http://www.centralbanking.com/operational-risk/governance/3238311/ukraines-gontareva-on-one-of- the-toughest-jobs-in-central-banking

Ukraine’s Gontareva on one of the toughest jobs in central banking Christopher Jeffery Dan Hardie 12 May 2017 The outgoing National Bank of Ukraine governor speaks about transforming the central bank while engaging in wartime deficit funding and overhauling the banking sector How did you end up as governor of the National Bank of Ukraine (NBU)? This is really a question for the president, Petro Poroshenko. But perhaps it was because I was a seasoned banker with more than 20 years of experience and the president knew me personally. The request came as big surprise and, initially, I refused it. But he convinced me. And it also came just after the ‘Revolution of Dignity’ [the Maidan Revolution in 2014, which overthrew then-president Viktor Yanukovych], at a very patriotic time when everybody wanted to implement real reform. After a few weeks of quite difficult discussions, the president convinced me to accept his proposal, and my nomination was put to Ukraine’s parliament, the Verkhovna Rada, where a majority of the deputies who voted supported the motion. Were there any terms you required from President Poroshenko in terms of support or otherwise before you took on your role? At the time, it was a very difficult macro situation. So we only discussed some general areas for reform – particularly the real need for reform in the banking sector – but nothing on specific details, of what should be done. What was the situation like when you took over as governor? It was the epicentre of a perfect storm. There were real economic problems everywhere, an unbelievably problematic banking system and an out-of-date central bank. This is why we instigated three main reforms in parallel straight away. The first priority was macro-financial stability. The second was a cleaning-up of the Ukrainian banking sector. And the third was the transformation of the central bank itself. At the same time, there was a war going on in the country. Before I joined the central bank, we had already lost Crimea [which was occupied by Russian forces in March 2014], which represented about 3.6% of our GDP and 2 million people from our population. The current account deficit was more than 10% of GDP and our foreign reserves were depleted. We had also faced a bank run, with the banking sector having lost about 35% of private individuals’ deposits. It was just incredible. And on top of that, a real war started in our eastern regions [in August 2014, when Russia began giving major military support to separatist rebels fighting the Ukrainian government]. As a result of that war in the industrial east, we lost another 10% of our territory, 15% of our GDP and 30% of our export revenues. Some of our infrastructure and industrial capacities were physically destroyed. And we lost them all in one day. It’s not like you have a period of time to adjust. Everything happened so quickly. So we experienced all these deficits and lost almost 20% of our GDP in 2014 and 2015. That represented an incredible hit to our banking sector. Valeria Gontareva was appointed governor of the National Bank of Ukraine in June 2014, following the ‘Maidan Revolution’ earlier that year. She holds a degree from the Kyiv Polytechnic Institute and a master’s degree in economics from the Kyiv National Economic University. She worked for several scientific research institutes in Ukraine before beginning a career in commercial banking in 1993. Gontareva worked for ING Bank and Société Générale before becoming chairwoman of the Ukrainian financial services group ICU. Was it difficult to implement reforms at such a time? It was very difficult, but we started immediately. First, we switched to a flexible exchange rate regime. Until then, Ukraine’s exchange rate had been pegged to the US dollar, which is why there were so many imbalances. To have our currency tied to the US dollar was suicidal for the economy. It was clear even towards the end of 2013 that Ukraine stood on the brink of an economic precipice. This emerged after our previous president, Yanukovych, who had consistently said Ukraine would like to join the European Union, decided instead in 2013 to move closer to Russia. He even borrowed €3 billion ($3.3 billion) – the first tranche of a €15 billion loan – in so-called Russian debt, via a eurobond that included special conditions from Russia. Yanukovych concluded this deal only because it was absolutely clear from a macroeconomic point of view that Ukraine was already in collapse. But the Ukrainian people were against this idea. They wanted closer association with Europe, and that’s why the revolution happened. But we had all these problems at the same time. How much did you sleep in an average week? The first year at the central bank, I didn’t sleep more than five hours per day. It was wartime. [Russian- backed separatists were fighting the government in the east of the country]. I was also a member of Ukraine’s ‘security council’ – the only woman among all these men: military men; the president; and the prime minister. So, for the first nine months, I did not have one weekend off, and no more than five hours’ sleep. It is rare to undertake major banking reform at the same time as a major exchange rate reform, especially during wartime. How did you manage it? I remember in July 2014 that I met with the vice-chairman of the Federal Reserve, Stanley Fischer. As I recounted these problems to him, I was keen to seek his advice about what I should do with the military expenditure. When it came to deficits, it wasn’t just the unplanned war. [State-owned natural gas monopoly] Naftogaz had a huge deficit. There were all these big deficits and military expenditures that needed somehow to be accommodated in our budget. But who should finance it all? How could we help banks if we didn’t know if the bank was solvent or not – because we didn’t know their asset quality and we hadn’t done any stress tests? I sought out Mr Fischer’s guidance, as he was previously governor of the Central Bank of Israel – and Israel is always on a war footing. But he explained the situation was very different in Israel, as it has a special budget for military expenditure. I remember he said the mission was “impossible”. But then he added that the first priority has to be how to finance the war, the military expenditure. If your army cannot stop the real war in your territory, there is little point worrying about anything else. Did that make life difficult when implementing reforms? I understood that war financing should not be the area for the central bank. But there was little choice. I even promised to write a special article for the International Monetary Fund about what to do when you work with a country engaged in war because you cannot pretend that it is business as usual. You cannot immediately switch to a flexible exchange rate when your industry is physically destroyed. You can do that if something has happened to commodity prices, for example – but when it’s real destruction, absolutely different steps should be taken. That’s why it was very difficult for us to follow the proper steps and stabilise the situation. We introduced incredibly draconian administrative measures in the foreign exchange [forex] market. It was very difficult, and not really recommended as proper steps. It was a very painful exercise. But finally, together with the international community – the IMF, the World Bank, the European Bank for Reconstruction and Development [EBRD] and the EU – which really supported us, we introduced a programme of macro-financial support that stabilised the situation. Macro-financial stability is one of our big achievements. For two years in a row now, we have lived in a more or less stable macro-financial situation. Were you worried at any point when you put those draconian forex restrictions in place that you could publish those decrees, but that nobody would actually put the measures into effect? It was very difficult to introduce new rules at a time when our banking system was completely dysfunctional. We had to have very strict monitoring processes. For example, we immediately stopped all capital transactions. When we cleaned up the Ukrainian banking system, we closed 20 banks, which were not really banks, but money-laundering machines. Ukraine came off the FATF [Financial Action Task Force] blacklist more than 10 years ago, but all these companies and all these banks were still doing it. We introduced a special division within the central bank. They started to do deep diagnostic examinations of banks – asset quality reviews and stress tests. And finally we created a proper plan for the recapitalisation of the Ukrainian banking system. It was very difficult. Was there are a lot of resistance from powerful or well-connected people in Ukraine, when you started doing this? We pushed 89 banks [as of April 11] into liquidation, and we nationalised the biggest Ukrainian bank [PrivatBank], which belonged to an oligarch, at the end of last year. Asset-wise, we revamped 60% of the Ukrainian banking system. Number-wise, it was 50%. This was not something the NBU had been able to do before. Did any of the oligarchs resist your efforts to liquidate banks? If the central bank had done its job properly after the crisis of 2008 and implemented appropriate supervision, we would not have faced these problems. After the crisis of 2008, it was clear that some banks were not in a good position, but they were still supported by the central bank. As a market participant, I already knew PrivatBank had major problems. But when I learned the true picture as governor of the central bank, I was really shocked. When we finally nationalised PrivatBank at the end of last year, its capital shortage was $5.6 billion – more than 6% of the country’s GDP. More to that a post-nationalisation audit of the bank has shown even more shortage of capital. It also posed a problem for the country’s payment network, as the bank’s payment system, Privat24, handled more than 50% of Ukraine’s transactional business. The bank has almost no real assets. Its corporate loan portfolio was an empty shell, a pyramid. The money held as individual private deposits – about 33% of all retail deposits in Ukraine – was siphoned offshore to acquire assets abroad over a 20-year period. PrivatBank’s corporate portfolio consisted of loans to ‘related parties’. These related parties were not normal businesses, but empty shells that had no collateral nor any cashflow. We recognised this as soon as we assessed PrivatBank’s diagnostic state via an asset quality review and stress test. To give you some understanding of the context, the missing UAH146 billion ($5.6 billion) represented almost 50% of the monetary base of Ukraine. Added to that, after the nationalisation, we did a post-nationalisation audit in line with Ukrainian law. This audit will be published soon. But I can tell you that more than 97% of the corporate portfolio was linked to ‘related parties’. After nationalisation the new management even said it was 100%. What stopped you from acting earlier? Was it concern about the effect on the wider Ukrainian economy if you took action against PrivatBank before? Or was it due to the political influence of some people connected to PrivatBank? When we are talking about the de-oligarchisation of the Ukrainian economy, it is the central bank who did all this, as we put banks into liquidation. For example, since the 2008 crisis, Nadra bank never repaid any of the monies that the central bank had used to support it. After completing our stress tests, it was absolutely clear that Nadra Bank was not viable. It had a huge capital shortage. All these banks had powerful links – some of them to oligarchs, some of them to politically connected people. I have faced sustained harassment for three years: whether on the television, in the mass media and even in our parliament – everybody criticised me. Last week, my house was vandalised. I was called a “Russian witch” for “killing Ukrainian banks”. In the first week of March, an effigy of me was left in a coffin outside the central bank. Does this explain why, when it looked like you were going to take action against the banks last autumn, a number of members of the Rada who met with international donors accused you of having links to former president Yanukovych, who was ousted in the Maidan Revolution? I was accused of having links to Russia, links to Yanukovych, links to Poroshenko. All of that was part of a campaign. I was accused of destroying the country and banking system. And you know why? Because I cleaned up the Ukrainian banking system. Who did you bring into the NBU to help you? Only one person: my first deputy governor, Alexander Pisaruk. But he left the NBU more then one year ago. I was very proud that he joined me and helped me clean up things. But I believe that when you want to build the proper institutional capacity, you do not need to invite all your friends to join. You need to re-engineer processes and first of all to hire a professional HR manager. How have you changed the NBU? When I joined, 11 deputies reported to me. Right now, I have just five deputies. I have a new law that grants independence to the central bank. This law was voted in June 2015. We prepared this law together with the IMF and the World Bank. We’re very proud that we have this law. When I joined the central bank, it had 12,000 people, and right now it has 5,000. I want to get that figure down to 3,000. If you take out the staff at our printing mill – we also produce our cash – the figure is more like 2,000. To build a proper institutional capacity within NBU we launched 70 re-engineering processes so to do that we had to follow a project management approach, and set up a special project management division. When did you start that? Back in 2014? Yes – it was when I started all three reforms in parallel. A priority was macro-financial and macro-prudential stability. But at the same time, we had about 50 technical assistance projects running with help from the international community, including the World Bank, the IMF, the EBRD and so on. We also observed we had 25 regional branches without much activity taking place in them. An immediate project was how to clean up non-core activity. As part of that, we closed these branches, as they were no longer needed in the 21st century. We also hired 500 additional, professional people in the central bank. Frankly speaking, we fired more than 7,500 people. Did you put a lot of new people into banking supervision? A lot of employees and heads of department in supervision are new. Was there ever any point, particularly in 2014, that you just thought “there are too many challenges here”? Did you worry about a lack of political support for the needed reforms? You should have a clear mandate for reforms. For example, we needed to switch to a new monetary policy with inflation targeting. And last year we announced our target, which we reached at the end of the year. And for the next five years, we already have our targets, and for us it’s the main challenge to reach them. But to achieve these targets, there were certain prerequisites. The first was to stop fiscal dominance. That meant the NBU could not finance the budget any more. There could be no more financing of military expenditures, which we managed to do in 2014. The NBU and the Ministry of Finance could not support monopolies like Naftogaz with money any more was the case in 2014–2015. Otherwise you cannot fulfil your mandate. I was very happy in 2015, when our former minister of finance, Natalie Jaresko, restructured Ukraine’s external debt, limited the budget deficit and switched to finance the budget deficit from other sources than the central bank printing machine. It was a prerequisite for us to start our inflation targeting monetary regime: to set up proper instruments; to set up open market operations; to set up proper research; to set up analytical capacity to observe what’s going on with inflation, with GDP, with unemployment, to have all these analytical tools. And when you have all these prerequisites, you do not need political will, because you have your strategy in place. Has there been any action taken against the bank owners? Unfortunately not yet. My personal experience is if something is voted in parliament, it doesn’t mean that it will be properly implemented. The main problem in our country is implementation. In April 2015, our parliament voted for a law that we prepared together with the IMF and the World Bank. It was all about the responsibilities of management and shareholders of banks in bankruptcy. I told you we liquidated 89 banks. Some of them, of course, were bankrupt because of normal risk. But when they were bankrupt due to money laundering, it’s a crime. Then there were what we call ‘zombie banks’, with no real assets at all, it’s also a crime. When it comes to the ‘oligarch banking model’, the oligarchs are responsible for the bank bankruptcies because they withdrew all the money and built up their empires with it. Then, when times got difficult, they didn’t pay anyone back properly. It was fraud for which the oligarchs are responsible. But two years after most of these banks were sent to the DGF (Deposit Guarantee Fund), none of the shareholders or management of these banks are in prison. Yet, according to the law, people can get five years for their criminal responsibility. We have a real problem with our court system. We have no real rule of law in our country. We have a problem with all the judicial systems, including the regional systems. It’s the main bottleneck right now for our reforms. Would a special anti-corruption court help? All these 89 banks [closed by the NBU] will never appear in an anti-corruption court as the main aim of such court is not the banking sector. For me, total judicial reform is needed. It is a priority! The finance minister resigned in February 2016, as did the prime minister. There was a lot of pressure put on the reformers about that time, wasn’t there? I can tell that we have a very good relation with the minister of finance right now, Oleksandr Danylyuk, and Oksana Markarova – she also was the first deputy minister under Natalie Jaresko – and that’s why we have some continuity in the Ministry of Finance. You can observe how we orchestrated the nationalisation of PrivatBank, and it worked very smoothly. And right now, we still see the minister of finance as the main engine of reform in the cabinet of ministers. That’s why I am very lucky that I have always enjoyed very good relations with the minister of finance. It’s very important for the central bank and the ministry of finance to be on the same side.

Much of the Ukrainian banking industry has been cleaned up, but the insurance industry looks very much like the banking industry used to be. Does the central bank have the powers to fix the insurance industry? If you look at the composition of Ukraine’s financial sector, 93% is in banking, 2% in securities and 5% in insurance. So the insurance market is relatively small. But when we composed our plans to reform the financial sector in 2015, the central bank was expected to regulate non-banking institutions, and we need to regulate insurers as part of a ‘twin peaks’ approach. Among the 400 insurance companies, there are about 42 that are viable. But we are not yet the regulator in this market. So the insurance industry is a smaller problem? It’s not a big problem. How important was the support of the IMF, the World Bank and other central banks throughout your tenure? Without all the international support, without our Extended Fund Facility programme, which was designed as a standby programme, we could not have done anything – not even preserve financial stability in the country. Right now, our forex reserves have reached $17.2 billion, or more than four months of coverage of trade – that’s across reserves including the international support. It’s very important that we continue our collaboration with the IMF. Not just because we need the $12.8 billion of contingent funds in the next three years, but also because the IMF programme represents a road map for reform. We still need real structural reform. All of the banking sector, monetary policy and the transformation of the central bank has been done. But other structural reforms remain. For example, the minister of health, Ulana Suprun, visited our strategy session last week. Instead of spending the planned 40 minutes with us to discuss health reforms, we spent two hours with her. Yesterday [April 10], all members of the central bank management board told me they would like to help the Ministry of Health to implement institutional reforms. In many ways, it is easier to implement institutional reforms as an independent central bank, as we can organise projects via our project office. Initially, as I am quite an organised person, I set about establishing all that. But now, after three years, our staff know how to do it. They know if you just create the concept, it can be very interesting and promising, but without building the institutional capacity, you will never deliver on it in reality. That’s why we can discuss how we can help others, with our project office helping them to build models and make technical decisions. Our people will volunteer to do that and spend their time because they understand how important health reform is for our country. It is the same thing for pensions, land and education reform. Do you think the politicians might have stalled on reform if it hadn’t been for IMF support? For example, when the fund’s managing director, Christine Lagarde, said back in February 2016 quite bluntly that the IMF could not keep giving money to Ukraine if the reforms do not continue. This is absolutely the case. I can tell you the central bank always met deadlines. Of course, when we committed to the IMF to deliver something, we always did that on time. It was very important for us to prepare a programme. For example, you know how difficult it was for us to have this law on the responsibilities of commercial bank management. But we put this law as a priority action in our programme. After we made the independence of the NBU a priority action in the reform programme in 2015, our parliament voted, and now you have an independent central bank that has to clean up the banking system. As you see, we used ‘special techniques’. (Laughs.) Has there been anything you’ve disagreed over with the IMF? Did they sometimes not understand the local circumstances? There are no ‘local circumstances’ here. There is no need to ‘reinvent some Ukrainian version of the bicycle’ – it’s not necessary to do that. The reforms were about how to create the basis for sustainable growth. We are deep in the middle of Europe, and are not a country that is a special client. The only disagreement with the IMF from my side was what I told you earlier about how I would like to write for them a special clause about what to do when a country is in a war. Because it’s not business-as-usual mode when you are in a real bloody war. It’s different. How did you manage to finance the military spending in that first year? Through the budget deficit, and the central bank covered the deficit. Even though the international community was playing an active role, it could not directly finance military expenditure. It could cover a budget deficit – for example, for pensions or for some guaranteed payments – but not military spending. So we endured incredible fiscal dominance as we had to cover all these deficits. But who else could do it? Nobody. Have you thought about life after you are governor, following your formal resignation on April 10? Yesterday, I said my mission is complete because all needed reforms are already done. I would like to take a sabbatical. I know that I do not want to be a regulator any more. And I will never be a politician. Were you planning to resign for some time? Was your resignation accepted? I planned to resign, but it has not yet been accepted. But I hope that our president will accept it as soon as possible. Christine Lagarde said he should accept it, as slavery was eliminated a long time ago! While I have only just announced my resignation I planned to do that three months ago, so it is the first personal non- political decision among governors in Ukrainian history. My mission is completed. I did everything I planned to do. It was just the official announcement that came out yesterday, and I still will work one more month before I leave, to ensure there is continuity. So May 10 is my last working day at NBU. I’m very proud that we built a real institutional capacity in the central bank. It’s not a ‘one-man show’. And they know that. And if our president nominates a professional non-political technocrat and seasoned banker, which I proposed to him, we can continue with that. What’s the timeline for accepting your resignation and announcing your successor? Unfortunately, it’s not formally written in the rules. Before the press conference yesterday, we discussed this with the president because I promised the markets that I will do it in one month’s time. I hope that I will be removed by parliament within a month. If the president nominated somebody who was not a non-political technocrat to be governor, how would you feel about that? It is just impossible. Quite frankly, President Poroshenko supports our reforms. And when you asked me about political will, believe me, such a smooth nationalisation of PrivatBank would never have happened unless he supported it. It was a very difficult exercise because it has a huge fiscal cost for the state, and everything needed to take place step by step due to the magnitude of this bank and the risk it posed to the financial system and transactional banking. The president always pushed other participants to do it. He was always very supportive, and I am absolutely sure that he will pick the right candidate. More than that, believe me, when I said that we really set up an institutional framework. We even signed contracts with each particular deputy governor for different terms that state that someone cannot come into the central bank and fire these people at once – it is just impossible. We created all these layers of committees – a credit committee, a supervisory committee, monetary committee and so on. Our institutional capacity is not a slogan, it’s a reality. In my last speech to our staff in our strategic session, I said: “I’ll observe you, and I’ll see if it’s a reality or just a slogan.” Would you be happy to see someone appointed from within the central bank to your role? One of the candidates that I proposed on my shortlist is from the management board. But, nevertheless, the top candidate I proposed is from the private banking sector. For me, getting the banking sector fixed is still a priority. But it is a presidential call to nominate him. My job was to convince the president about a professional technocrat candidate, and his job is to convince this candidate. Because after the humiliation that happened to me during the last three years, it’s not a dream job for anyone. But I am sure that the president will do that.

This interview took place on April 11, 2017. Central Banking made a number of efforts to seek comments from the former owners of PrivatBank and their legal representatives in relation to this article, but none were forthcoming.