“There is a draft law to introduce quasi-convertibility as soon as the Rada is working”, Volodymyr Stelmakh, the governor of the National Bank of Ukraine (NBU) announced at the European Bank for Reconstruction and Development (EBRD) annual meeting hosted by the Russian federation last weekend.
“In one to one and a half years’ time, the hryvnia will be a fully convertible currency”, Stelmakh added. If and when the government is in a position to greenlight it, that is the question.
While the phasing out of the de facto peg to the USD may be delayed by the ongoing political wrangling, the announcement is likely to alert the banks that the days of unconditional exchange rate stability may be over and that they need to hedge their foreign currency risks.
This is especially true at a time when the NBU announced an interest rate cut from 8.5% to 8% in order to boost lending to the real economy.
Despite the hryvnya’s stable exchange rate corridor against the dollar and declining interest rates, NBU statistics show that both retail and corporate clients continue to prefer borrowing in foreign currency.
According to NBU’s February 2007 bulletin, the share of foreign currency credits at the end of 2006 was 5.7% higher in year-on-year terms, equal to 49% of the total UAH 231bn credit stock.
The most worrying phenomenon is the rising share of long term forex loans to individuals, which accounted for 18.5% of the total credit stock at the end of 2006 – some 6% higher than at the beginning of the year.
The latter creates not only a currency mismatch between banks’ assets and liabilities, but also a maturity mismatch between credits and deposits – creating a long term liquidity gap.
The main reason for this is that both banks and individual clients prefer to contract long term credit in foreign currency. Banks, these days, are able to attract relatively inexpensive hard currency funds from abroad charging a very generous interest rate margin of nearly 6%.
For individuals, the reason revolves mainly around foreign currency differential. According to NBU’s 2006 year-end data the interest rate on foreign currency credits was on average 4% lower in 2006 than on hryvnya denominated loans.
Also, long term loans are usually taken to buy either real estate assets or cars, both of which are also predominantly priced in foreign currency. Linking credits to asset price seems to make sense.
The only snag is that the majority of clients receive their incomes in local currency and are therefore taking on a significant foreign currency risk, especially as the USD-UAH fluctuation corridor is likely to be widened by the central bank.
According to Moody’s credit rating agency’s recent memo, “banks may be able to hedge most of their FX risk, but this risk is, effectively, shifted on customers in the form of additional credit risk.”
Jacques Mounier, the chief executive officer of Calyon Bank in Ukraine, argued, “We are in Ukraine. Business should be done in hryvnas and other currencies should be marginal but they are not. The risk is being passed to the man on the street.”
For the time being bankers are quite bullish because interest rate margins on forex loans are very healthy and Ukraine’s macroeconomic fundamentals look quite solid. As a result, non-performing loans (NPLs) look quite benign.
But Moody’s warned that this exuberance could be unfounded. “NPLs as % of total loans are not a meaningful measure when the loan book growth is at 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 credit scoring systems, Moody’s argued, have not been tested through the economic cycle. In other words, what is going to happen if things turn sour and the Ukrainian local currency starts losing its value against the dollar? Will people who have taken out long term credits in hard currency be able to service their debts?
This question should normally be answered by the so-called stress-testing and scenario simulations done by credit risk management teams. The tools to perform such an analysis are indeed available and are constantly perfected by more experienced foreign banks that have entered the sector recently.
The fear, however, according to analysts, is that competition, combined with economic optimism and loose monetary policy causes an appetite for much higher risk, which encourages less stringent application of text book risk management rules.
Fortunately, the arrival of foreign players is likely to curb these excesses. While profit expectations from the Ukrainian market tend to encourage an aggressive lending strategy, the global appetite for risk-taking is now at its peak.
We can therefore expect a more prudent approach from shareholders in Paris, Vienna, Milan and Stockholm, especially as forex risk increases with liberalisation of Ukraine’s exchange rate policy.
