World Bank report recommends stricter regulation of Ukraine's banks (11/11/01)

World Bank report recommends stricter regulation of Ukraine's banks

by Roman Woronowycz
Kyiv Press Bureau

KYIV - The World Bank issued a report on October 23 recommending stiffer regulation of Ukraine's banks and financial institutions to strengthen the industry, as well as a process of consolidation that would allow it to begin to better influence the development of Ukraine's economy.

The report was issued as the World Bank completed a reform program within Ukraine's financial sector begun in 1997 that laid the substantive groundwork for the more dramatic changes now required.

Alan Roe, editor of the project, which analyzed the state of Ukraine's financial sector, said that one of the first things needed is curtailment of the number of banks in the country.

"Ukraine has far too many banks - 194, I believe," explained Mr. Roe. "A process must take place to consolidate them."

Mr. Roe said the World Bank is not advocating a selective liquidation process, but the development of stringent criteria by the National Bank of Ukraine (NBU), which would support the leanest and most competitive banks, and force the weakest ones out of business.

The World Bank representative said the first requirement that should be imposed is raising the minimum capital deposits the National Bank of Ukraine requires of the country's commercial banks. He also said the NBU must more stringently uphold what have been at times lax policies regarding the fulfillment of other financial requirements.

Mr. Roe said the recently completed World Bank financial sector adjustment program already had brought much-needed change to Ukraine's banking industry. Among the accomplishments he listed: the introduction of international accounting systems; reform of bank regulations and introduction of compliance and core banking principles; more information exchange to determine the status of the largest banks; and education on insolvency and liquidation procedures.

He said that one reason the Ukrainian financial sector continues to struggle today is because an unusually large proportion of the economy is still cash-based. No more than 5 percent of businesses utilize debt in their operations. Also, non-banking financial institutions, which are a rich source of capital in developed countries, are almost non-existent in Ukraine. Whereas financial organizations such as pension funds, mutual funds, stocks and investment trusts make up about 19 percent of the financial sectors of Hungary and the Czech Republic, in Ukraine they constitute a mere 1 percent of financial transactions.

Much more must be done to put the industry on par with Western Europe, explained Mr. Roe. Besides the consolidation of banks through more stringent NBU policies, there must be an effort by commercial banks and non-banking financial institutions to develop a sounder client base. First, the financial sector has to stop credit policies that rely, for the most part, not on objective criteria but on subjective relations between the lending institution and the client.

Second, banks need to begin to cut costs. Banking services in Ukraine are very expensive because banking expenses are high. Whereas in Western Europe overhead is about 3 to 4 percent of total transactions, in Ukraine it is closer to 30 percent. There are several disparate reasons for the higher overhead, including high fixed costs, the influences of inflation on the economy, inefficient organizational structures and procedures - remnants of the country's Soviet past, and bad borrowing practices.

The result is that Ukrainian banks must charge what are considered usurious interest rates in order to make a profit. That, in turn, limits its clientele to high-risk borrowers, many of a dubious nature, who are willing to pay the high cost of obtaining loans and who often default. This obvious Catch-22 again increases the cost of doing business for a lending institution.

Mr. Roe explained that banks have to become more selective in choosing to whom to extend credits and must move away from cozy relationships. He estimated that the potential for Ukraine's financial system is such that, if it could stimulate a 5 percent rise in new bank credits annually, this would lead to a 1 to 2 percent annual growth in Ukraine's GDP.

The World Bank official called for more transparency from commercial banks and better access to information about them. He said that a system of credit ratings and credit information needed to be established in Ukraine, along with a separate data base on the solvency of banks.

Finally, Mr. Roe called for more specific government policies to create a positive environment for creating new financial institutions of many types. Here, however, he added an important addendum: "The solution to the banking problem here is to sort out quality institutions, not to, I repeat not to, create still more institutions."

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