Tightening Up

Economic News

22 Jul 2010
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On October 13, the National Bank of Ukraine (NBU) announced emergency measures intended to shore up confidence in the banking sector by preventing a flight of capital and reassuring savers that their assets are secure, while Ukraine absorbs the impact of the financial crisis.

The NBU imposed a six-month suspension on early withdrawal of term deposits with maturity dates from commercial banks. It also increased its deposit guarantee to $38,000, more than three times the previous limit, as well as raised the reserve requirements for banks.

The NBU has already extended $1.1bn in emergency funding to various banks since the beginning of October in order to keep them liquid. This includes a $600m rescue package to Prominvestbank, Ukraine's sixth largest bank, which has also accepted government management as part of the agreement. Prominvestbank was the subject of a run on deposits, said to have been triggered by a smear campaign.

Overall, some $3bn, or 4% of all deposits, has been withdrawn since the beginning of October, according to Royal Bank of Scotland analyst Tim Ash.

Ash told international press that the measures came amid increasing stress on the local banking system combined with the drying up of international credit. He added that a third factor is political uncertainty, with erstwhile allies President Viktor Yushchenko and Prime Minister Yulia Tymoshenko warring over the former's decision to dissolve parliament and call a snap election to break the country's political deadlock.

The NBU has recently been following the policy of allowing the hryvnia to depreciate from its target value of 4.95 to the US dollar. It is hoped that this should help lower the cost of Ukraine's exports and reduce the current account deficit. However, the bank now finds itself in a difficult position, as the falling currency has eroded consumers' spending power and made hryvnia savings less attractive.

A report by ratings agency Standard and Poor's (S&P) published on October 13 warned that the combination of falling currency and high inflation - which ran at a year-on-year rate of 24.6% in September - posed a risk to the banking sector.

"We expect that continuing high inflation and a weakening hryvnia will reduce the ability of borrowers - especially consumers and small and midsize enterprises - to repay debt obligations, leading to marked asset-quality deterioration. The banking sector is highly vulnerable to political instability and depositor confidence," S&P said in a statement.

On the other hand, the NBU may be reluctant to use its foreign reserves to bolster the hryvnia, as it is committed to deploying large sums to refinance floundering banks. Ominously, S&P's report also downgraded the credit rating outlook of three Ukrainian banks to negative, indicating the possibility of more bail-outs in the future. Even those banks that have invested prudently and are relatively well-provisioned may feel the squeeze, as external lenders become less able and willing to extend credit, particularly given the short-to-medium term uncertainties in Ukraine. Reports in the international press that Ukraine is looking for a new funding deal with the International Monetary Fund (IMF), apparently to bolster its banks, is a sign of how serious the situation could become.

While the NBU seems to be in an unenviable position at the moment, authorities remain outwardly convinced that their emergency measures will restore confidence, which they see as the most important issue.

"The psychological factor is 90% responsible for creating panic," NBU deputy chairman Anatoliy Shapovalov told the local press. "This decision was made so that people calm down and banks work in a normal manner."

Analysts interviewed in local media have concurred that the system can be brought back to an even keel, and that talk of panic is exaggerated. "The economic crisis does not yet threaten Ukraine. Bank deposits have grown 137% in the last 12 months," economist Victor Lysytsky told local press.

Lysytsky's statement suggests that as faith in banks has increased considerably, the imposition of reserve requirements, which limit the proportion of deposits that banks can lend, should therefore not severely limit growth.

The NBU has around $38bn in foreign reserves - enough to fund additional refinancing up to a point, if necessary. Nonetheless, if the bank's policies do not have the desired effect, a tense situation could rapidly unravel.

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