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09KYIV243, UKRAINE’S BANKS SQUEEZED PRIOR TO RECAPITALIZATION

February 5, 2009

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Reference ID Created Released Classification Origin
09KYIV243 2009-02-05 04:58 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Kyiv

VZCZCXRO3382
PP RUEHIK RUEHLN RUEHPOD RUEHSK RUEHVK RUEHYG
DE RUEHKV #0243/01 0360458
ZNR UUUUU ZZH
P 050458Z FEB 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 7209
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE

UNCLAS SECTION 01 OF 03 KYIV 000243 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EUR/UMB, EEB/OMA 
 
E.O. 12958: N/A 
TAGS: EFIN ECON ETRD PREL PGOV XH UP
SUBJECT: UKRAINE'S BANKS SQUEEZED PRIOR TO RECAPITALIZATION 
 
REF: A) KYIV 140, B) KYIV 166, C) 08 KYIV 2294 
 
Sensitive but Unclassified.  Not for Internet or 
Distribution Outside the USG. 
 
1.  (SBU) Summary. Ukraine's banking sector troubles are 
among the IMF and World Bank's foremost concerns amidst a 
deepening financial crisis.  Short of liquidity and with 
worsening loan performance by the day, banks are awaiting a 
decision by the National Bank of Ukraine (NBU) and the GOU 
on a framework mechanism for recapitalization and 
resolution.  The NBU has not announced how much additional 
capital the largest 17 banks will need, but reports 
indicate that it might be less than originally anticipated. 
The NBU has sent signals this week that it is willing to 
accept a proposal from the IMF and World Bank on a 
framework, though concrete measures to establish a 
Recapitalization Board and a Problem Bank Unit have 
nonetheless stalled. 
 
2.  (SBU) In the meantime, Ukraine's domestic banks are 
facing the greatest troubles, causing the World Bank to 
worry about the adequacy of Ukraine's deposit insurance 
program.  Subsidiaries of foreign banks are making their 
own plans to roll over debt coming due this year and infuse 
banks with whatever additional capital the NBU will 
require.  The liquidity shortages have spawned a parallel 
market for dollars and hurt everyday citizen depositors, 
who tell us they cannot withdraw foreign exchange and also 
face strict limits on access to hryvnia (UAH) deposits. 
End summary. 
 
Recapitalization Urgent 
----------------------- 
 
3.  (SBU) The NBU completed diagnostic audits for Ukraine's 
seventeen largest banks on January 22 (Ref A).  Although 
the NBU Board has yet to announce which banks will need 
additional capital, the sum may be less than originally 
foreseen.  As of December, it was expected banks might need 
up to $10 billion, however, press reports quote the NBU's 
Oleksander Kiriyev, Executive Director for Banking 
Regulation and Supervision, as saying (during the meeting 
mentioned in Ref A) that the 17 largest banks will need an 
additional $3.08 billion in capital.  Foreign banks will 
require an additional $1.8 billion, Ukrainian private banks 
$900 million, and the two state-owned banks $350 million, 
in addition to the $1.875 billion injection they received 
in late 2008.  Although most, if not all, of the 17 will 
need to account for worsening loan portfolios and higher 
capital requirements, it now appears that foreign banks are 
prepared to provide whatever additional capital their 
Ukrainian subsidiaries need in full (Ref B).  It is unclear 
whether Ukrainian banks will get the needed capital 
injections from their shareholders, or through a still 
undetermined process that will likely be jointly governed 
by the NBU and GOU.  Auditors mandated by the NBU have now 
begun to review the next 17 largest banks.  Their results 
are expected in late February. 
 
4.  (SBU) During a January 30 coordination meeting of 
technical assistance donors, Lalit Raina, the World Bank's 
Washington-based financial sector manager for Eastern 
Europe and Central Asia, pointed out another challenge 
facing the banking sector: the Deposit Insurance Fund (DIF) 
may not have sufficient funds to cover deposits at banks 
that are liquidated.  Insurable deposits in Ukraine's 
banking system total UAH 126 billion ($15.75 billion), but 
the DIF only has UAH 3.5 billion ($437 million) in cash and 
securities on hand.  The DIF has identified 23 banks that 
it believes are particularly at risk; these banks have UAH 
22 billion ($2.75 billion) of insurable deposits, or 
roughly seven times the DIF's funds.  Raina observed, 
however, that the UAH 44 billion ($5.5 billion) line item 
in the 2009 budget foreseen for bank recapitalization and 
resolution could also be used, at least partially, to cover 
deposits for banks that the NBU has taken under temporary 
administration.  The DIF would only be called to task after 
a bank's license was revoked, but the budgetary money could 
conceivably help cover deposits in banks that remained only 
under temporary administration.  Using funds for this 
purpose would reduce the amount available for 
recapitalization, of course.  He continued, "There are real 
risks.  Time is running out.  Banks will fail.  But there 
is no courage or will to create laws to put a 'ring fence' 
around bad banks." 
 
 
KYIV 00000243  002 OF 003 
 
 
Bank Resolution Framework 
------------------------- 
 
5.  (SBU) The IMF and World Bank have worked together with 
Department of Treasury experts to propose a basic framework 
for problem bank resolution.  The proposed framework would 
establish a high-level board to oversee all bank resolution 
efforts, a Problem Bank Unit (PBU) under the NBU Board to 
manage the provisional administration o
f failing banks, and 
a bridge bank under the PBU to merge or absorb banks 
through purchase and assumption transactions. 
 
6.  (SBU) The NBU has yet to table a suggestion of its own, 
but Kiriyev has told Treasury, World Bank, and IMF 
officials that the NBU is open to the donors' proposed 
framework.  Kiriyev has been under intense pressure from 
the IMF and World Bank to prepare a response to Ukraine's 
growing banking crisis. 
 
7.  (SBU) The IMF's financial sector experts told us on 
February 4 that they still do not even know where or how 
the NBU and/or the Ukrainian government would oversee the 
recapitalization and liquidation process, nor could they 
say for certain which legal and regulatory measures were 
being pushed in parliament.  On February 2, director of the 
Institute for Economics and Forecasting at the National 
Academy of Sciences Valeriy Heyets told us that a 
legislated framework for recapitalization and liquidation 
will be difficult to achieve.  "There is so much lack of 
faith in the Rada, and in the GOU and NBU right now.  No 
one believes that politicians and their kind will look 
after the common good." (Note: The Verkhovna Rada is 
expected to review legislation related to the economic 
crisis during its plenary session on February 5.  End 
note.) 
 
8.  (SBU) A fully staffed IMF team, in Kyiv to review the 
Fund's 16.4 billion Stand-By Arrangement, warned on 
February 4 that Ukraine is facing serious problems 
implementing its conditionalities.  Flying in from 
Washington to assist the review team, the IMF's European 
Department director Marek Belka said his visit was 
"exceptional," insinuating that Ukraine may fail to qualify 
for its second tranche of roughly $2.5 billion, due to be 
disbursed in late March. 
 
European Banking Exposure 
------------------------- 
 
9.  (SBU) Foreign bankers and diplomats have told us they 
expect foreign banks to provide additional capital needed 
for their Ukrainian subsidiaries.  Francesco Giordano, 
chief of strategy at UniCredit in Ukraine, told us that his 
parent bank is fully committed to rolling over short-term 
debt.  (Note: UniCredit's exposure to Ukraine is run out of 
its Vienna-based subsidiary Bank Austria.)  He also said 
that the bank has made a strategic decision to refinance 
even poor performing loans on the verge of default, since 
collateral or repossessed assets also have falling market 
value.  "We are taking the long view -- even 50 years," he 
said, referring to UniCredit's strategy to help its 
customers stay financially solvent, although it means "they 
have (UniCredit) over a barrel right now." 
 
10.  (SBU) Reading the pulse of European bankers, a well- 
informed Austrian embassy commercial attache Clemens Machal 
told us on February 3 that "Ukraine is too big to fail" and 
that European parent banks would remain fully committed to 
their Ukrainian subsidiaries.  Although Austrian bank 
exposure in Central and Eastern Europe equates to roughly 
100 percent of Austria's total GDP, the Austrian government 
was comfortable that its banks had the strength to weather 
the crisis.  As a result, Vienna sees itself as a leader in 
European diplomatic efforts to reduce the risks of the 
European banking sector in the region.  Specifically 
mentioning Erste Bank, UniCredit, and Raiffeisen Aval, 
Machal stated that Austrian banks had previously pursued 
conservative strategies, were not hard hit by the U.S. 
subprime crisis, and still possessed enough liquidity to 
roll over short-term debt and increase capital.  The 
Austrian diplomat acknowledged that the Ukrainian banking 
sector and the economy more broadly were European problems, 
adding "no one seriously expects" the U.S. government to 
"bail out" Kyiv. 
 
Banks Failing Depositors 
------------------------ 
 
KYIV 00000243  003 OF 003 
 
 
 
11.  (SBU) Anecdotes abound about bank clients who have 
been denied access to personal cash accounts, or who have 
had to accept piecemeal withdrawals of mature term 
deposits.  We have heard that holders of dollar and euro 
accounts cannot receive foreign exchange, and instead must 
rely on hryvnia withdrawals converted at the official NBU 
exchange rate, which is significantly lower than interbank 
rates or cash rates in Kyiv's currency kiosks.  One embassy 
source told us that euros earned in Estonia and 
subsequently wired to a business account in Ukraine could 
not be accessed, even though he had a valid foreign 
exchange claim against the bank.  This is a worsening of 
the situation from a few weeks ago, when short-term dollar 
account holders could still retrieve at least partial 
funds. 
 
12.  (SBU) Demand for dollars remains ferocious, and even 
though the banks and kiosks quote prices at which they 
would sell dollars, it is nearly impossible to actually 
obtain foreign exchange by these means.  Others have 
stepped in to fill this gap.  Econoff went to a department 
store in central Ukraine to witness old ladies in heavy 
jackets selling dollars to a variety of clients.  It is an 
open secret that even though the rate for dollars on the 
street corner has exceeded the official NBU rate by 20 
percent, the ladies are a steady source of dollars, so much 
so that they had to ward off customers to minimize 
attention to their operation. 
 
13.  (SBU) Citizens on the street have also relayed stories 
of a hryvnia liquidity shortage, as the NBU has pursued a 
policy of tightened money supply to clamp down on exchange 
rate volatility.  Local banks, in turn, have limited 
withdrawals or stopped them altogether.  We have heard that 
banks are failing to honor maturing term deposits that had 
been established in recent months by customers attracted to 
handsome interest rates for both foreign exchange and 
hryvnia.  One contact told us that she was only able to 
withdraw roughly UAH 500 ($65) of her maturing UAH 12,000 
($1,500) term deposit on a daily basis, forcing her to 
stand in long lines with other account holders during lunch 
breaks or after work.  Queues can be seen at various 
Ukrainian banks around Kyiv, notably at Nadra Bank, which 
has had an on-again/off-again relationship to energy tycoon 
Dmitry Firtash (Ref C) but is now under NBU administration. 
Concerns about runs on these banks are growing, especially 
since the banks themselves only allow a certain amount of 
daily withdrawals before closing teller services. 
 
14.  (SBU) Comment.  The growing panic among depositors 
reflects real public anxieties about Ukraine's troubled 
banks, as well as exasperation among foreign donors, who 
are standing by with concrete suggestions on how to 
reconstitute Ukraine's banking sector oversight bodies and 
implement a much-needed recapitalization and liquidation 
program.  The IMF has upped the ante, bringing in its lead 
for European operations to press f
or adherence to the 
Fund's conditionalities.  The consequences of inaction for 
domestic banks are severe, particularly if the queues we 
have observed persist in the coming days.  All eyes are on 
a headless NBU (absent Governor Stelmakh, who has been on a 
month-long "vacation"), a leaderless Ministry of Finance 
(absent Minister Pynzenyk, who is "hospitalized"), as well 
as on the divided Rada, to come up with an immediate 
solution.  End comment. 
 
TAYLOR

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