Ukrainian oligarch and banker Oleg Bakhmatyuk (left) owes my wife Svetlana Kushko (right) a pile of cash. Here’s how come.

By Gary Scarrabelotti

The Ukrainian general staff should be sacked and its generals replaced by Ukraine’s bankers. 

Whereas the generals have proved out of their depth in dealing with the Russian-backed separatists of the Donbas, and perhaps feel kindly toward them, Ukraine’s bankers have shown themselves completely unsympathetic to Ukrainians in general, no matter what their loyalties, and utterly ruthless in setting up the country’s middle class for extinction. They really should be running the war. 

Banking crisis 

Since the “Maidan” revolution of November 2013 – February 2014, Ukraine has entered a steep economic crisis.  The economic bust has triggered a banking crash. Above 30 Ukrainian banks have had their banking licenses withdrawn by the National Bank of Ukraine (NBU: the equivalent of our Reserve Bank) and are being liquidated.  Another 15 or so have been put into “temporary administration”. 

This is a disaster not only for the Ukrainian middle class but also for Ukraine itself. It is middle class savers — professionals, small business people, medium-sized farmers — who will be central to any revival of the Ukraine economy.  However, their savings and capacity to borrow are being eliminated and, consequently, their trust in Ukraine’s political and financial institutions is being destroyed. 

This is the second (for some, the third) time since 1991 that Ukrainians have had to endure a savings wipe out.  The first was the result of the hyperinflation that accompanied the collapse of the Soviet Union.  In between then and now there was the GFC that hit Ukraine during 2008 – 2009 more severely than any other large country. Now in 2014 – 2015 the Ukraine middle class is having its savings wiped out again. It’s a shattering experience to see all you have worked for go up in smoke for the second (or third) time in 24 years. 

Declaration of Interest

My wife, Svetlana, is Ukrainian and strikingly beautiful.  She’s also a toiler and thrifty to a degree known only to our parents’ generation. By dint of hard work, and by spending only on the bare necessities, she built up substantial savings. They put her in the middle class bracket and they were intended to provide for herself and her Mum in their old age. 

Svetlana deposited her tidy sum with VAB Bank, the most important operating in the agricultural sector.  She could have shipped the money out of the country and buried it — as so many do — in a Cyprus bank account.  But being deeply patriotic, and convinced in her blood that Ukraine’s future lay in agriculture, she decided that VAB had to be a safe place in which to invest her funds. Last month VAB was put into liquidation.  There is only a slim prospect that Svetlana will see any of her savings again.

Wipe out

Svetlana’s experience is being repeated in countless middle-class households throughout Ukraine. 

There is a Deposit Guarantee Fund (DGF) in place to protect small savings — up to 200,000 UAH. This doesn’t amount to much: $US 8,500 at the current exchange rate, though back before the “Maidan” it was worth $US 25,000.  Above 200,000 UAH, however, there is no deposit guarantee. For middle class savers who have squirrelled away sums greater than that, the implications are dire.

Because of the experience of 1991, many Ukrainians distrust banks. Rather than put money into one, people kept their savings hidden in their apartments. Partly in an attempt to mobilise this money, banks began offering, during the Yanokovich era, high interest rates (between 12% ‑25%) on large deposits.  Money came out from under the mattresses — literally — and went into term deposit accounts. Today, those once carefully stashed hoards are disappearing.

The weaknesses of the Ukraine banking system have been well known for some time. Banks are undercapitalized and over lent; protocols for evaluating the creditworthiness of borrowers are notoriously lax; and efforts to recover assets from borrowers in arrears are perfunctory, especially if the laggards are big wigs. 

Bank Oligarch 

But that is not the worst of it. Ukraine’s oligarchs own or control most of the important banks. For example: 

• Igor Kolomoisky — PrivatBank, Ukraine’s biggest; 

• Rinat Akhmetov, Ukraine’s richest man — First Ukrainian International Bank; 

• Viktor Pinchuk — Credit Dnepr Bank; 

• Dmitry Firtash — Nadra Bank, Ukraine’s largest commercial bank (liquidated); 

• Mykola Lagun, Ukraine’s pin-up banker — Delta Bank, Ukraine’s fourth largest (liquidated along with its subsidiaries, Kreditprombank and Omega Bank) and Astra Bank (under temporary administration which means, in practice, ‘liquidation pending’};  

• Vadim Novinsky and Andrei Klyamko — Forum Bank (liquidated) and Unex and BM banks;  

• Oleg Bakhmatyuk — VAB (liquidated) and Financial Initiative. 

I could go on.  And to add chaos to my theme, a group of investors has won a court battle in Kyiv to have the liquidation of Delta bank reversed. Confusion reigns over what to do next. Poor depositors!

Anyway, all of the banks mentioned here, including a lot more I’ve passed over, have been paid “stabilization funds” by the NBU.  In other words, the capital base of all of these banks and more, whether liquidated or still operating, is out of whack with their loan books.

The money being paid out by the NBU to prop up the Ukraine banking system is sourced not from Ukrainian taxes or from the country’s reserves (taxes are not paid and there are no reserves) but from the IMF and the World Bank. About one quarter of IMF funds lent to Ukraine is going to its banks. 

Fatal flaw 

The reason why Ukraine is notching up hefty international obligations is not because of a tragic banking accident. It has to do with the nature of the beast.  It exists to finance the business interests of the oligarchs. When an oligarch wants to borrow money for one of his projects, he prefers to borrow from a bank owned or controlled by himself.  What better way to get a big loan on easy terms than from an institution where you, ultimately, pay the salaries of the bank officials! 

When an oligarch owns a bank, he regards himself, understandably, as the shareholder to whom he owes the greatest obligation.  So, if he judges that it is not in his interest, for example, to maintain a Capital Adequacy Ratio decreed by the NBU and international bankers, he won’t. This is the chief reason why so many banks have gone under.

The process often begins with “temporary administration” imposed by the NBU until agreement can be reached about how much extra capital has to be kicked in. Naturally, the oligarch does not wish to contribute more. He argues that he will put in some extra, of course, but only if the government would make a matching or greater offer. Negotiations break down. The bank goes into liquidation.  Meanwhile, the oligarch’s business ventures continue to benefit from the loans already made to them. Pity about the depositors!

Far more valuable to Ukraine than any amount of military training Australia could possibly offer, would be a banking mission headed by David Murray and his team from the Financial System Inquiry.

Even when agreed upon, refinancing arrangements don’t necessarily save the day. For instance, the NBU paid 3.3 billion UAH to Firtash’s Nadra Bank. Notwithstanding, depositors had a beastly time trying to withdraw their deposits and the bank still went belly-up. 

A similar thing happened with VAB. In 2014 it received a 5.5 billion UAH refinancing loan but went into temporary administration in November 2014 and was liquidated in March 2015. 

If, despite hefty refinancing loans, Ukrainian banks are still crashing, that suggests their capital adequacy remains deficient. Indeed, the IMF has admitted that it’s actually getting worse: 

“As of end-January 2015 the banking system’s capital adequacy ratio (CAR) stood at 13.8 percent, down from 15.9 percent at end-June.” (Ukraine: IMF Country Report, No. ¹⁵⁄₆₉, March 2015, p.18.) 

So where is the money going, if bank equity is in decline? It’s disappearing, some suggest, into foreign bank accounts. Meanwhile, middle class savers are being slaughtered and their trust in the system trashed. 

Revolution risk 

The consequences of this mass disappearance of depositors’ funds could well be a new revolutionary movement in Ukraine.  There is already talk of a “new Maidan.”  If it happens, it will be directed against not only the oligarchs but also at the political system itself over which the oligarchs exercise the most powerful influence. 

If the western backers of the Poroshenko government want to avoid an event that is sure to drive Ukraine’s politics to the far Right, and could finally rip the country apart, drastic policy measures need to be taken. 

The Ukraine national parliament (Verkhovna Rada) recently enacted legislation to the effect that, in the event of future bank liquidations, the property of the major shareholders (the oligarchs) would be distrained to meet the repayment of depositor’s funds. This doesn’t help depositors who lost out on liquidations that took place before the measure was signed into law by President Poroshenko on 6 March 2015. And it is not clear how it will benefit depositors in banks liquidated subsequently. 

This legislation offers, however, a slim ray a hope for my wife: it came into force on 9 March and VAB was liquidated on 19 March.  Oleg Bakhmatyuk, theoretically, has to cut Svetlana a cheque or hand her a big pile of cash. But I’m not holding my breath. Debate has broken out about how the new law will actually work and what agency can issue a demand to bank owners to make good depositors’ funds. 

Pay up or else … 

The fortunes of most oligarchs have been built upon a combination of politically-connected insider trading in state assets and the transfer of state-owned enterprises via a rorted privatization process that stretches back to the break-up of Soviet Union.  The least, then, that the oligarchs could do is to return to Ukrainians all of what they have swallowed up in their shonky banks.  Really, the law of 6 March should be retrospective.  But even that would leave the oligarchs’ place in the banking system intact.  If the oligarchs are too broke, too greedy, or too short sighted to restore depositors’ accounts from their own resources, a root-and-branch reform of the banking system is called for.  It might look something like this: 

• IMF funding for refinancing loans should be suspended temporarily. 
• Banks should be nationalized without compensation of the oligarchs and their remaining capital in the banks allocated on a pro rata basis to depositors with accounts greater than 200,000 UAH. (Small depositors should continue to be taken care of through the DGF.) 
• Nationalised banks should be merged and their capital topped up by the state using reactivated IMF refinancing loans. As part of the refinancing process, depositors’ equity in the banks will probably need to be topped up to ensure that the value of their equity equals the value of their original deposits. 
• The new banks — jointly owned by the state and the major depositors — should be operated in such a way as to restore depositors’ funds via a dividend stream payable to their accounts. 
• Assuming future privatization of state holdings in these new banks, each oligarch should be limited to investing in one privatized bank only; to owning not more than, say, 20% equity in that bank; and to be excluded from managing any bank directly, or via a related party. 
• To meet Ukraine’s international obligations incurred by this, and other, institutional reforms, it should no longer be said of Ukraine, as Igor Kolomoisky once shamelessly put it, that “only the weak pay taxes.” 

Diplomacy

Australia recently opened an embassy in Kyiv. We contribute to the IMF and the World Bank. We say we care about the survival of Ukraine as a state independent of Russia and, I’m guessing, we’d be unhappy with a rump Ukraine run by far-right nationalists.

Well, if such be the case, our diplomacy ought to focus heavily on producing a new generation of bankers and a new generation of banking policies.  This is a field in which Australia has deep experience and about which we can speak with authority. 

Far more valuable to Ukraine than any amount of military training Australia could possibly offer, would be a banking mission headed by David Murray and his team from the recently completed Financial System Inquiry. 

We need to understand: Ukraine is in a deep crisis and that its banking system is every bit the equal of Vladimir Putin and the Donbas separatists as a threat to the country’s survival.