Meeting the Challenges of Ukrainian Banking

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Meeting the Challenges of Ukrainian Banking

• Yaroslav Sovgyra
• Vice-President Senior Analyst
• EMEA Banking

Kyiv, 7 February 2007
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Key challenges and risk factors for Ukrainian
banks

• Corporate governance issues, including insiders
• Weak risk management functions
• Significant credit portfolio concentration
• Rapid growth in lending
• Increasing proportion of FX lending
• Low level of liquidity
• Low level of economic capitalisation
• Other Issues and Challenges

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Corporate Governance (1/2)

• Ownership of Ukrainian banks excluding
  subsidiaries of Western banks
• The ownership structure of Ukrainian banks is
  usually opaque
• Beneficial ownership is not always known to the
  regulators and rarely publicly disclosed
• Supervisory Board is not independent the
  beneficial owner often dominates/overrides both
  the Supervisory Board and the Management Board

Opaque ownership structure and dominance of the
beneficial owner result in negative rating
implications for banks
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Corporate Governance (2/2)

• Insider lending risk
• Insider lending is one of major inherent
  weaknesses we continue to observe in Ukrainian
  banks
• This is especially true for smaller pocket
  banks
• Insider lending figures are usually understated
• Moodys criteria
• Related party loans should not exceed 25 of Tier
  1 capital
• Over 25 of the Supervisory Board should be
  independent

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Weak Risk Management Functions (1/2)

• The majority of Ukrainian banks score poorly on
  Risk Management because of the following
• Supervisory Board is rarely independent and
  rarely involved in defining risk appetite and
  control structure controlling shareholder could
  be authorising the largest transactions
• Management Board often thinks risk management is
  a secondary matter and business considerations
  should prevail
• Although senior management in banks is aware of
  risks, but they are inclined to tolerate
  excessive risk-taking culture due to intense
  competition

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Weak Risk Management Functions (2/2)

• Risk management function is rarely independent,
  does not have a veto power, often deemed not
  important enough and is poorly organised
• There is not always separation between
  underwriting, analysis and approval
• There may be insufficient control over trading
  desks
• ALM has limited tools at its disposal profit
  maximisation mentality often prevail over
  liquidity considerations
• Risk quantification (VaR, stress tests, scenario
  analyses) is often in early stages of development
• Systems are often not up to the job and require
  significant investments

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Credit Portfolio Concentration (1/2)

• Credit concentration
• Large exposures to single obligors or industries
  increase the risk profile of an institution and
  are a potential source of earnings volatility
• Borrower Concentration
• Capital or earnings may be used to cover
  unexpected losses
• Top 20 group exposures relative to earnings,
  capital
• Moodys quantitative criteria
• Top 20 group exposures are lt 50 of Tier-1 OR
  lt100 of PPI (BEST)
• Top 20 group exposures are gt 200 of Tier-1 OR
  gt750 of PPI (WORST)

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Credit Portfolio Concentration (2/2)

• Industry Concentration
• Large exposures to single obligors or industries
  increase the risk profile of an institution and
  are a potential source of earnings volatility
• aggregate exposure to borrowers in specific
  industry or sector of the economy (commercial
  real estate, shipping, energy)
• Moodys quantitative criteria
• No single sector exposure gt 50 of Tier-1 (BEST)
• No single sector exposure gt 500 of Tier-1
  (WORST)

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Rapid Growth in Lending (1/3)

• Ukrainian banking system displayed a very high
  rate of growth in both corporate and retail
  lending in 2005 and 2006, which we perceive as
  being a source of significant credit risk
• That said, the share of retail loans, especially
  mortgage loans, is increasing, which is a
  positive development (1) consumer and mortgage
  loans are granular (2) consumer loans are high
  risk, but also high margin products (3) car
  loans and mortgage loans are well-collaterised

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Rapid Growth in Lending (2/3)

• Source Association of Ukrainian banks

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Rapid Growth in Lending (3/3)

• Because of the rapid growth in loans, the true
  level of NPLs is difficult to judge
• NPLs as of total loans is not a meaningful
  measure when the loan book growth 40-50 a year
• One should look at performance of loan cohorts
  which are 3-4 years old to get a true picture
• But there is a lack of historical data
• The scoring systems (even if some of them are
  adequate) have not been tested through the
  economic cycle
• Credit risk management tools and systems are
  often inadequate, especially if the Risk function
  is not independent (see above)

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Increasing proportion of FX lending (1/2)

• Foreign exchange lending represents a source of
  significant FX and credit risk for Ukrainian
  banks
• A portion of FX risk may remain un-hedged the
  existence of regulatory ratios which limit the
  size of FX position is not a sufficient
  deterrent, in our opinion
• Refinancing risk longer-term FX assets
  (mortgages) vs. shorter-term FX liabilities
  (Eurobonds, LPNs, syndicated loans)
• Banks may be able to hedge most of their FX risk,
  but this this risk is, effectively, shifted on
  customers in the form on additional credit risk
• FX lending to SMEs poses especially high risk
• Banks do have tools at their disposal to control
  the risk of FX lending applying tighter lending
  criteria for FX lending, esp. for mortgage loans
  (higher income multiple, lower LTV, shorter
  repayment period for FX loans) but do they use
  these tools?

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Increasing proportion of FX lending (2/2)
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Low level of liquidity (1/3)

• Moodys judges banks liquidity position by
• assessing how long would the bank be able to
  survive without having access to
  interbank/capital markets (should be at least 12
  months)
• looking at balance sheet liquidity (liquid
  assets) as well as on off-balance sheet liquidity
  arrangements (committed credit lines by other
  banks, Central bank refinancing, establish
  securitisation programmes etc.)
• Although the balance sheet liquidity position may
  be distorted by interbank loans and deposits,
  most of which should be netted off when analysing
  the banks liquidity position
• assessing the banks liquidity contingency
  planning
• Looking at certain key ratios (1) liquid assets
  total assets, (2) loan-to-deposit ratio, (3)
  market fund reliance ratio (formula (Market
  funds Liquid assets)/Total assets

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Low level of liquidity (2/3)
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Low level of liquidity (3/3)

• Volatile operating environment makes the banks
  vulnerable to liquidity crisis scenarios (run on
  deposits etc.)
• Rapid growth in lending quickly erodes balance
  sheet liquidity of Ukrainian banks
• The banks have relatively low levels of balance
  sheet liquidity, as judged by (1) liquid assets
  total assets ratio and (2) loan-to-deposit ratio
• Capital increases, syndicated borrowings and
  Eurobond issues only help for a short while
• Limited sources of alternative liquidity
• Profitability considerations often prevail over
  the needs to maintain strong liquidity position

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Low level of economic capitalisation

• Ukrainian banks, whilst maintaining sufficient
  level of regulatory capital, generally display
  low level of economic capitalisation
• The level of free economic capital (capital less
  fixed assets) is even lower
• A significant proportion of capital may be
  represented by asset revaluation surplus, which
  we view negatively
• Internal capital generation ability (capital
  generated from recurring earnings) of most
  Ukrainian banks is very weak
• On top of it, Ukrainian banks constantly need
  capital injections from their owners to sustain
  their current pace of growth
• Low level of economic capitalisation is one of
  the rating-constraining factors for Ukrainian
  banks

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Other Issues and Challenges

• Tax contingencies
• Most Ukrainian banks use aggressive tax planning
  strategies (via insurance etc.) which (1)
  potentially expose them to significant tax
  contingencies and (2) make the banks financial
  results more opaque
• Regulatory environment in Ukraine is still
  relatively weak
• Whilst detail regulations exist on Licensing,
  Capital Regulation, Asset Quality, Related Party
  Lending, Liquidity etc., we feel that these
  regulations are not enforced with a sufficient
  rigour, and in some cases bank regulators may be
  subject to external influences
• Money laundering is not actively tackled FMU
  monitoring activities only resulted in two court
  judgements over the last three years

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Ukrainian banks rated by Moodys (1/7)

• Ukrainian bank ratings
  Rating outlooks
• 
  (Deposit rating/FSR)
• Alfa bank Ukraine (B2/NP/E)
  Positive/Stable
• Bank Finance and Credit Ltd (B2/NP/E)
  Stable/Stable
• Bank Nadra (B2/NP/E)
  Positive/Stable
• Bank NRB (B2/NP/E)
  Positive/Stable
• Calyon bank Ukraine (B2/NP/D-)
  Positive/Stable
• Credit-Dnepr (B3/NP/E)
  Stable/Stable
• DonGorBank (B2/NP/E)
  Stable/Stable
• Forum Bank (B2/NP/E)
  Positive/Stable
• Index-Bank (B2/NP/E)
  Positive/Stable
• Industrialbank (B3/NP/E)
  Stable/Stable
• Kreditprombank (B2/NP/E)
  Stable/Stable

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Ukrainian banks rated by Moodys (2/7)

• Ukrainian bank ratings
  Rating outlooks
• 
  (Deposit rating/FSR)
• Pivdennyi Bank (B2/NP/E)
  Stable/Stable
• Pravex-Bank (B2/NP/E)
  Stable/Stable
• Privatbank (B2/NP/E)
  Positive/Stable
• Raiffeisen Bank Aval (B2/NP/E)
  Positive/Stable
• Rodovid Bank (B3/NP/E)
  Stable/Stable
• TAS-Investbank (B2/NP/E)
  Stable/Stable
• TAS-Kommerzbank (B2/NP/E)
  Stable/Stable
• Ukreximbank (B2/NP/D-)
  Positive/Stable
• Ukrgasbank (B2/NP/E)
  Stable/Stable
• Ukrsibbank (B2/NP/E)
  Positive/Stable
• Ukrsotsbank (B2/NP/D-)
  Positive/Positive
• VaBank (B2/NP/E)
  Stable/Stable

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Ukrainian banks rated by Moodys (3/7)

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Ukrainian banks rated by Moodys (4/7)

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Ukrainian banks rated by Moodys (5/7)

• Deposit ratings of some Ukrainian banks are
  driven by imputed support from their parents
• Alfa Bank Ukraine Alfa Group
• Raiffeisenbank Aval Raiffeisen bank
• Calyon Bank Ukraine Credit Agricole
• Index-Bank Credit
  Agricole
• Ukreximbank Government
  of Ukraine
• Ukrsibank BNP
  Paribas

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Ukrainian banks rated by Moodys (6/7)

• While deposit ratings of other banks are based
  either on their systemic importance or on
  government ownership
• Ukreximbank 100
  government-owned
• Privatbank
  systemically important
• Ukrsotsbank systemically
  important
• Raiffeisenbank Aval systemic
  parental support
• Ukrsibbank systemic parental support

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Ukrainian banks rated by Moodys (7/7)

• Most Foreign Currency Long-Term Deposit Ratings
  of Ukrainian banks are constrained by the Foreign
  Currency Deposit Ceiling for Ukraine B2
  (Positive Outlook)
• Local Currency Long-Term Deposit Ratings of
  Ukrainian banks cannot exceed the Local Currency
  Deposit Ceiling for Ukraine Baa1
• National Scale ratings can reach Aaa.ua, but they
  are not globally comparable

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Contacts

• Yaroslav Sovgyra
• yaroslav.sovgyra_at_moodys.com
• Vladlen Kuznetsov
• vladlen.kuznetsov_at_moodys.com
• Konstantin Sorin
• konstantin.sorin_at_moodys.com