While the rest of Europe is witnessing the decline of small banks, with most countries dominated by a few large players, the western Ukranian region of Lviv would benefit from maintaining regional specialisation.
Traditionally dominated by small-and medium-sized enterprises (SMEs) in textiles, agriculture and tourism, Lviv's proximity to EU members Poland, Romania and Slovakia makes it a focal area for cross-border trade and export-oriented industries.
High levels of foreign direct investment in the region have boosted foreign bank interest. Of the five banks headquartered in Lviv, Electron Bank, Bank Lviv, Dnister, Kredobank and Universal Bank, all but Dnister are in the hands of foreign investors.
"There are a lot of foreign companies from Poland, Germany and Italy working in the Lviv region. Foreign business prefers to work with foreign banks," said Valentyn Seleznyuk, an analyst at Ukranian investment bank Millenium Capital.
The pace of foreign acquisition was accelerated by Lviv banks' need to draw in international players to secure a long-term funding base. Moderately sized balance sheets meant these banks were relatively comfortable entry-points for Western banks willing to explore the Ukrainian market.
According to Dragon Capital in Ukraine, the growth of banks with foreign capital has increased dramatically in the past three years. As of July, 2007, some 88% of the total $1.3bn in banking assets was controlled by foreign investors. This is significantly higher than the share of foreign participation in all sectors of Ukraine, which is approaching 40%, following recent acquisition of Ukrsotsbank by Italy's UniCredito group.
Oleg Pronin, analyst at Dragon, said, "Foreign banks are attracted by the region's potential to develop credit access for small- and medium-sized businesses and individuals."
The absence of clients for big-ticket lending, however, means the banking sector is more retail-focused and client-intensive than in other regions of the country.
To accommodate regional needs, banks are having to expand their branch networks, opening specialised centres for financing SMEs.
While large industrial groups in the east have long had access to the financial market through their own banks and direct interactions with foreign lending institutions, focus on retail leaves corporate sector lending in Lviv relatively immature. SMEs continue to operate in the informal economy, inhibiting the fast take-up of financial services, another argument for specialised regional banks.
Both local and international banks operating in Ukraine have developed fairly reliable credit control and risk assessment models that take into account the undeclared income of individuals and SMEs. The key is a good understanding of clients' business needs, an understanding that requires close geographical proximity.
Until now, most banks have operated on the basis of strictly collateralised loans, eliminating a large portion of potential clients who lacked quality assets. This affects the development of rural finance, one of Lviv's most promising growth areas. Banks are often hesitant to work with the agricultural sector because in the absence of proper land reform, land cannot be used as collateral to obtain financing. Lenders are rarely satisfied with other forms of collateral such as future harvests or equipment.
The gap is bridged to some extent by specialised credit lines extended by the World Bank and the European Bank for Reconstruction and Development. In addition, foreign banks such as Germany's ProCredit have created successful schemes to lend to SMEs without collateral, though these loans tend to be small, with short-term maturity.
Boosting the rural economy is the main challenge facing the Lviv region and banks hoping to retain their regional niche focus. The level of per capita income in the area is considerably lower than in more developed Kiev or even Dnipropetrovsk. In the absence of growth, the region will face stagnating incomes and an exodus of talented labour, meaning there is unlikely to be enough business to go around to support regional bank specialisation.
Regional banks themselves face labour shortages. Luckily the region's proximity to the West has helped answer this problem. There has been a healthy inflow of expertise and personnel from neighbouring Poland, which sees western Ukraine as a prime growth area.
Lviv's location makes it a prime candidate for regional bank specialisation. The economy is likely to remain quite local in the near future, with strong regional ties across its borders. If local authorities invest in infrastructure to support the growth of industry, Lviv could become a small but confident regional tiger, outpacing other Ukrainian regions that rely heavily on resource-consuming industries.