Banks and Bank Regulation

Ukraine has a two-tiered banking system. The National Bank of Ukraine (NBU) is the country’s central bank. Commercial banks, including Ukreximbank, the state export-import bank of Ukraine, and Oschadny Bank, the state savings bank of Ukraine, operate under the authorization and supervision of the NBU.

National Bank of Ukraine

The 1999 National Bank Law states that the primary function of the NBU is to ensure the stability of the monetary unit of Ukraine, the hryvnia (UAH). The NBU is also tasked with maintaining the stability in the banking system and price stability, within the scope of its power.
The National Bank of Ukraine exercises regulation and banking supervision in accordance with the provisions of the Constitution of Ukraine, the Law of Ukraine “On Banks and Banking”, the Law of Ukraine “On the National Bank of Ukraine” and other legislative acts of Ukraine and regulations of the National Bank of Ukraine.

The purpose of banking supervision is stability of the banking system and protection of interests of depositors and creditors as to the safekeeping of client’s funds on banking accounts.

Supervisory activity of the National Bank of Ukraine covers all banks, their subdivisions, affiliated and related parties of the banks on the territory of Ukraine and abroad, offices of foreign banks in Ukraine, as well as other legal entities and individuals in their compliance with the requirements of the Law of Ukraine “On Banks and Banking” as to performing banking activity.

In order to exercise its functions, the National Bank is entitled to obtain free of charge from the banks, bank unions (associations) and legal entities that have been granted a license by the National Bank to perform certain banking transactions, as well as from the persons whose activities are supervised by the National Bank pursuant to the Law of Ukraine “On Banks and Banking”, the information of their activities and explanations with regard to the obtained information and effected transactions.

The obtained information is not to be disclosed, except in the cases prescribed by the laws of Ukraine.

In the course of banking supervision, the National Bank of Ukraine has the right to require that the banks and managers thereof eliminate banking legislation violations, fulfill NBU regulations in order to avoid or to overcome undesirable consequences, which could jeopardize safety of the funds, entrusted to these banks or inflict damage on a proper banking activity.

The National Bank of Ukraine carries out the banking supervision in the form of on-site inspections and off-site supervision.

The highest governing body of the NBU is the 15-member Council. Seven members are appointed by the Verkhovna Rada (the Parliament) and seven by the President. The Bank Governor, who is nominated by the President and appointed by the Rada, acts ex officio as the 15th member. The Council is responsible for developing the principles underlying the country’s monetary policy.

The banking sector

The Ukrainian banking sector has historically suffered from a number of significant weaknesses, including undercapitalization, weak corporate governance and management, poor asset quality, and even excessive political intervention in some instances. The situation is improving and reforms are continuing. Today, Ukraine’s banks are required to prepare accounts based on International Financial Reporting Standards (IFRS).
 
Most banking services are available in Ukraine, and consumer credit facilities are expanding rapidly. Intermediation costs remain fairly high, although the presence of Western banks, particularly in retail banking, should force the sector to become more efficient over time. In November 2006, the Parliament passed a law that permit foreign banks to operate branch offices in Ukraine since the country joined the WTO.
 
As of April 1, 2016, 111 commercial banks were registered in Ukraine, 43 of which are banks with foreign capital (against 176 and 53 accordingly as of January 1, 2013).

 Ukraine’s banking sector has a high level of concentration. According to NBU data, over 91% of the sector’s total assets are held by the 20 largest banks as of April 1, 2016.

Ukraine is experiencing one of the most challenging periods in its modern history. The ongoing economic, social and political crisis has hit all market segments and the banking sector in particular. Industrial output decline, capital outflows, job cuts, and the vast volatility of the monetary fundamentals and the exchange rate created an extremely challenging environment for local banks.

One of the key problems currently faced by Ukrainian banks is the liquidity short¬age, enhanced by vast deposit outflow. During 2014, the Ukrainian banking sec¬tor lost UAH 200 bn in deposits, which is about 15% of the banking sector's to¬tal assets. As a result, banks faced a liquidity crunch, and many of them had no other option but to close and leave the market. As of May 1, 2016, 71 banks are going through the liquidation process held by the Deposit Guarantee Fund, thus leaving the market. The rapid and sharp worsening of the economic environment has also caused a spike in the NPL ratio. According to First Deputy Governor of the National Bank of Ukraine Kateryna Rozhkova, NPL ration in the Ukrainian banking system exceeds 40% as of April 2016.

In addition to the revenue shortfall due to escalated credit and market risks and the vastly depreciated domestic currency, banks are forced to create extra provi¬sioning for bad loans and FCY-denominated loans. As a result, the total banking sector loss reached UAH 53 bn as at year-end 2014 and UAH 77.9 bn as at year-end 2015. According to NBU data, the system's RoE was minus 51.91% as of December 2015 (compared to -30.46% as of December 2014) and the system’s RoA was minus 5.46% as of December 2015 (compared to -4.07% as of December 2014).

In March 2015, the IMF Executive Board approved a new four-year Extended Fund Facility program for Ukraine totaling USD 17.5 bn. The first tranche of USD 5 bn was already released, USD 2.7 bn thereof aimed at supporting the budget. The remaining amount was used for replenishing National Bank FX-reserves. The key requirement of the new IMF program was the de-escalation of the conflict in the Eastern regions of the country. It is based on the expectation that the Ukrain¬ian economy will eventually cease to feel the impact of the conflict and start per¬forming again in 2016 (after a deep recession in 2015).

In addition, and this is most impor¬tant, the IMF program provides assis¬tance for urgently needed reforms of economic governance and the fight against corruption, for the energy sec¬tor, as well as optimizations in public spending and improvements in invest¬ment climate. It is partly related to the banking system and envisages a set of measures for its stabilization, aimed at providing general monetary stabil¬ity and economic growth. (For more details on the IMF program, please refer to our section on page 54.) All in all, the described set of IMF-measures, if implemented as stated, should be strongly supportive to the Ukrain¬ian economy and monetary system. However - as it is always the case during crises - there are major risks on the execu¬tion side. Not only is enough political will required to perform all the needed steps, it is also necessary to reach an accord within the Ukrainian society to ensure general public support of the government in implementing these reforms.

Following the adoption by the Parliament in March 2015 of the Law, which increased responsibility of persons related to a bank (the Law), the National Bank of Ukraine (the NBU) developed several regulations (Regulation No. 328 and Regulation No. 332 of 21 May 2015 and Regulation No. 357 of 4 June 2015 – collectively referred to as the Regulations) aiming at practical implementation of new requirements established by the Law.

To remind, the Law expanded the list of persons related to a bank as well as liability of such persons, set out new restrictions on transactions with related persons, introduced new requirements regarding disclosure of the banks' ownership structure and reconsidered the approach to obtaining approval for acquisition of a significant interest in a bank.

Being inspired by the IMF support of the targeted transparency of the Ukrainian banking system, the NBU has further developed most of the novelties established by the Law. In particular, the NBU changed the requirements to solvency of the ultimate beneficial owners of Ukrainian banks (the UBOs) and established new approaches to disclosure of bank shareholding structure.

New regulations - important takeaways:
Pragmatic approach to UBO solvency: to be cleared by the NBU, a UBO should have income exceeding the bank's regulatory capital

The NBU enhanced requirements to financial standing of the UBOs. Under the new rules, the UBO's income should be sufficient to ensure further capitalisation of the bank. In setting out the UBO income sufficiency test, the NBU linked the UBO's income to the bank's regulatory capital or its charter capital, in case it exceeds the regulatory capital.

Example: a person acquiring 50% shareholding in a bank with regulatory capital of UAH 500m should prove legitimate income in amount exceeding UAH 250m. Otherwise, such person will not obtain the NBU approval for the acquisition of a significant interest in such bank.
In case a bank claims absence of the UBO, the NBU may apply 'informal ownership concept' or inspect ten largest 'ultimate key stakeholders'

In case a bank’s shareholding structure does not reveal a clear link with a particular UBO, the NBU will most likely suspect such bank in having nominee shareholders acting in the interests of a real UBO. In such case, the NBU will be able:

to apply the so-called 'informal ownership concept' in case the lack of information on the formal ownership in a bank. As a result, the NBU will be entitled to recognise a person having a significant or decisive influence over the bank's management and activity as an owner of a significant interest in such bank. To the moment, the NBU has already tested the informal ownership concept on several occasions. In particular, the NBU identified and imposed sanctions on several informal owners of a significant interest in Ukrainian banks. Furthermore, the NBU is planning to dramatically increase fines applicable to informal owners of a significant interest in a bank, who did not obtain the respective NBU approval; or to check financial standing of ten largest 'ultimate key stakeholders' – persons holding at least 2% shareholding in a legal entity in the bank's ownership chain and which do not themselves have key stakeholders (e.g., individuals or foreign public listed companies). If at least two ultimate key stakeholders holding more than 5% shareholding in a bank or one person holding ultimately at least 10% stake fail to prove sufficient financial standing, the NBU may designate ownership structure of a bank as "non-transparent".

Banks designated by the NBU as having non-transparent ownership structure may face serious adverse consequences. In particular, the NBU may refuse to grant a refinancing loan to such bank, prevent it from purchasing foreign currency or otherwise restrict banking operations. Business reputation of the managers of such bank may be seriously affected. In the worst-case scenario, the NBU may designate such bank as a "problematic" one.

New NBU approach requires investors to conduct thorough and careful structuring of acquisition of Ukrainian banks

The Regulations established new rules directly affecting the structures commonly used by lawyers when documenting an acquisition of a Ukrainian bank:

New formula for calculation of indirect ownership in a bank. The formula should provide the NBU with additional instruments for identifying indirect owners of a significant interest in a bank. According to the Regulations, the NBU will use the formula in addition to the criterion of control.

Ban on discretionary trust structures. Regulations designate the ownership structure of a bank as non-transparent if significant holding in a bank is transferred to a discretionary trust making it impossible to determine all owners of a significant interest in a bank.

Certain exemptions for private investment vehicle structures. The NBU appreciated the fact that some private investment vehicles, such as limited partnerships, may find it difficult (if possible at all) to provide all documents and comply with formal requirements commonly applied by the NBU to the acquirers of a significant interest in a Ukrainian bank. Therefore, in case private investment vehicles meet the criteria envisaged by the Regulations, the NBU may exempt such vehicles from obligation to comply with all formal requirements.

Separate submission procedure for persons qualified as indirect owners of a significant interest in a bank following the adoption of the Law

As a result of application of the new rules set out by the Law, certain persons found themselves in a position where they de-facto became indirect owners of a significant interest in a bank irrespective of control over the direct owner of the bank. The Regulations addressed this situation and established a procedure for obtaining an approval by such persons. The NBU extended the final term for submission of required documents to the NBU until 8 July 2015.