In December 2015 NPLs in Ukraine amounted to €14.0 billion, equivalent to a NPL ratio of 28.0% and a NPL coverage ratio of 64.6%. As of mid-2016, 81 banks were under temporary administration or liquidation in Ukraine (mostly under the umbrella of the Deposit Guarantee Fund).
The third Ukraine Financial sector forum, held in Kiev in March 2016 under the umbrella of the Vienna Initiative, reviewed the progress in NPLs resolution.
The Law on Financial Restructuring was adopted by the parliament in June 2016 and will be effective on 19 October 2016. This so-called “Kyiv approach” to coordinated out-of-court restructuring represents a key measure envisaged in the Memorandum with the IMF, and was developed with assistance of the EBRD. In addition, EBRD is supporting the implementation of the Financial Restructuring Law, which consists amongst others in: (1) supporting the drafting the Arbitration Rules and training and establishment of the Arbitration Committee; (2) supporting the training and establishment of the Secretariat; and (iii) providing some financial support for the operation of the Secretariat and Arbitration Committee for the first two years.
Moreover, the strengthening of the corporate insolvency and credit enforcement regimes is also in progress and amendments to the Tax Code will give favourable treatment to NPL write-offs.
Assessment of NPL Burden and Corporate Debt Distress
IMF, Ukraine – First Review under the Extended Arrangement, August 2015
The NPL ratio increased in 2015. Slightly less than half of the increase was due to new impaired loans, while the rest stemmed from the declining credit stock and valuation effects. The aggregate regulatory capital adequacy ratio (CAR) dropped in 2015, reflecting (i) the impact of the exchange rate depreciation on the banks’ negative open position in FX; (ii) higher NPLs; and (iii) increased provisioning. Since January 2014, 51 insolvent banks, accounting for 21.8% of the system’s total assets, have been intervened (42 of them liquidated and the remaining placed under temporary administration), including two large banks.
Oesterreichische National Bank, Ukraine: struggling banking sector amid substantial uncertainty, data as of June 2015
The reversal of deposit flows pushed the loan-to-deposit ratio back up to 159% at end-March 2015. While loans still expanded, if at a decelerating pace in the first quarter of 2014, they contracted substantially from the second quarter (year on year in real terms, exchange rate-adjusted). Accordingly, as of end-March 2015, the contraction of total loans had accelerated to 43%, and retail credit had shrunk by 44%.The credit crunch was not primarily triggered by reduced liquidity, but by the renewed deterioration of credit quality (because of the fall of the hryvnia and Ukraine’s slide into recession) and the worsening overall economic outlook.
The depreciation (exchange rate valuation effects) pushed the already high share of foreign currency-denominated loans in total loans from 34% (end-2013) to 56% (end-March 2015). Even for retail loans, the ratio rose back to 57% – a highly problematic level, given many unhedged borrowers in the household sector, particularly with regard to mortgage loans (which make up more than one-third of household loans). In any case, the share of retail credit in total credit declined from about one-quarter at end-2011 to one fifth three years later. The rise of NPLs and the weakening of lending contributed to a decline of capital adequacy from 18.3% at end-2013 to 14.8% at end-March 2014. After some recapitalization measures, capital adequacy recovered to 16% in late 2014, but then plummeted to 8.4% at end-March 2015. Ukrainian banks’ aggregate capital adequacy thus no longer complies with the regulatory minimum level of 10% set by the NBU. Although fully up-to-date data are not yet available, the plunge is probably due to a further dramatic deterioration of credit quality.
National reforms and support by the international organisations
IMF, Ukraine, First Review under the Extended Arrangement, August 2015
Policy reforms related to NPLs:-
Strengthening the Deposit Guarantee Fund (DGF). The process of improving asset recovery, depositor payout, and DGF accountability is ongoing. The authorities have extended the timeframe to complete bank liquidation from three to five years with the view to maximize asset recovery. In addition, a process has been launched to conduct due diligence investigations (forensic audits) of failed banks.
Addressing NPLs. To address the rising NPLs, the authorities will draw on the recent Fund TA and strengthen the legal framework related to private debt restructuring. Parliament will approve by end-March 2016 (structural benchmark) amendments to the legislation listed in MEFP 17 (Memorandum of Economic and Financial Policies), consistent with IMF staff advice, to strengthen the corporate insolvency and credit enforcement regimes and to remove tax impediments. Specifically, these will include (i) the Bankruptcy Law to address key areas of weakness; (ii) the relevant laws to strengthen the legal environment of credit; and (iii) the Tax Code and other regulations to remove disincentives to insolvency and debt restructuring activities (MEFP 17). The authorities are also progressing on designing a coordinated out-of-court restructuring arrangement for corporate debt (MEFP 18) and facilitating the restructuring of foreign-currency denominated mortgage loans through a voluntary negotiation process between borrowers and banks (MEFP 19). In light of this comprehensive approach, the president has committed to veto the recent legislation on FX loan conversion (which would entail substantial losses for banks, without necessarily resolving underlying problems).
IMF will continue to implement measures to improve depositor payout, the least cost resolution process, and prospects for asset recovery from failed banks. In this regard, we: (i) extended the timeframe to complete bank liquidation from three to five years; (ii) are creating a centralized unit to improve asset recovery; and (iii) have completed the terms of reference to conduct due diligence investigations (forensic audits) of failed banks and are pursuing funding to launch the bid process to select the auditing firms no later than end-August 2015. The DGF will develop an action plan to initiate immediate recovery of bank losses from shareholders found responsible for their banks’ failures. For non-systemic banks, the DGF will start preparations for takeover, including early verification of banks’ deposit records and prequalification of bidders, to improve the timeliness of depositor payouts. Also, banks meeting certain criteria will be automatically liquidated and the time period for temporary administration shortened to reduce the asset deterioration that occurs under the current lengthy administration process.
Work on an alternative out-of-court mechanism for debt restructuring is also progressing. With technical assistance from the EBRD and the WB, significant progress have been made in designing a coordinated out-of-court restructuring arrangement for corporate debt (the “Kyiv approach”), in line with international best practice including the INSOL principles, and the Istanbul approach. [Update: The law was adopted in June 2016 (not 2015) and will be effective on 19 October 2016.]
Steps were taken to facilitate the restructuring of foreign currency denominated mortgage loans through a voluntary negotiation process between borrowers and banks. 11 banks have signed a Memorandum with the NBU on voluntary restructuring of mortgage loans and other banks with large portfolios are considering signing. Moreover, parliament passed amendments to the Tax Code in May 2015 that provide borrowers with tax relief from the proceeds arising from the partial debt forgiveness and tax deductibility of such losses to banks. By end July 2015, the NBU, after consulting with Fund staff and stakeholders, will issue a Code of Conduct to guide the voluntary negotiations, debt restructuring, and appeals process.