Identifier
Created
Classification
Origin
09KYIV140
2009-01-23 15:55:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Kyiv
Cable title:  

FAULTLINES IN UKRAINE'S BANKING SYSTEM

Tags:  EFIN EREL ETRD PGOV PREL XH UP 
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VZCZCXRO3837
PP RUEHIK RUEHLN RUEHPOD RUEHSK RUEHVK RUEHYG
DE RUEHKV #0140/01 0231555
ZNR UUUUU ZZH
P 231555Z JAN 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 7131
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUEHZG/NATO EU COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC PRIORITY
UNCLAS SECTION 01 OF 02 KYIV 000140 

SENSITIVE
SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA

E.O. 12958: N/A
TAGS: EFIN EREL ETRD PGOV PREL XH UP
SUBJECT: FAULTLINES IN UKRAINE'S BANKING SYSTEM

Sensitive but unclassified. Not for internet or distribution
outside the USG.

UNCLAS SECTION 01 OF 02 KYIV 000140

SENSITIVE
SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA

E.O. 12958: N/A
TAGS: EFIN EREL ETRD PGOV PREL XH UP
SUBJECT: FAULTLINES IN UKRAINE'S BANKING SYSTEM

Sensitive but unclassified. Not for internet or distribution
outside the USG.


1. (SBU) Summary. IMF representatives indicated to us that
the first diagnostic audits of Ukraine's banking sector were
completed on January 22. In the IMF's view, the audits show
that none of Ukraine's seventeen largest banks has enough
capital to meet an expected deterioration of loan portfolios.
While the IMF assumes foreign-owned subsidiaries will be
able to raise enough capital to meet their expected
shortfall, domestic banks may be hard pressed to do the same.



2. (SBU) The IMF and the World Bank expressed particular
concern about regulatory and governance weaknesses at the
National Bank of Ukraine (NBU),as more and more banks may
require recapitalization or resolution in the near future.
One key analyst expressed separately on January 23 that,
despite the magnitude of potential bank failures and the need
for immediate preventative action, Ukraine's financial
watchdogs have thus far proven unable to generate an adequate
policy response. End summary.

IMF and World Bank Anxious
--------------


3. (SBU) At a meeting of IMF, World Bank, and USG
representatives on January 22, the IMF's Engen Akcakoca told
us that Phase I diagnostic studies of Ukraine's seventeen
largest banks had been completed. The IMF team led by Ceyla
Pazarbasioglu, which arrived in Kyiv this week for the first
formal review of Ukraine's performance under the $16.4
billion Stand-By Arrangement (SBA),assumes that capital
infusions will be required in all of Ukraine's largest banks,
including seven subsidiaries of foreign banks, according to
Akcakoca. The IMF expects that foreign-owned banks will
receive capital from parent institutions, while domestic
banks will rely primarily on shareholders and the NBU to meet
increased capital requirements.


4. (SBU) External auditors are now reviewing Ukraine's next
largest group of seventeen banks under a so-called Phase II
diagnostic study. Their findings will be presented to the
NBU on February 24. Phases III and IV of the diagnostic
study, encompassing Ukraine's medium and small-sized banks,
will be due at the end of May 2009. The NBU plans to use a

simplified methodology for Phases III and IV, to be developed
by the IMF's Akcakoca and likely funded by an EBRD grant.


5. (SBU) According to the IMF's Stand-By Arrangement, the
NBU is to examine the auditors' reports and determine if, and
how much, extra capital is needed at individual banks to
absorb an expected deterioration of loan portfolios. If
existing shareholders are unable or unwilling to provide the
additional capital, the NBU and GOU are to establish a
mechanism for the GOU to recapitalize and/or take control of
failing banks. However, foreign donors are concerned that
little progress has been made in creating such a mechanism.
At the January 22 meeting, World Bank country director Martin
Raiser pointed out that the NBU and GOU have not yet even
established bank recapitalization and liquidation units.


6. (SBU) While the Phase I-IV diagnostic process appears
fine on paper, IMF and World Bank officials further worry
that many banks could fail prior to the completion of Phase
II-IV audits and before adequate legal, regulatory, and
governance structures have been put in place. There is
growing consensus, according to Raiser, that the
international donor community itself should develop
procedures for the recapitalization, restructuring,
administration, and liquidation processes, since Ukraine's
institutional and policy oversight bodies are sorely lacking
in capacity and leadership. Raiser concluded, "We may have
to design this for them," and he applauded the willingness of
the IMF and U.S. Treasury to provide immediate technical
assistance.


7. (SBU) Raiser decried the lack of transparent financial
disclosure and reporting in Ukraine, since this may scare off
potential private investors and force the GOU to undertake a
"series of nationalizations." In addition to advocating new
regulations for mergers and acquisitions, the IMF's Thordur
Olaffson, in turn, revealed that the Fund had demanded
published statements on banks' asset quality from the NBU.
He said that the NBU had agreed to implement a framework for
asset quality disclosure by the end of January, but that this

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was a "large legal undertaking" which may not be completed
before the IMF team departs on February 6.

Leading Analyst Also Worried
--------------


8. (SBU) On January 23, Edilberto Segura, former World Bank
country director and current President and Chief Economist at
the Bleyzer Foundation, separately told us that NBU officials
are now "so scared, they don't even know what to do." Segura
said that, using IMF methodology, about 30 percent of loans
could be classified as bad (i.e. "non-standard" or "doubtful"
or "a loss"). However, the NBU continues to state officially
that bad loans constitute just 1.5 percent of banks' loan
portfolios. Segura believes that Minister of Finance Viktor
Pynzenyk has been "stripped of power" within the government,
even though "he understands the gravity of the situation."
Likewise, the Ministry of the Economy "lacks both a
fundamental understanding of the problem and the means to
cooperate" with other government agencies. Segura's
Foundation and its affiliate SigmaBleyzer, one of the leading
private equity players in Ukraine, have resorted to holding
closed door briefings, drawing up financial sector
contingency plans for key members of parliament and the
government's monetary council. Segura said that the IMF
should draw on its previous experience in Nigeria, where it
held emergency workshops to train government officials and
lawmakers on anti-crisis policies for the financial sector.


9. (SBU) Comment. The completion of the first diagnostic
study of Ukraine's largest banks was an important milestone
in the fulfillment of the IMF's conditionalities. The NBU
and GOU must now use their newly acquired information to
swiftly recapitalize, or liquidate, banks. From discussions
with the international donor community and private analysts
that corroborate other information we have heard, it appears
the NBU and GOU are still unprepared for the next step of
implementation. They may not have the luxury of waiting much
longer, if the state of the banking system is as dire as some
fear. As it undertakes a review of Ukraine's performance in
the months since the SBA was announced, the IMF team will
need to hold Ukraine to its commitments, while at same time
helping it develop the means to put them into action. End
comment.

TAYLOR