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Where there is no law, but every man does what is right in his own eyes, there is the least of real liberty
Henry M. Robert

BURY YOUR MONEY IN BANKS Or why Ukrainians need accounting

13 November, 2012 - 00:00

Last week the Cabinet, driven by an impassioned desire to evacuate its debt pyramid into the next millennium, made another thoroughly abortive attempt to pass responsibility to the banking system for the approaching default.

Although Oleksandr Suhoniako of the Banking Association explained, only days after the Cabinet resolution about converting domestic government bonds into deferred liabilities, that the absence of the voluntary conduct clause was just a technical error ("There is no default in Ukraine; the government is honoring its commitments and will continue to do so..."), the rank-and-file depositor should take a closer look at the existing banking system. The domestic bonds held by resident banks will be exchanged anyway, albeit "with due regard for the specifics of each bank."

Interestingly, last week's confrontation between the Cabinet and the banks exposed certain characteristics of the whole banking system. Thus, Mr. Suhoniako drew the ranking bureaucrats' attention to the lamentable condition of a number of banks, noting that over the past 25 days citizens' deposits had fallen by Hr 300 million. His pessimism is not shared by people at the National Bank, believing that the head Ukrainian banker was laying it on too thick. Maybe so. However, it would not do to ignore what could be the last warming before a mass confiscation of bank assets, the more so that there are heavy losses on the banking front.

The Day has written about the Ukraine Bank drama. Now is a time as good as any to discuss the background, precisely what made the Bank's ex-President Viktor Kravets find another job. When given the appointment, after being transferred from an important post at the National Bank, he was supposed to "enhance its financial positions," just like his predecessor. Indeed, Mr. Kravets, a topnotch financier, seemed firmly resolved to transform his bank, a de facto government-run institution, into a purely business entity at once. Gradually, the bank began to make loans to profitable businesses and was among the first to receive a lucrative loan from its Western counterparts. In fact, EBRD voiced its interest in purchasing a block of shares — and EBRD is known for carefully weighing all the pros and cons of every single investment project. A while later, after another credit tranche "for the countryside" remained suspended (experts blame this on the bank's President with his penchant for compromise), and after the government bureaucracy assumed a firmer control over the bank's decision-making (and quite possibly due to the bank's mismanagement — remember media reports on bank officials' theft?), EBRD discarded the investment idea. Add here a heavy percentage of problem loans (no one knows exactly how heavy) out of the 987-million-worth credit portfolio, with rural clients annually losing Hr 2-3 billion, investments in domestic bonds frozen, and the rest in Russian stocks. Now it becomes clear why the Ukraine Bank was suddenly in need of new management and a reorganizing loan from the NBU.

Remarkably, the situation with Ukraine Bank is not unique in this country. In the nearest future the same may happen to most other Ukrainian banks, although the problems they face did not suddenly arise yesterday. In the first half of the year capital facilities in the banking system showed noticeable stagnation (according to the Commercial Banks Association, 37% of the banks had less than 1% in terms of asset yields) and credit activity dropped abruptly. Tempestuous government monetary demand forced the banks to concentrate on investing in government securities. NBU reports that over the past 12 months the broad money turnover increment has amounted to 25% (Hr 2.8 billion), while loans to the government by the banking system rose by 47% (Hr 3.2 billion). Incidentally, Interfax-Ukraine says that the Finance Ministry has made no payments on the domestic government bonds maturing September 11 (September 16 data), but voluntary conversion was extended until September 18.

These dry figures have important practical meaning. Ukrainian banks are currently too closely linked to the bankrupt government to serve as safe depositories for someone else's savings. And so their clients have to think twice before making further deposits and withdraw everything at the slightest alarming sign. The fact that Ukrainian banks are inherently susceptible to crises is an open secret, contrary to what many believe. It suffices to analyze any bank's balance report and single out all the risky items, proceeding from the economic political realities. In other words, Ukrainians should follow their Russian neighbors' example and take a course in bank accounting and reporting.

Summing up the above, the first symptom of this problematic disease lies in their major investments in government securities. The latter were traditionally considered the most reliable and liquid instruments for the commercial banks and those of the latter with the largest amount of such securities were regarded as rock-solid, compared to the others. After government securities showed noticeable decline, further to be frozen, financial institutions having large holdings in them found the assets meant to maintain their liquidity bound hand and foot. Before long this will affect their ability to honor their commitments. Another risk factor is the low share of highly liquid investments in the banks' portfolio of assets. In the current financial crisis highly liquid investments capable of securing banks' performance for their partners and timely payments to clients are nothing but their correspondent account balance at the National Bank, cash balance, and to an extent such correspondent account balance at other banks. The third aspect which deserves special notice is the excessive ratio of interbank transactions. While in economic crisis this indicator is yet another risk factor, simply because loans issued by ailing banks may well turn out bad, while the cost of drawing resources against the backdrop of lowering interbank operations will jump or the process will stop altogether. The fourth aspect is the low profitability of bank transactions or its absence, pointing to that bank's getting ineffective and being threatened by bankruptcy. And the fifth aspect is low capitalization (i.e., capital-assets ratio), meaning that a given bank does not have in terms of its own capital, the money needed to serve as the guarantee of its honoring its commitments, considering the amount of such liabilities. The higher this ratio, the greater the probability that the bank will carry out its obligations to its clients and partners.

This author purposefully refrained from identifying banks whose indices answer several or all problem balance criteria. But the most inquisitive may consult the journal Visnyk Natsionalnoho Banku Ukrainy (1998, No. 9) and other special publications carrying bank balance reports for the first half of this year. They may also visit banks and ask for such information. In the latter case, a rank-and-file depositor should bear in mind that an ailing bank will show less enthusiasm in conducting such a dialogue.

 

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