2008. For households, the proportion of loans in foreign currencies stayed near 72 percent during 2009; for the other sectors, the ratio fell sharply. This finding seems clearly attributable to the decline in domestic currency lending to households.

D. Foreign Banks Versus Domestic Banks Some assume an increase in foreign banking capital as a share of total Ukrainian banking capital implies better management and diversified sources of capital support. The smaller foreign banks have had higher levels of equity to assets both at the end of 2008 and the end of 2009. On the other hand, this same category of banks showed the largest decline in retail loans in 2009 (minus 17 percent) and almost no growth in corporate loans. Domestic banks (non-top 10 and non-problem banks) saw their total loans grow 6 percent.51 In terms of deposit trends, mid-sized foreign banks saw their retail deposits grow almost 26 percent and overall deposits grow 10.6 percent. The smaller foreign banks experienced declines in overall deposits, mainly because of declines in corporate deposits. In terms of liability structure, on the other hand, foreign banks are more dependent on bank funds, even compared to the largest banks. Foreign banks have a much higher ratio of foreign currency loans to foreign currency deposits.

51 These facts are based on “Ukrainian Banking System in 2009,” UniMonitor, UniCredit Group, Kyiv, March 7, 2010.

33 A Review and Assessment of the Ukrainian Financial Sector June 2010 Beyond such numerical comparisons lie more substantive issues. First, policy makers need to assess the extent to which foreign banks (i.e., the involvement of foreign capital in the Ukrainian banking system) are bringing new products and services to either “legal entities” (e.g., corporations) or “natural persons” (e.g., households). Second, the extent to which foreign banks are linked to the costs or benefits of dollarization must be explicitly addressed.

E. Earnings and Profitability Ukrainian banks continued to show negative net profits during the first 2 months of 2010, though at a lower level than during the last half of 2009 (see Table 6). The huge increase in provisioning seen in 2009 has slowed in 2010, and observers speculate about when and if banks will be able to release provisions. They could do so by selling off problem loan portfolios or if economic conditions improved sufficiently. Although the NBU stopped publishing data on return-on-assets (ROA) and return-on- equity (ROE) as part of their Financial Soundness Indicators, calculations by UniCredit Group show that these dropped 3.5 percent and 26.3 percent respectively during 2009. Table 6 depicts the sources of net profits (losses) for all banks from monthly NBU data. Table 6: Monthly Financial Results, All Banks, June 2009 to February 2010 UAH million June July Aug Sept Oct Nov Jan Feb Income 11252 12431 11986 11838 11670 11484 11053 10336 Interest Income 9681 10401 9745 9838 9846 9606 9735 8911 Fee & Commission 1174 1426 1624 1597 1389 1260 1002 1119 Trade Gains 234 457 463 228 178 223 186 149 Other Operational Income 143 113 119 111 210 123 103 109 Other Income 15 33 35 41 42 268 23 42 Assets Recovery 5 2 1 24 5 3 4 5 Expenses 13585 16470 14129 12279 14294 15551 11560 11197 Interest Expense 5482 5512 5399 5397 5480 5299 5390 4933 Fee & Commission 271 256 322 308 274 201 193 197 Other Operational Expense 777 594 468 1647 214 660 356 533 Administrative Expense 2246 2358 2099 2352 2158 2242 2003 2183 Provisions 4982 8243 5796 3688 6111 7346 3616 3318 Income Tax -172 -493 45 -1114 58 -196 -1 -31 Net Profit or Loss -2333 -4039 -2143 -441 -2625 -4067 -508 -861 Source: NBU website. A monthly report for December 2009 is not published in the series.

Although interest rates are not discussed often in analyses of the Ukrainian financial system, net spreads have clearly risen for all but the “domestic bank” group, which

34 A Review and Assessment of the Ukrainian Financial Sector June 2010 excludes the top 10 banks, foreign banks, and problem banks.52 Chart 32, depicting the “integral” rates calculated by the NBU for deposits and credits, is consistent with this. Although revenues have risen above levels seen in 2008, interest earning assets are declining. Operating expenses rose during 2009 but show signs of moderation. Finally, when assessing the condition of Ukrainian banks, it is important to remember that a wide range of policies and procedures influence the interpretation of financial reports and the assessment of future prospects. For example, many banks have restructured loans without explicit official guidance, including extending loan terms, granting holidays on principal repayment, and reducing the size or frequency of front-end loan payments. As with the official practices of forbearance, such restructuring might encourage banks to postpone acknowledging economic reality. Some banks, however, have been able to sell off significant loan portfolios and thus presumably clarify their financial situation to shareholders and possible buyers. In this regard, it should be remembered that Ukrainian banks, which must be as listed joint stock companies, should be making financial statements in accordance with IFRS. It is the official data released by the NBU that might not be painting an accurate picture of the condition of the banking sector.

52 A 2008 IMF Working Paper suggests that interest rate differentials have played a significant role in at least one aspect of dollarization in countries that are new member states of the EU. See Rosenberg and Tirpak, IMF, 2008.

35 A Review and Assessment of the Ukrainian Financial Sector June 2010

Appendix A: A History of the Ukrainian Banking System The development of the Ukrainian banking system has been similar to that of the other countries that separated during the dissolution of the USSR. From a single “ruble zone”, national monetary and banking systems of several emerging nations emerged. Birth was given to central banks, commercial banks‚ national currencies‚ the systems of payments‚ currency exchanges‚ systems of the agencies engaged in regulation and bank supervision. On March 20, 1991, the resolution of the Verkhovna Rada of the Ukrainian SSR was adopted, entitled “On Procedure of Enactment of the Law of Ukrainian SSR.” Pursuant to “On Banks and Banking Activity,” which took effect on May 1, 1991, the National Bank of Ukraine (NBU) was created on the basis of the Ukrainian Republican Bank of the State Bank of the USSR. In August 1991, Ukraine turned a new page as an independent democratic state. Article 7 of Resolution of the NBU directed that the following actions should occur no later than November 1, 1991: establishment of a procedure for issuing licenses to bankers’ establishments authorizing to fulfill transactions in foreign currency within the Ukrainian SSR and abroad; a reconsideration of all the issued licenses authorizing the fulfillment of these transactions; and re-registration of all the banks, their affiliates, and other credit establishments located on the territory of Ukraine. On October 7, 1991, the Statute of the NBU was approved by a resolution of the Presidium of the Verkhovna Rada of Ukraine. The NBU was acknowledged as a state establishment accountable to the Verkhovna Rada of Ukraine. To ensure the functioning of this system, regional clearinghouses have been created in the Crimea and every oblast. These clearinghouses are united into the all-country network of clearing chambers of Ukraine, with the Central Clearing Chamber in the city of Kyiv at the top.

Creation of Commercial Banking System

First Stage: 1991–1992; Re-registering and reorganizations

Work during this stage focused on the implementation of the Law “On Banks and Banking Activity“ and Statute of National bank. The establishment of credibility required overcoming the absence of appropriate personnel and equipment, appropriate laws, an accepted methodology, and funds. The first person appointed to head the NBU was well-known banker Volodymyr Matvienko, who served as Governor from August 1991 to March 1992. In December 1991, the Verkhovna Rada passed a resolution ratifying the name and attributes of the monetary unit of Ukraine—the Hryvnia. Between August 1991 and March 1992, 82 commercial banks were re- registered. At the beginning of 1992, the first Ukrainian bank with foreign interest was registered in Donetsk oblast. By the beginning of February 1992, 22 commercial banks already had been opened. Direct correspondent relations were arranged with many foreign banks, and the NBU’s computer center was created to provide for interbank settlements.

Second Stage: 1992–1993; “New wave” of commercial banks

The second Governor of the NBU Board (March 1992–November 1992) was another well- known banker, Vadym Hetman whose first action was to initiate mass computerization of the

A-1 A Review and Assessment of the Ukrainian Financial Sector June 2010 Central Bank. He also created organizational grounds for the establishment of a system of interbank electronic settlements. Under his leadership, the department of balance of payments was created. Mr. Hetman made a considerable effort to foster the elaboration and adoption of the Law of Ukraine, “On Banks and Banking Activity,” together with the first President of the Association of Ukrainian Banks, Mr. Markov‚ then a People’s Deputy of Ukraine. In June 1992, the Stabilization Fund for Ukrainian National Currency was formed. In July 1992, a single settlement-cash center at the NBU was created, and NBU opened correspondent accounts to facilitate the transition to a new settlement system with the CIS member states. In August 1992, the Currency Exchange of the NBU was created, and in September 1992, Ukraine joined the International Monetary Fund and The World Bank. In October 1992, Ukraine joined the European Bank for Reconstruction and Development. In November 1992, Ukraine left the “ruble zone.” Banks that arose during this time profited handsomely from the hyperinflation that took place in 1992–1994.

Third Stage: 1994–1996; Bankruptcy wave

During this period of intensified work at the NBU, the clearing systems were further developed. However, the comfortable existence of many banks that had been profiting from hyperinflation came to an end. A wave of bankruptcies concentrated management within the banking system. Unfortunately, depositors began to develop a deep-seated trust of banks.

Fourth Stage: 1996–1998; Stabilization and the introduction of the Hryvnia

In February 1997, Mr. Yuschenko was once again approved by the Verkhovna Rada to be NBU Governor. The fight against inflation dominated this stage, which helped set the stage for monetary reform. Hryvnia was introduced on August 26, 1996, and published on August 29. From September 2–6, both hryvnia and karbovanets were circulated, but merchants were required to give a change only in hryvnias. All bank accounts were converted into hryvnia. During the transition period, 97 percent of USSR karbovanets were taken out of circulation, including 56 percent in the first 5 days of the currency reform. After September 16, remaining karbovanets were only allowed to be exchanged into hryvnias in banks and could not be used with merchants. The NBU implemented a sequence of policies regarding the formation of statutory capitals of banks. Standards for bank operations were upgraded to enhance safety and soundness, including standards for solvency, liquidity, and the maximum size of credit per loan debtor. A system for licensing commercial bank activities was introduced at the end of 1996, and a system for mandatory reserves was first applied.

A-2 A Review and Assessment of the Ukrainian Financial Sector June 2010 Appendix B: Basel Core Principles for Effective Banking Supervision Principle 1(1). Clear responsibilities and objectives for each supervisory agency Principle 1(2). Operational independence and adequate resources Principle 1(3). Suitable legal framework for authorization and ongoing supervision Principle 1(4). Suitable legal framework to address compliance with laws, as well as safety and soundness concerns Principle 1(5). Legal protection for supervisors Principle 1(6). Arrangement for information sharing between supervisory authorities and confidentiality of shared information Principle 2. Clearly defined permissible activities for banks and control of the use of the word “bank” Principle 3. Criteria for structure, directors, operating plan, controls, financial condition, and capital base Principle 4. Authority to review and reject transfer of ownership Principle 5. Authority to review major acquisitions and investments Principle 6. Minimum capital adequacy requirements (meet Basel Capital Accord for internationally active banks) Principle 7. Independent evaluation of procedures related to loans, investments, and portfolio management Principle 8. Policies, practices, and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves Principle 9. Prudential limits and management information systems required on concentration of loan exposures Principle 10. Arm’s-length rule and monitoring for connected lending Principle 11. Policies and procedures to control country risk and transfer risk Principle 12. Policies and procedures to measure and monitor market risk; limit and/or specific capital charge on market risk exposure Principle 13. Comprehensive risk management processes Principle 14. Adequate internal controls Principle 15. Strict “know your customer” rules and high ethical and professional standards Principle 16. Effective supervisory system consisting of on-site and off-site supervision Principle 17. Regular contact with bank management and understanding of bank’s operations Principle 18. Analytical reports and statistical returns on solo and consolidated basis Principle 19. Independent validation of supervisory information through on-site examination or external auditors Principle 20. Ability to supervise on a consolidated basis Principle 21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank Principle 22. Adequate supervisory measures to ensure timely corrective action Principle 23. Consolidated supervision over internationally active banking organizations Principle 24. International exchange of information with other supervisors Principle 25. Supervision of local foreign bank operations and information sharing with home country supervisors

B-1 A Review and Assessment of the Ukrainian Financial Sector June 2010

Table B-1: Banks With Foreign Ownership # Banks With Partial Foreign Size # Banks With 100 Percent Foreign Size Ownership Group Ownership Group 1 PROMINVESTBANK 1 1 OTP BANK 1 2 UKRSOTSBANK 1 2 UNICREDIT BANK 2 3 SWEDBANK 1 3 ERSTE BANK 2 4 RAIFFEISEN BANK AVAL 1 4 SBERBANK OF RUSSIA 2 5 VTB BANK 1 5 CALYON BANK UKRAINE 2 6 NADRA 1 6 PRAVEX BANK 2 7 CREDITPROMBANK 1 7 ING BANK UKRAINE 2 8 FORUM 1 8 BM BANK 3 9 ALFA-BANK 1 9 CREDIT EUROPE BANK 3 10 UKRSIBBANK 1 10 PROCREDIT BANK 3 11 CREDIT-DNIPRO 2 11 CITIBANK UKRAINE 3 12 UNIVERSAL BANK 2 12 MEGABANK 3 13 VAB BANK 2 13 HOME CREDIT BANK 4 14 INDEX-BANK 2 14 DEUTSCHE BANK DBU 4 15 CREDOBANK 2 15 BANK RUSSIAN STANDARD 4 16 MARINE TRANSPORT BANK (MTB) 2 16 CREDITWEST BANK 4 17 INDUSTRIALBANK 3 17 BANK RENAISSANCE CAPITAL 4 18 UKRINBANK 3 18 BANK TRUST 4 19 SEB-BANK 3 19 PLATINUM BANK (PB) 4 20 KYIVSKA RUS 3 21 PIRAEUS BANK MKB 3 22 VOLKSBANK 3 23 RADABANK 4 24 PROFIN BANK 4 25 PLUS BANK 4 26 ENERGOBANK 4 27 PETROCOMMERCE—UKRAINE 4 28 BANK OF CYPRUS 4 29 BG BANK 4 30 ASTRA BANK 4 31 UKRBUDINVESTBANK 4 32 MISTO-BANK 4

Banks with partial foreign capital 32 Banks with 100 foreign capital 19 Total 51 Source: NBU Reference Book, 01/29/2010 “Size Group”: NBU Groupings: 1,2,3,4

B-2 A Review and Assessment of the Ukrainian Financial Sector June 2010

Appendix C: I. Banks in Temporary Administration and/or Liquidated and II. Supplemental Information on Banks That Have Been in Temporary Administration in the Banks of Ukraine (as of March 26, 2010) I. Banks in Temporary Administration and/or Liquidated As of April 1, 2010, there were 19 banks undergoing liquidation. In chronological order for entry into liquidation, they are as follows: 1. GradoBank 2. Kyivsky Universalny Bank (Kiev Universal Bank) 3. Sloviansky Bank 4. European Bank for Development and Savings 5. Knyazhyi Bank 6. Prychornomorya Bank 7. Odesa Bank 8. Yevropeisky Bank (European Bank) 9. Natsionalny Standart (National Standard Bank) 10. LisBank 11. Bank Regionalnogo Rozvutky (Bank for Regional Development) 12. Schidno-Yevropeisky bank (Eastern European Bank) 13. Ukrainian Financial Group 14. UkrPromBank 15. Arma Bank 16. BIG Energia Bank 17. TransBank 18. Dnister Bank 19. IpoBank As of April 6, 2010, there were 6 banks under temporary administration: 1. Nadra (through 02/11/2011) 2. Rodovid (through 05/16/2010) 3. Volodymyrsky (through 07/16/2010) 4. Stolytsya Bank (through 07/19/2010) 5. Inprombank (Kharkiv, through 09/10/2010) 6. Dialogbank (Dnipropetrovsk, through 04/15/2010) Presently these banks only service accounts of physical persons—in particular, pension and social accounts, wages, alimony, and interest payments on deposits. Banks offer prolongation of previously issued deposits (to be covered by Deposit Guarantee Fund) to current customers. Temporary administrators also work on outstanding claims in an effort to minimize banks' indebtedness. Operating costs are minimized by cutting staff and salaries and closing branches and departments, thus minimizing rent costs.

C-1 A Review and Assessment of the Ukrainian Financial Sector June 2010 II. Supplemental Information on Banks That Have Been in Temporary Administration in the Banks of Ukraine (as of March 26, 2010) 1. Kyiv Bank: Effective date of temporary administration: 02.09.2009. Moratorium expiration date: 08.09.2009. 2. Odessa Bank: Effective date of temporary administration: 02.23.2009. Moratorium expiration date: 08.23.2009. 3. Prychornomorya: Effective date of temporary administration: 01.30.2009. Moratorium expiration date: 02.08.2009. 4. Ukrprombank: Effective date of temporary administration: 01.20.2009. Moratorium expiration date: 07.20.2009. 5. SotsComBank: Effective date of temporary administration: 03.02.2009. 6. Ukrgasbank: Effective date of temporary administration: 03.02.2009. 7. Liquidation stage: Ukrprombank LLC. 01.20.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (01.21.2009–01.21.2010), the moratorium on satisfaction of creditors’ claims was imposed on 01.21.2009–07.21.2009, and the moratorium on satisfaction of creditors’ claims was extended from 08.05.2009– 01.21.2010, excluding the commitments under the bank deposit agreements, bank account agreements, and the commitments regarding within the limits set by the bank’s temporary administrator and approved by the NBU. Based on the NBU Board Decree #232 of 04.16.2009, the decision on proposals to the Ministry of Finance of Ukraine regarding state participation in the capitalization of ‘‘Ukrprombank’’ LLC was taken. 8. Normal working stage: JSB “National Loan.” 12.19.2008. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (12.19.2008–12.18.2009), and the moratorium on satisfaction of creditors’ claims was imposed on 12.19.2008– 06.18.2009. The moratorium on satisfaction of creditors’ claims was extended from 08.05.2009–12.18.2009, excluding the commitments under the bank deposit agreements, bank account agreements, and money remittance commitments within the limits set by the bank’s temporary administrator and approved by the NBU. 9. Temporary administration stage: OJSC CB ‘‘Nаdrа.’’ 02.10.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (02.10.2009– 02.10.2010) (temporary administration prolonged until 02.11.2011). The moratorium on satisfaction of creditors’ claims was imposed on 02.10.2009–08.10.2009. The moratorium on satisfaction of creditors’ claims was extended from 08.11.2009–02.10.2010, excluding the commitments under the bank deposit agreements, the bank account agreements, and the commitments as regards remittances within the limits set by the bank’s temporary administrator and approved by the NBU. According to the NBU Board Decree of 04.16.2009, the decision on proposals to the Ministry of Finance of Ukraine regarding state participation in the capitalization of the OJSC CB ‘‘Nadra’’ was taken. 10. Normal working stage: CB ‘‘Zakhidinkombank” LLC (Luts’k). 02.12.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (02.13.2009–02.12.2010), the moratorium on satisfaction of creditors’ claims was imposed

C-2 A Review and Assessment of the Ukrainian Financial Sector June 2010 on 02.13.2009–08.12.2009, and the moratorium on satisfaction of creditors’ claims was extended from 08.13.2009–02.12.2010, excluding the commitments under the bank deposit agreements, the bank account agreements, and the commitments as regards remittances within the limits set by the bank’s temporary administrator and approved by the NBU. 11. Liquidation stage: JSB ‘‘Тrаnsbаnk.” 02.28.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (03.02.2009–03.01.2010), the moratorium on satisfaction of creditors’ claims was imposed on 03.02.2009–09.01.2009, and the moratorium on satisfaction of creditors’ claims was extended from 09.02.2009– 12.02.2009, excluding the commitments under the bank deposit agreements, bank account agreements, and money remittance commitments within the limits set by the bank’s temporary administrator and approved by the NBU. 12. 03.02.2010 Liquidation stage: OJSB ‘‘BІG Еnergy.” 03.13.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (03.16.2009– 03.15.2010), and the moratorium on satisfaction of creditors’ claims was imposed on 03.16.2009–09.15.2009. 13. Temporary administration stage: JSB ‘‘RОDОVІD BАNK.” 03.13.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (03.16.2009–03.15.2010), and the moratorium on satisfaction of creditors’ claims was imposed on 03.16.2009–09.15.2009 (temporary administration prolonged until 04.15.2010). According to Decree #580 of 06.10.2009 of the Cabinet of Ministers of Ukraine on Capitalization of the open joint stock company ‘‘RODOVID BANK,’’ the state participates in the bank’s capitalization by buying the stock of additional issue in exchange for the internal debt securities, the state share in the statutory capital of the stated bank makes 99. 972128268 percent. 14. 02.07.2010 Liquidation stage: JSB ‘‘Regional Development Bank.” 03.23.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (03.24.2009–03.23.2010), the moratorium on satisfaction of creditors’ claims was imposed on 03.24.2009–09.23.2009, the moratorium on satisfaction of creditors’ claims was extended from 09.24.2009–03.23.2010, excluding the commitments under the bank deposit agreements, bank account agreements, and money remittance commitments within the limits set by the bank’s temporary administrator and approved by the NBU. Bank’s temporary administrator, individual, and independent expert: Andriy Semenovych Yatsura, office address: 8-а Dehtyarivs’ka Street, Kyiv 04050, contact telephone number: (044) 494-23-23. 15. 02.22.2010 Liquidation stage: CB ‘‘АRМА” LLC. 04.16.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (04.17.2009– 04.16.2010), and the moratorium on satisfaction of creditors’ claims was imposed on 04.17. 2009–10.16. 2009. 16. Liquidation stage: OJSC Selyans’kiy commercial bank ‘‘Dnister” (Lviv). 04.16.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (04.17.2009–04.16.2010), and the moratorium on satisfaction of creditors’ claims was imposed on 04.17.2009–10.16.2009.

C-3 A Review and Assessment of the Ukrainian Financial Sector June 2010 17. Temporary administration stage: OJSC CB “Volodymyrs’kiy.” 07.17.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (07.17.2009–07.16.2010), and the moratorium on satisfaction of creditors’ claims was imposed on 07.17.2009–01.16.2010. 18. Temporary administration stage: OJSC “Stolytsya Bank.” 07.17.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (07.20.2009–07.19.2010), and the moratorium on satisfaction of creditors’ claims was imposed on 07.20.2009–01.19.2010. 19. Temporary administration stage: OJSC “Іnprombank” (Kharkiv). 09.10. 2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (09.11.2009–09.10.2010), and the moratorium on satisfaction of creditors’ claims was imposed on 09.11.2009–12.10.2009. 20. Temporary administration stage: CB “UFG”-LLC. 09.10.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (09.14.2009– 09.13.2010), and the moratorium on satisfaction of creditors’ claims was imposed on 09.14.2009–12.13.2009. 21. Temporary administration stage: 09.29.2009. OJSC CB “Іpоbаnk.” Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (10.02.2009–10.01.2010), and the moratorium on satisfaction of creditors’ claims was imposed on 10.02.2009–01.01.2010. 22. Temporary administration stage JSCB “East-European Bank.” 10.01.2009. Temporary administration was appointed for the term of 1 year based on the NBU Board Decree (10.05.2009–10.04.2010), and the moratorium on satisfaction of creditors’ claims was imposed on 10.05.2009–01.04.2010. It shall be noted that because of the money deficiency in correspondent accounts and in the cash-desks of the banks above, the temporary administrators shall keep records of payment documents on the off-balance accounts 9804 “Payment documents of the clients (individuals excluding) defaulted due to the bank’s failure” and 9806 “Documents of the individuals defaulted due to the bank’s failure.” Payments shall be performed depending on the proceeds to the correspondent accounts and the banks’ cash-desks and in line with the moratorium on satisfaction of creditors’ claims. The priority will be payment of moneys to individuals—in particular, pension and welfare payments, salaries, payments of ailments, and deposit interests. The bank’s depositors are proposed to extend the available deposit agreements, which shall be subject to guarantee of the Deposits Guarantee Fund. Temporary administrators will study the claims on returning the banks’ receivables. The banks’ expenses shall be cut at the expense of diminishing the number of employees and salaries, closing branches by way of decreasing the lease fees. Source: NBU and informal FINREP translation, April 2010.

C-4 A Review and Assessment of the Ukrainian Financial Sector June 2010

Table C-1: NBU Refinancing of 88 Banks, December 8, 2008 Bank Name Amount, UAH 1312 P 2 OJSC Ukreximbank 623000000,00 1312 P 3 Prominvestbank 5850000000,00 1212 P 6 OJSC Oshchadbank 4600720000,00 1312 P 11 OJSC Swedbank 13700000,00 1312 P 13 JSB Legbank 13863150,00 1312 P 17 OJSC Bank Finance and Credit 2698000000,00 1312 P 18 JSC Ukrinbank 33409000,00 1312 P 34 OJSC UPB 140500000,00 1312 P 35 OJSC CB Interbank 6000000,00 1312 P 36 Reiffeisen Bank Aval 400000000,00 1312 P 37 JSB Brokbusinessbank 465000000,00 1312 P 45 OJSC CB Pivdenkombank 20000000,00 1312 P 46 CB Privatbank Dnipro 3410000000,00 1312 P 47 CJSC Finansovy Soyuz 50000000,00 1312 P 48 CB Novy Dnipropetrovs’k 8040731,00 1312 P 49 Polikombank 8500000,00 1312 P 57 OJSC JSB Capital 52200000,00 1312 P 59 OJSC CB Promekonombank 12000000,00 1312 P 60 CB Daniel LLC 7000000,00 1312 P 62 OJSC CB Business Standard 25000000,00 1312 P 66 OJSC Rodovidbank 2172000000,00 1312 P 67 OJSC CB Expobank 80000000,00 1312 P 68 Ukrprombank LLC 1348000000,00 1312 P 72 Bank Familny LLC 4200000,00 1312 P 74 OJSC CB National Standard (‘‘Natsionalny Standard ’’) 27000000,00 1212 P 76 OJS VAB Bank 151500000,00 1312 P 84 JSB Tavryka 73000000,00 1312 P 87 JSB BRR 28500000,00 1312 P 93 OJSC JSB Dnister 21400000,00 1312 P 98 JSCB Merkury 37300000,00 1312 P 101 JSCB Industrialbank 81700000,00 1312 P 106 JSCB Pivdenny 350000000,00 1312 P 107 JSB Porto-Franko 20000000,00 1312 P 109 JSCB Investbank 1700000,00 1312 P 110 JSCB Odessa-Bank 51703000,00 1312 P 113 JSB Poltava-Bank 45000000,00 1312 P 122 JSCB Finbank 30200000,00 1312 P 123 ASUB Grant 34500000,00 1312 P 125 HAK Zembank 100000000,00 1312 P 126 OJSC Megabank 21600000,00 1312 P 135 OJSC Inprombank 17900000,00 1312 P 137 OJSC Demark BANK 85000000,00 1312 P 139 CJSC Donhorbank 75000000,00 1312 P 144 JSB Bazis 17000000,00 1312 P 146 OJSC Bank Ukraine Capital 32000000,00

C-5 A Review and Assessment of the Ukrainian Financial Sector June 2010

1312 P 151 JSB European (Evropeyskiy) 160000000,00 1312 P 167 Finrostbank LLC 38000000,00 1312 P 183 OJSC CB Prychornomorya 5100000,00 1312 P 191 JSCB Arkada 107800000,00 1312 P 195 Ukrkomunbank 18800000,00 1312 P 201 OJSC TFB Contract 10000000,00 1312 P 202 OJSC CB Khreshchatyk 377534878,54 1312 P 203 JSC Kyiv 412900000,00 1312 P 206 CB Misto Bank LLC 15550000,00 1312 P 209 JSCB Zoloti vorota 50000000,00 1312 P 216 OJSC Bank BIG Energy 65000000,00 1312 P 217 JSCB SEB 28000000,00 1312 P 223 OJSC JSB Stolychny 22000000,00 1312 P 225 OJSC CB Nadra 7100000000,00 1312 P 228 OJSC BG Bank 17000000,00 1312 P 232 Diamantbank 70000000,00 1312 P 241 OJSC Ahrokombank 10000000,00 1312 P 242 OJSC Universalbank 22590200,00 1312 P 248 JSCB Forum 40000000,00 1312 P 258 JSCB Imexbank 200000000,00 1312 P 260 JSCB TK Credit 14700000,00 1312 P 262 JSB Express-bank 46475500,00 1312 P 270 JSB Credit-Dnipro 166500000,00 1312 P 272 CJSC Alfa-Bank 398749696,44 1312 P 273 CB Zakhidinkombank LLC 51100000,00 1312 P 274 OJSC JSB Ukrgasbank 1228500000,00 1312 P 280 JSB Kyivs’ka Rus 313850000,00 1312 P 282 CJSC Swedbank Invest 136000000,00 1312 P 287 UniCreditbank LLC 11850000,00 1312 P 288 JSB Clearing House 174000000,00 1312 P 289 OJSC Creditprombank 539300000,00 1312 P 302 OJSC CB Aktivbank 191723000,00 1312 P 308 CB SKB LLC 39740000,00 1312 P 312 CB Stolytsya LLC 30000000,00 1312 P UCB Cambio LLC 28200000,00 1312 P CB Financial Initiative 1285000000,00 1312 P 320 Bank of Investments and Savings 36800000,00 1312 P 324 CB Delta LLC 22000000,00 1312 P 328 Bank Bohuslav LLC 8100000,00 1312 P 330 OJSC Eurogasbank 25500000,00 1312 P 332 OJSC Erdebank 1700000,00 1312 P 333 Partner-bank LLC 40000000,00 1312 P 380 OJSC TRUST Bank 34000000,00 1312 P 6 OJSC Oshchadbank

Total Refinancing by NBU December 8, 2008 ------Æ 36937199155,98 Source: the Weekly Mirror, #47 (726) 13—19 December 2009 Received from the Association of Ukrainian Banks

C-6 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 1: Financial Account and Components 15,000

10,000

5,000

- USD mln (5,000)

(10,000)

(15,000) 2005 2006 2007 2008 SA2009

Direct Investment Portfolio Inv estment Other Investment Reserves Assets Financial Account Total

Source: NBU, FINREP

Chart 2: Short-Term External Debt and FX Reserve Measures

40,000 0.9 s 35,000 0.8 30,000 0.7 0.6 25,000 0.5 20,000 0.4 USD mln 15,000 0.3 10,000 0.2 5,000 0.1 Ratio Short-term External Debt/FCReserve External Short-term Ratio 0 0 1/1/2007 1/1/2008 1/1/2009 1/1/2010 Short-term Ex ternal Debt Foreign Currency Reserves Official Reserv e Assets Ratio Short-term Ex ternal Debt/FC Reserv es

C-7 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 3: Merchandise Trade Balance: 2007–2009

30,000 25,000 20,000 15,000 10,000 USD mln 5,000 -995 - (5,000) -1632 -1189 -2577 -751 -418 -486 -4060 -4451 -3909 -3583 Q1/2007 Q2/2007 Q3/2007 Q4/2007 Q1/2008 Q2/2008 Q3/2008 Q4/2008 Q1/2009 Q2/2009 Q3/2009

BALANCE EXPORTS IMPORTS

Source: NBU, FINREP.

Chart 4: Real GDP (year-over-year) Growth Rate, %, Industrial Production Index (year-over-year) Growth % 12.9% 11.8% 10.7% 10.2% 7.7% 10.0% 7.9% 5.1% 2.3% 0.0% 8.9%9.1% 8.1% 7.9% 6.3% 6.3%6.3% -10.0% -3.1%

-20.0% -16.0% -15.0% -17.8% -20.3% -30.0% -21.9% -31.9% -31.1% -28.4% -40.0% Q12007 Q22007 Q32007 Q42007 Q12008 Q22008 Q32008 Q42008 Q12009 Q22009 Q32009 Q42009

GDP real growth, to corresponding period of previous year, % Industrial production index , to corresponding period of prev ious y ear, %

Source: ukrstat.ua.gov, FINREP

C-8 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 5: CPI (year-over-year) Rate %, PPI (year-over-year) Rate, %

50.0

40.0

30.0

20.0

10.0

0.0

-10.0 Jan-07 Jan-08 Jan-09 Jan-10 CPI Change over a year ago % PPI Change over a year ago %

Source: ukrstat.gov.ua, Global Insight, FINREP

Chart 6: Industrial Producer Price Index Growth From December of the Previous Year, %

40.0 34.1 36.5 34.0 32.1 35.0 29.4 30.0 24.2 23.5 23.023.3 25.0 19.8 18.3 19.5 20.0 14.5 15.8 12.4 12.9 15.0 9.8 11.0 7.3 5.4 5.1 10.0 3.4 14.3 2.32.3 12.7 13.2 5.0 10.6 6.8 0.0 4.2 4.9 2.0 3.1 3.5 2.8 0.2 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2007 2008 2009

Source: ukrstat.gov.ua, FINREP

Chart 7: Consumer Price Index Growth From December of the Previous Year, % 25.0 22.3 19.8 18.0 20.0 15.5 16.1 16.6 14.6 14.9 14.8 13.1 14.2 15.0 11.7 9.7 8.6 8.5 9.1 7.4 8.2 10.0 6.9 12.3 5.7 5.9 11.3 4.4 10.1 5.0 2.9 8.6 2.9 5.6 6.2 4.2 0.0 0.5 1.1 1.3 1.3 1.9 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2007 2008 2009

Source: ukrstat.gov.ua, FINREP

C-9 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 8: Growth of the Monetary Aggregate (M0, M1, M2, M3)

500000.00

400000.00

300000.00

200000.00

100000.00

0.00 Jan-07 Jan-08 Jan-09 Jan-10

M3 M0 M1 M2

Chart 9: Total Assets, Total Loans, Total Assets Growth Rate (%) 1000000000.00 30.00%

800000000.00 22.56% 24.00% 18.48% 600000000.00 16.29% 14.96% 18.00%

400000000.00 8.22% 12.00% 8.15% 200000000.00 7.71% 2.92% 6.00% 0.00 0.00% -0.68% -1.86% -200000000.00 -5.99% -6.00% Q12007 Q22007 Q32007 Q42007 Q12008 Q22008 Q32008 Q42008 Q12009 Q22009 Q32009 Q42009

Total Assets Total Loans Total Assets Grow th Rate (Quarterly )

C-10 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 10: Corporate Loans, Retail Loans, Total Loans Growth Rate (%) 800000000.00 30.05% 32.00% 700000000.00 28.00% 600000000.00 24.00% 500000000.00 20.00% 16.04% 16.70% 16.28% 400000000.00 16.00% 12.75% 300000000.00 12.00% 200000000.00 9.27% 8.00% 7.66% 100000000.00 1.73% 4.00% 0.00 0.00% -0.53% -0.38% -100000000.00 -2.87% -4.00% 07 07 07 07 08 08 08 08 09 09 09 09 20 20 20 20 20 20 20 20 20 20 20 20 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Corporate Loans Retail Loans Total Loans Grow th Rate (Quarterly )

Chart 11: Dynamics of OVDP Holders for September 2008–March 2010 100 95 90 85 80 75 70

n 65 l b

H 60 A

U 55

d, 50 ne w 45 o

P 40 D V 35 O 30 25 20 15 10 5 0

9 9 8 9 8 9 9 8 8 9 9 9 9 9 9 0 0 9 0

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1

------

t t r

r r

v v y c g c

p n b n p n b

u c c

a p a

e a e o o e a e e a e u

O O A

J J

F J F M M

S S D D N N

A M

NBU Banks Others Non-residents

C-11 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 12: LLP and Total Loans; LLP/Total Loans Ratio

800 0.15 0.15

0.12 Millions 0.12 600 0.10 0.09 0.08 400 0.06 0.05 0.05 0.04 0.06 0.04 0.04 0.04 0.04 200 0.03

0 0.00 Q12007 Q22007 Q32007 Q42007 Q12008 Q22008 Q32008 Q42008 Q12009 Q22009 Q32009 Q42009

Total Loans LLP Ratio LLP/Total Loans

Source: NBU, FINREP

Chart 13: Regulatory Capital to Risk-Weighted Assets, Regulatory Tier 1 Capital to Risk-Weighted Assets, and Capital to Assets 20.00 %

15.00 %

10.00 %

5.00 %

0.00 % 6/30/07 9/30/07 3/31/08 6/30/08 9/30/08 3/31/09 6/30/09 9/30/09 12/31/07 12/31/08 12/31/09 3/31/2007

I1: Regulatory capital to risk-w eighted assets I2: Regulatory Tier 1 capital to risk-w eighted assets I13: C apital to assets

Source: NBU, FINREP.

C-12 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 14: Currency Composition of Deposits by Resident Sectors

400,000 100.00% 350,000 80.00% 300,000

Jan-10 e 250,000 Jan-09 60.00% 48.88% 200,000 Jan-08 45.15% Jan-07 40.00% UAH mlnUAH 150,000 33.04% 38.84% percentag 100,000 20.00% 50,000 0 0.00% Jan-07 Jan-08 Jan-09 Jan-10 Total Deposits Foreign Currency denominated deposits Foreign Currency deposits percentage

Source: Table 3.2.1.2, Monetary Statistics NBU and FINREP

Chart 15: Foreign Currency Denominated Deposits and Domestic Currency Denominated Deposits

250,000 Jan-08 Jan-09 Jan-10 192,434 187,651 200,000 169,287 Jan-07 154,446 150,000 113,548 161,853 100,000 UAH mlnUAH 94,933 50,000 72,100

0 Jan-07 Jan-08 Jan-09 Jan-10

Domestic Currency Deposits Foreign Currency Deposits

Source: Table 3.2.1.2, Monetary Statistics NBU and FINREP

Chart 16: USD Value of Foreign Currency Deposits of Resident Sectors

25000 20000 15000 10000 5000 0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

Source: NBU, FINREP

C-13 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 17: Currency Composition of Deposits by Non-Financial Corporations 140,000 100.00% 120,000 80.00% 100,000 e Jan-10 60.00% 80,000 Jan-09 Jan-08 40.20% 60,000 40.68% 40.00% UAH mln Jan-07 26.04% percentag 40,000 31.03% 20.00% 20,000 0 0.00% Jan-07 Jan-08 Jan-09 Jan-10 Total Deposits Foreign Currency denominated deposits Foreign Currency deposits percentage

Source: Table 3.2.3.2, Monetary Statistics, NBU and FINREP

Chart 18: Foreign Currency Denominated Deposits and Domestic Currency Denominated Deposits of NFCs

100,000 Jan-08 Jan-09 68,950 Jan-10 64,963 55,195 Jan-07 50,000 43,424 44,555 UAH mln 37,112 24,277 19,535 0 Jan-07 Jan-08 Jan-09 Jan-10

Domestic Currency Deposits Foreign Currency Deposits

Source: Table 3.2.3.2, Monetary Statistics, NBU, and FINREP

Chart 19: USD Value of USD Deposits of Non-Financial Corporations

5000 4000 3000 2000 1000 0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

Source: NBU, FINREP

C-14 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 20: Currency Composition of Deposits of Households

250,000 100.00%

200,000 80.00% Jan-10 Jan-09 e 150,000 Jan-08 52.58% 60.00% Jan-07 49.09% 39.30% 45.35% UAH mlnUAH 100,000 40.00% percentag

50,000 20.00%

0 0.00% Jan-07 Jan-08 Jan-09 Jan-10 Total Deposits Foreign Currency denominated deposits Foreign Currency deposits percentage

Source: Table 3.2.4.1, Monetary Statistics, NBU and FINREP.

Chart 21: Foreign Currency Denominated Deposits and Domestic Currency Denominated Deposits Of Households

150,000 Jan-10 Jan-08 Jan-09 112,840 103,991 106,791 100,000 Jan-07 102,986 101,756 60,810

UAH mln 50,000 67,336 50,460

0 Jan-07 Jan-08 Jan-09 Jan-10

Domestic Currency Deposits Foreign Currency Deposits

Source: Table 3.2.4.1, Monetary Statistics NBU and FINREP.

Chart 22: USD Value of USD Deposits of Households

12000 10000 8000 6000 4000 2000 0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

Source: NBU, FINREP

C-15 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 23: Currency Composition of Loans to Resident Sectors

800,000 100.00% 700,000 80.00% 600,000 Jan-08 Jan-09 Jan-07 Jan-10 500,000 50.21% 58.83% e 50.50% 51.10% 60.00% 400,000 40.00% UAH mln 300,000 percentag 200,000 20.00% 100,000 0 0.00% Jan-07 Jan-08 Jan-09 Jan-10 Total Loans Foreign Currency Loans Foreign Currency loans percentage

Source: Table 3.3.1.2, Monetary Statistics, NBU and FINREP.

Chart 24: Foreign Currency Denominated Loans and Domestic Currency Loans to Resident Sectors

Jan-09 450,000 425,108 Jan-10 400,000 362,319 350,000 Jan-08 300,000 346,734 218,925 250,000 297,441 Jan-07 200,000 121,272 UAH mlnUAH 150,000 217,126 100,000 123,710 50,000 0 Jan-07 Jan-08 Jan-09 Jan-10 Domestic Currency Loans Foreign Currency Loans

Source: Table 3.3.1.2, Monetary Statistics, NBU and FINREP.

Chart 25: USD Value of Foreign Currency C Loans to Resident Sectors

80000

60000

40000

20000

0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

Source: NBU, FINREP

C-16 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 26: Currency Composition of Loans to Non-Financial Corporations

500,000 100.00%

400,000 80.00% Jan-08

Jan-07 Jan-09 e 300,000 42.71% Jan-10 60.00% 44.21% 51.21% 41.56%

UAH mlnUAH 200,000 40.00% percentag

100,000 20.00%

0 0.00% Jan-07 Jan-08 Jan-09 Jan-10 Total Loans Foreign Currency Loans Foreign Currency loans percentage

Source: Table 3.3.4.2, Monetary Statistics, FINREP.

Chart 27: Domestic Currency Denominated and Foreign Currency Denominated Loans to Non-Financial Corporations

Jan-10 300,000 Jan-09 265,139 250,000 223,677 Jan-08 200,000 152,179 213,092 Jan-07 150,000 188,540 88,747 UAH mln 100,000 113,463 50,000 70,328 0 Jan-07 Jan-08 Jan-09 Jan-10 Domestic Currency Loans Foreign Currency Loans

Source: Table 3.3.4.2, Monetary Statistics, FINREP

Chart 28: USD Value of USD Loans to Non-Financial Corporations

30000 25000 20000 15000 10000 5000 0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

Source: NBU, FINREP

C-17 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 29: Currency Composition of Loans to Households

300,000 Jan-10 100.00% Jan-09 72.34% Jan-07 Jan-08 80.00% 71.93% 62.97% 62.88%

200,000 e 60.00%

40.00% UAH mlnUAH 100,000 percentag 20.00%

0 0.00% Jan-07 Jan-08 Jan-09 Jan-10 Total Loans Foreign Currency Loans Foreign Currency loans percentage

Source: Table 3.3.5.2, Monetary Statistics, NBU and FINREP

Chart 30: Foreign Currency Denominated Loans and Domestic Currency Loans to Households Jan-09 Jan-10 198,296 200,000 170,893

150,000 Jan-08 103,619 100,000 Jan-07

UAH mln 52,576 77,391 50,000 61,156 65,359 30,913 0 Jan-07 Jan-08 Jan-09 Jan-10 Domestic Currency Loans Foreign Currency Loans

Source: Table 3.3.5.2, Monetary Statistics, NBU and FINREP.

Chart 31: USD Value of USD Loans to Households

30000 25000 20000 15000 10000 5000 0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

Source: NBU, FINREP

C-18 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 32: Loan Rates and Deposit Rates (“Integral Rates”)

0 Apr-08 Jun-08 Oct-08 Apr-09 Jun-09 Oct-09 Feb-08 Feb-09 Feb-10 Dec-07 Aug-08 Dec-08 Aug-09 Dec-09

Integral Deposit Rate Integral Loan Rate Spread

Source: NBU, FINREP

Chart 33: Domestic Currency Loan Rates and Foreign Currency Loan Rates

0 Apr-08 Jun-08 Oct-08 Apr-09 Jun-09 Oct-09 Feb-08 Feb-09 Feb-10 Dec-07 Aug-08 Dec-08 Aug-09 Dec-09

Domestic Currency Rate Foreign Currency Rate Spread

Source: NBU, FINREP

C-19 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 34 : Deposit Rate Spreads: Domestic Currency and Foreign Currency

0 Apr-08 Jun-08 Oct-08 Apr-09 Jun-09 Oct-09 Feb-08 Feb-09 Feb-10 Dec-07 Aug-08 Dec-08 Aug-09 Dec-09

Domestic Currency Rate Foreign Currency Rate Spread

Source: NBU, FINREP

Chart 35: Term Deposit Rate Spreads: Domestic Currency and Foreign Currency

0 Apr-08 Jun-08 Oct-08 Apr-09 Jun-09 Oct-09 Feb-08 Feb-09 Feb-10 Dec-07 Aug-08 Dec-08 Aug-09 Dec-09

Domestic Currency Term Rate Foreign Currency Term Rate Spread

Source: NBU, FINREP

C-20 A Review and Assessment of the Ukrainian Financial Sector June 2010

Chart 36: Term Deposit Rate and Deposit Rate: Domestic Currency and Foreign Currency

3.5 3 2.5 2 1.5 1 0.5 0 Apr-08 Jun-08 Oct-08 Apr-09 Jun-09 Oct-09 Feb-08 Feb-09 Feb-10 Dec-07 Aug-08 Dec-08 Aug-09 Dec-09

Domestic Currency Term Spread Foreign Currency Term Spread

Source: NBU, FINREP

Chart 37: Performance of Individual Deposit Guarantee Fund in 2009 4790 4798 215 4716 5 000 4553 4579 4530 4302 4183 4226 4 500 210 4 000 205 3280 3193 3200 3 500 2919 2987 illion illion 200 3 000

2 500 UAH b 195 1914 UAH m 1689 2 000 190 1 500

185 202 194 204 213 205 194 189 190 191 197 199 202 201 203 206 210 1 000 1-Jul-09 1-Jan-09 1-Apr-09 1-Jun-09 1-Jan-10 1-Oct-08 1-Nov-08 1-Oct-09 1-Nov-09 1-Feb-09 1-Mar-09 1-Dec-08 1-Aug-09 1-Sep-09 1-Dec-09 1-May-09

Individual Deposits (left scale) Fund's Assets (right scale)

Source: NBU website, IDGF website

C-21 A Review and Assessment of the Ukrainian Financial Sector June 2010

Table C-2: Financial Soundness Indicators 3/31/2006 6/30/2006 9/30/2006 12/31/2006 3/31/2007 6/30/2007 9/30/2007 Core I1 RC/RWA 14.92 % 14.31 % 13.90 % 14.19 % 13.99 % 13.95 % 13.89 % I2 RT1/RWA 11.28 % 10.78 % 10.48 % 10.84 % 10.34 % 10.11 % 10.17 % I3 NPL-Prov/C 336.02 % 362.20 % 378.52 % 352.44 % 364.26 % 361.88 % 321.93 % I4 NPL/TL 57.34 % 58.02 % 59.22 % 59.76 % 58.33 % 55.53 % 49.16 % I5 Sectoral Distribution of Loans/TL I6 ROA 0.35 % 0.77 % 1.12 % 1.34 % 0.39 % 0.64 % 0.90 % I7 ROE 2.93 % 6.54 % 9.56 % 11.38 % 3.15 % 5.41 % 7.83 % I8 IM/GI 52.88 % 52.83 % 53.96 % 54.49 % 56.08 % 55.61 % 55.19 % I9 NIE/GI 64.38 % 61.15 % 59.41 % 59.79 % 62.16 % 61.00 % 59.52 % I10 LA/TA 17.26 % 16.68 % 14.79 % 14.27 % 13.99 % 14.54 % 13.35 % I11 LA/STL 38.24 % 36.89 % 35.98 % 37.83 % 40.68 % 40.07 % 38.07 % I12 Net Open Fx 3.20 % 8.37 % 11.32 % 10.55 % 16.76 % 16.36 % 19.06 % Encouraged I13 C/A 11.97 % 11.58 % 11.51 % 12.47 % 12.02 % 11.48 % 11.42 % II4 (ii) '5 to 5' 200.69 % 202.30 % 202.66 % 191.44 % 188.44 % 183.45 % 182.58 % I15 Geographic Distribution of (See Annex (See Annex (See Annex (See Annex (See Annex (See Annex (See Annex Loans/TL Table A2) Table A2) Table A2) Table A2) Table A2) Table A2) Table A2) I18 TrI/TI 10.53 % 9.27 % 8.38 % 8.25 % 8.91 % 7.91 % 8.44 % I19 PE/NIE 46.20 % 47.45 % 47.72 % 47.15 % 50.53 % 50.20 % 50.44 % I20 Reference Rates 723.00 744.00 685.00 654.00 603.00 615.00 575.00 Spread (b)

I21 High-Low 691.00 754.00 594.00 830.00 633.00 835.00 737.00 Interbank (b) I22 CD/TL 88.66 % 84.09 % 79.39 % 74.90 % 71.93 % 68.19 % 67.22 % I23 FDL/TL 45.69 % 47.24 % 48.41 % 50.48 % 52.35 % 52.46 % 53.08 % I24 FCD/Tliab 45.84 % 47.27 % 49.24 % 50.31 % 50.99 % 51.08 % 50.54 %

Abbreviations: RC: Risk-Weighted Capital; RWA: Risk-Weighted Assets; RTI: Regulatory Tier 1 Capital; NPL-Prov: Non- Performing Loans Net of Provisions; TL: Total Loans, IM: Interest Margin; GI: Gross Income; NIE Non-Interest Expenses; LA: Liquid Assets; TA: Total Assets; STL: Short-Term Liabilities; Net Open Fx: Net Open Position in Foreign Exchange to Capital; C: Total Capital and Reserves; A: Total Assets;’5 to 5’: Total Exposure of the 5 Largest Deposit Takers to the 5 Largest Resident Entities to Capital; TrI/TI: Trading Income to Total Income; PE: Personnel Expenses; Reference Rates Spread: Spread Between Reference Lending and Deposit Rates; High-Low Interbank: Spread Between Highest and Lowest Interbank Rate; CD: Customer Deposits; FDL: Foreign Currency Denominated Liabilities; FCD: Foreign Currency Denominated Deposits

See footnotes on NBU website.

C-22 A Review and Assessment of the Ukrainian Financial Sector June 2010

Table C-2 (continued): Financial Soundness Indicators 12/31/2007 3/31/2008 6/30/2008 9/30/2008 12/31/2008 3/31/2009 6/30/2009 9/30/2009 12/31/2009

I1 13.92 % 14.26 % 14.41 % 14.49 % 15.14 % 16.49 % 15.88 % 17.19 % 19.81 % I2 10.09 % 10.36 % 10.97 % 10.94 % 12.05 % 13.01 % 13.00 % 13.80 % 15.59 % I3 313.82 % 7.44 % 9.03 % 8.26 % 9.16 % 14.29 % 24.15 % 23.03 % 31.97 % I4 48.12 % 2.68 % 2.95 % 2.97 % 3.88 % 6.13 % 8.92 % 9.58 % 13.70 % I5 (See (See (See (See (See (See (See Annex (See Annex (See Annex Annex Annex Annex Annex Annex Annex Table A1) Table A1) Table A1) Table A1) Table A1) Table A1) Table A1) Table A1) Table A1) I6 1.22 % 0.34 % 0.64 % 0.92 % 0.88 % I7 10.52 % 2.85 % 5.34 % 7.53 % 7.29 % I8 55.45 % 58.64 % 57.97 % 57.97 % 51.16 % 70.14 % 68.83 % 66.75 % 66.76 % I9 60.76 % 61.99 % 61.36 % 60.34 % 52.95 % 52.63 % 57.23 % 58.90 % 61.08 % I10 11.60 % 10.81 % 12.41 % 10.75 % 9.35 % 9.45 % 10.79 % 12.06 % 11.45 % I11 39.93 % 36.32 % 38.03 % 37.58 % 32.99 % 30.95 % 32.63 % 33.77 % 35.88 % I12 13.38 % 16.95 % 18.81 % 19.17 % 33.10 % 36.45 % 31.74 % 25.61 % 28.51 %

I13 11.58 % 12.11 % 11.94 % 12.16 % 12.86 % 13.42 % 13.00 % 13.23 % 13.10 % II4 171.06 % 151.33 % 154.15 % 162.36 % 187.36 % 165.92 % 188.96 % 187.64 % 169.21 % I15 (See (See (See (See (See (See (See Annex (See Annex (See Annex Annex Annex Annex Annex Annex Annex Table A2) Table A2) Table A2) Table A2) Table A2) Table A2) Table A2) Table A2) Table A2) I18 7.45 % 7.00 % 7.85 % 8.10 % 16.46 % 4.07 % 4.03 % 4.99 % 4.45 % I19 49.10 % 51.54 % 50.89 % 50.50 % 48.13 % 44.19 % 43.77 % 42.04 % 40.67 % I20 546.00 595.00 817.00 642.00 816.00 934 487 405 533

I21 939.00 1813.00 1010.00 1542.00 2753.00 6198 9990 14990 2499

I22 64.86 % 61.90 % 62.08 % 60.04 % 48.36 % 43.14 % 44.13 % 44.59 % 45.27 % I23 51.45 % 51.16 % 51.67 % 52.86 % 60.32 % 58.25 % 55.19 % 55.43 % 52.59 % I24 49.77 % 50.58 % 51.02 % 51.30 % 59.01 % 58.30 % 56.31 % 58.73 % 55.83 %

See definitions of indicators on previous pages. Refer to NBU website for footnotes and additional material.

C-23 A Review and Assessment of the Ukrainian Financial Sector June 2010

Table C-3: Asset Ratios for the Four Categories of Banks; With T-Tests

cash/TA ibank/TA fcy ibank loans/TA legal sh fcy share retail sh

Group 1 mean >> 0.0972 0.0288 0.4118 0.8856 0.6807 0.5213 0.3193 stdev >> 0.0407 0.0315 0.3819 0.1884 0.1852 0.2281 0.1852 Group 2 mean >> 0.1907 0.0624 0.5415 0.7376 0.6306 0.4678 0.3168 stdev >> 0.0984 0.0662 0.3656 0.1142 0.2983 0.2850 0.2675 Group 3 mean >> 0.1514 0.0648 0.6493 0.7563 0.7265 0.3479 0.2735 stdev >> 0.0811 0.0558 0.3715 0.1600 0.1866 0.2430 0.1866 Group 4 mean >> 0.1375 0.0975 0.5259 0.8475 0.7239 0.1954 0.2761 stdev >> 0.0989 0.1159 0.4178 0.9074 0.2462 0.1890 0.2371

Ttest(2,1) 0.0010 0.0499 0.7145 0.0205 0.6383 0.9088 0.8528 Ttest(3,2) 0.1798 0.9033 0.3602 0.6718 0.2383 0.1584 0.5614 Ttest(4,3) 0.4552 0.0337 0.1816 0.3039 0.9573 0.0117 0.9573

fcy share Prov/TA secs/TA fcy share

Group 1 mean >> 0.7118 0.1332 0.0252 0.5448 stdev >> 0.1938 0.1045 0.0412 0.1936 Group 2 mean >> 0.6407 0.1372 0.0317 0.5116 stdev >> 0.3243 0.1015 0.0613 0.1990 Group 3 mean >> 0.6169 0.1247 0.0530 0.4029 stdev >> 0.2479 0.1422 0.0967 0.1922 Group 4 mean >> 0.4767 0.1453 0.0363 0.2788 stdev >> 0.2827 0.1662 0.1070 0.1797

Ttest(2,1) 0.4175 0.5148 0.8942 0.8998 Ttest(3,2) 0.7906 0.7500 0.4058 0.0877 Ttest(4,3) 0.0265 0.5661 0.4810 0.0104

“Cash/TA”: cash and equivalents/total assets (TA); “ibank/TA”: interbank loans/TA; “fcy ibank”: foreign currency share of interbank loans; “Legal share”: loans to legal entities/TA; “fcy share”: foreign currency share of loans to legal entities; “Retail share”: retail loans/total loans; “fcy share”: foreign currency share of retail loans; “Prov/TA”: provisions/total assets; “Secs/TA”: securities for sale/TA; “Fcy share”: foreign currency share of TA Ttest (2, 1) is the t-test for the equality of the averages between groups 1 and 2. Ttest (3, 2) is the ttest for the equality of averages between groups 2 and 3. Ttest (4, 3) is the test for the equality of averages between groups 4 and 3. Values indicated are the probabilities that the averages of the two groups are equal, based on standard choice of 5-percent confidence interval for a two- tailed tests. Consequently, only values less than 0.05 are considered “significant.” Source: NBU data on Assets of Bank for YE 2009, FINREP calculations.

C-24 A Review and Assessment of the Ukrainian Financial Sector June 2010 Table C-4: Liability Ratios for the Four Categories of Banks; With T-Tests

bdep/TL fcy share legdep/TL fcy share DD sh leg fcy share HHdep/TL

Group 1 mean >> 0.3729 0.5868 0.1433 0.4483 0.4947 0.3512 0.2725 stdev >>0.1552 0.3689 0.0569 0.1453 0.1758 0.1455 0.1224 Group 2 mean >> 0.4446 0.6361 0.2003 0.3672 0.4721 0.2880 0.2541 stdev >>0.2154 0.3592 0.1464 0.1691 0.2098 0.1747 0.1697 Group 3 mean >> 0.3639 0.4363 0.2604 0.3014 0.4951 0.2365 0.2771 stdev >> 0.2137 0.3515 0.2060 0.1882 0.2002 0.1444 0.1411 Group 4 mean >> 0.2188 0.2988 0.3159 0.2475 0.5432 0.1778 0.3436 stdev >> 0.2082 0.3716 0.2126 0.2396 0.3048 0.1849 0.2072

Ttest (2,1) 0.2516 0.6828 0.1287 0.1263 0.7239 0.2468 0.7065 Ttest (3,2) 0.2422 0.0876 0.2913 0.2514 0.7254 0.3277 0.6461 Ttest (4,3) 0.0077 0.1235 0.2656 0.2553 0.3596 0.1111 0.0734

fcy share DD sh HH fcy share debt/TL OthShare subd/TL fcy TL

Group 1 mean >> 0.5911 0.2674 0.4792 0.0181 0.1012 0.0421 0.6237 stdev >>0.1616 0.1361 0.2135 0.0452 0.1676 0.0270 0.1951 Group 2 mean >> 0.5900 0.3061 0.5307 0.0072 0.0087 0.0386 0.5769 stdev >>0.2046 0.2633 0.1972 0.0218 0.0134 0.0369 0.2483 Group 3 mean >> 0.5672 0.2472 0.4931 0.0058 0.0224 0.0281 0.5065 stdev >> 0.1448 0.2126 0.2168 0.0133 0.0965 0.0375 0.2407 Group 4 mean >> 0.5100 0.2012 0.4338 0.0069 0.0095 0.0471 0.3938 stdev >> 0.2724 0.2203 0.2846 0.0215 0.0611 0.1073 0.2296

Ttest (2,1) 0.9845 0.5761 0.4572 0.3596 0.0320 0.7889 0.7178 Ttest (3,2) 0.6897 0.4452 0.5750 0.8156 0.5276 0.3528 0.2500 Ttest (4,3) 0.1622 0.3704 0.2811 0.7523 0.5593 0.1404 0.0564 “bdep/TL”: bank deposits/total liabilities; “fcy share”: foreign currency denominated share of bank deposits; “ legdep/TL”: deposits to legal entities/total liabilities; “fcy share”: foreign currency denominated share of deposits to legal entities; “DD sh leg”: demand deposit share of deposits to legal entities; “fcy share”: foreign currency denominated share of DD leg; “HHdep/TL”: household share of deposit/total liabilities; “fcy share”: foreign currency denominated share of HHdep; “DD sh HH”: demand deposit share of deposits to households; “fcy share”: foreign currency denominated share of demand deposits to household; “debt/TL”: debt instruments/total liabilities; “OthShare”: other liabilities/total liabilities; “subd/TL”: subordinated debt/TL; “fcy TL”: foreign currency denominated liabilities/total liabilities. Ttest (2, 1) is the t-test for the equality of the averages between groups 1 and 2. Ttest (3, 2) is the ttest for the equality of averages between groups 2 and 3. Ttest (4, 3) is the test for the equality of averages between groups 4 and 3. Values indicated are the probabilities that the averages of the two groups are equal, based on standard choice of 5-percent confidence interval for a two- tailed tests. Consequently, only values less than 0.05 are considered “significant.” Source: NBU data on Assets of Bank for YE 2009, FINREP calculations

C-25 A Review and Assessment of the Ukrainian Financial Sector June 2010

Appendix D: References Alvarez-Plata, Patricia and Alicia Garcia-Herrero, “To Dollarize or De-dollarize: Consequences for Monetary Policy,” Discussion Paper 842, Deutsches Institut fur Wirtschaftsforschung, Berlin, December 2008. “Doing Business in Ukraine,” Baker and McKenzie—CIS Limited, Kiev, May 2009. “Doing Business: Measuring business regulations,” World Bank Group, Washington, DC, 2010. “Developing Securities Markets and Non-Bank Financial Institutions in Ukraine: Key Impediments and Policy Reform Priorities Ahead,” World Bank and USAID Position Paper, 10th International Forum of Capital Market Participants, Alushta, Crimea, September 1, 2007. eStandardsForum, “Business Indicators Report: Ukraine,” Financial Standards Foundation, March 2009. Gide Loyrette Nouel, “Brief review of recent changes in Ukrainian legislation related to Foreign Borrowings by Residents,” Kyiv Banking and Finance Department, Kiev, October 6, 2008. Gubarenko, Alla, Alexey Kutsenko, Elena Pastukhova, and Oleg Shvyrkov, “Transparency and Disclosure by Ukrainian Banks 2009: Greater Transparency Amid Weakening Investor confidence,” Joint Research of Standard & Poor and the Financial Initiatives Agency with support from the USAID Capital Markets Project, December 2009. “Hryvnia Exchange Rate Fluctuations in 2010 Not to Go Outside 2009 Range, Says Advisor to NBU Governor,” Interfax-Ukraine, Kyiv, April 2, 2010. International Monetary Fund, “IMF Urges Ukraine to Stick With Recovery Policies,” IMF Survey Magazine, November 4, 2009. International Monetary Fund, “Ukraine: Second Review Under the Stand-By Arrangement and Request for Modification of Performance Criteria—Staff Report: Press Release on the Executive Board Discussion,” IMF Country Report No. 09/270, Washington, DC, September 2009. International Monetary Fund, “Ukraine: Financial System Stability Assessment, including Reports on the Observance of Standards and Codes on the following topics: Monetary and Financial Policy Transparency, Banking Supervision, and Payments Systems,” IMF Country Report No. 03/340, Washington, DC, September 2009. International Monetary Fund and World Bank, “Developing Government Securities Markets: A Handbook,” Washington, DC, 2008 Gide Loyrette Nouel, “Legal Aspects of Doing Business in Ukraine,” Kiev, 2010. Gide Loyrette Nouel, “On Cancellation of certain restrictions set forth by the Resolution of the National Bank of Ukraine No. 319 dated October 11, 2008,” Kyiv Banking and Finance Department, Kiev, October 17, 2008. Global Corruption Barometer 2009, Transparency International, 2009. Heritage Foundation, “2010 Index of Economic Freedom,” www.heritagefoundation.org.

D-1 A Review and Assessment of the Ukrainian Financial Sector June 2010 “Investment Climate in Ukraine as Seen by Private Businesses,” International Finance Corporation, 2009. Noel, Michel, Zeynep Kantur, Angela Prigozhina, Sue Rutledge, and Olena Fursova, “The Development of Non-Bank Financial Institutions in Ukraine: Policy Reform Strategy and Action Plan,” World Bank Working Paper No. 81, World Bank, Washington, DC, 2006. “Policy Recommendations on Economic and Institutional Reforms 2009,” Blue Ribbon Analytical and Advisory Centre, United Nations Development Program, Kyiv, April 2009. Rashkovan, Vladyslav, and Oleksander Anufriyev, “Ukrainian Banking System in 2009,” Unimonitor, Unicredit Group, Kyiv, March 7, 2010. Rosenberg, Christoph and Marcel Tirpak, “Determinants of Foreign Currency Borrowing of the New Member States of the EU,” Working Paper No. 08/173, International Monetary Fund, Washington, DC, 2008. Segura, Edilberto, “The Impact of the Global Liquidity Crisis on Ukraine and the Road to Recovery,” SigmaBleyzer, December 2009. “Strengthening Capacity for Investigation and Prosecution of Corruption in Ukraine,” Anti- Corruption Network for Eastern Europe and Central Asia, OECD, www.oecd.org. “Third Round Detailed Assessment Report on Ukraine: Anti-Money Laundering and Combating the Financing of Terrorism,” European Committee on Crime Problems, MONEYVAL, Strasburg, March 19, 2009. “Ukraine: Default-defiance, Ukrainian style,” Fixed income sovereign credit update, Renaissance Capital, December 2009. “Ukrainian Banking Sector: Looking Beyond the Elections,” Fitch Ratings, February 4, 2010.

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