The Verkhovna Rada wants to double the profit tax for banks for two years: from 18 to 36%. According to some estimates, in 2024 this should bring the state budget an additional 10 billion UAH.
The Ukrainian economy shrank by almost a third in 2022 due to the full-scale Russian invasion. This year, with the war ongoing, the national economy is expected to recover at just over 3 percent. However, despite such more or less positive dynamics, many industries are still in deep knockdown and are barely staying afloat.
In these circumstances, a special place among all spheres of the economy is occupied by the banking system, whose representatives were able to significantly improve their financial condition during the war. Thus, for 8 months of 2023, the total net profit of active Ukrainian banks amounted to more than 95 billion hryvnia, which is 11 times more than in the same period last year. This is a record figure for the entire period of Ukrainian independence. In January-August of this year, interest income of banks amounted to 129.3 billion hryvnia, which is more than 40% more than the same period in 2022.
As of September 1, only 9 of the 64 banks operating in Ukraine suffered a loss (one of them, Ukrstroyinvestbank, was eventually declared insolvent and withdrawn from the market), while the remaining 55, without exaggeration, were swimming in money.
At the same time, no one doubts that these results are rather situational and are in no way caused by a significant qualitative improvement in the sector’s performance. After all, the banking sector received these funds not from lending to the economy, but through purely “military” factors. Moreover, they are quite dubious in their consequences.
During the first months of a full-scale war, the authorities covered the huge state budget deficit (which arose due to an unprecedented increase in defense spending) mainly through the issue, that is, the printing of new money, for which domestic government loan bonds were purchased. In general, at the end of 2022, the NBU acquired government bonds worth 400 billion hryvnia through the issue. This amount of “extra” money has led to excess liquidity of Ukrainian banks - when there is more money in circulation in the banking system than needed.
Such an excess of funds is always dangerous, because it threatens the country with frantic inflation - if these 400 billion were massively poured into the economy, this would lead to an insane depreciation of the money supply and, as a result, an irrepressible rise in the price of all goods and services.
To curb these risks, the National Bank introduced the instrument of certificates of deposit - electronic securities that allow banks to place excess funds with the NBU on short-term deposits and receive additional interest income from them. In 2022, the income of Ukrainian banks from certificates of deposit amounted to 40.3 billion hryvnia, while for 7 months of 2023 (January-July) it was already about 48.6 billion hryvnia.
Another factor in banks increasing their income during a full-scale war was the increase in transaction fees - almost all banks raised it, and significantly.
In addition, banks carried out optimization in all areas of their activities - this reduction affected both the number of bank branches and personnel, marketing strategies, internal processes, and the like.
It is not surprising that a number of experts who are in opposition to the current government call the current situation a scheme, and bank excess profits as nothing more than a situational soap bubble.
Way out
It is clear that at a time when other sectors of the Ukrainian economy are barely making ends meet, and the state budget is supported only by assistance from international partners, the situation in which Ukrainian banks find themselves attracts a lot of attention. So it was only a matter of time before financial institutions were asked to share their windfall profits.
Moreover, this idea is not new in the world.
A tax called windfall tax has been repeatedly applied to companies that received economic benefits from external circumstances beyond their control. At one time it was introduced in the USA and many EU countries.
For example, during the First World War, the States applied such a tax to the largest companies in the military-industrial complex, due to which they were able to significantly finance their military expenses. Doesn't remind you of anything?
In addition, this tax is still used today. For example, in March 2022, the European Commission recommended that EU member states temporarily introduce taxes on windfall earnings of oil workers. Which, however, did not please those companies who were affected by this decision.
In addition to energy companies, European banks were also targeted. Thus, in particular, in the summer of 2023, the Italian government applied a 40% tax on the unpredictable profits of financial institutions obtained due to high interest rates. This resulted in a significant reduction in the capitalization of Italian banks.
Windfall tax in Ukrainian
Back in August, Ukrainian MPs proposed introducing a new 5% tax on net interest income for banks for a period of three years, that is, from January 1, 2024 to December 31, 2026. It was also assumed that banks would pay tax on net interest income simultaneously with income tax.
The banking sector and the expert community harshly criticized this idea, and subsequently abandoned it. But a solution had to be found. At the end of September, a revised bill was registered in parliament, which proposes to introduce an increased profit tax rate for banks: instead of the existing 18 percent, set to 36%. It is assumed that under the new tax conditions, banks will operate from the new year 2024 to the end of 2025. At the same time, deputies propose to deprive financial institutions of the right to reduce their pre-tax financial results by the amount of losses in previous years.
On October 19, people's deputies supported this bill in the first reading.
According to experts, in 2024, taxation of banks’ “excess profits” should bring the state budget an additional 10 billion hryvnia. However, it is unclear where the round sum of exactly 10 billion came from.
Chairman of the National Bank of Ukraine Andriy Pyshny noted that, under current circumstances, he supports the idea of increasing the profit tax rate for banks.
“In Ukraine, the introduction of additional profit on bank income may be a justified temporary step, given the conditions of the war. We now see reasons: both financial and legal, and, if you like, from the point of view of social justice, to support this initiative,” he said.
However, banks seem to be so accustomed to receiving excess profits that the adoption of the corresponding bill raises doubts about the final results - they may not be what the authorities expect. Moreover, there is a high probability that their clients will have to pay for the reduction in the profits of financial institutions.
Banks' reaction and possible consequences for the economy
It is possible that, wanting to reduce the amount of taxes paid, banks will resort to all sorts of tricks.
Financial analyst of the ICU group Mikhail Demkiv expects that the adoption of the relevant law could lead to a significant increase in operating costs of financial institutions.
“Increasing income taxes could become a financial incentive for banks to invest in their own development. We are talking about investments that can be classified as expenses in tax reporting. Banks have to invest money in infrastructure, and tax changes will push them to do this in 2024-2025, when the increased rate will be in effect,” he notes.
He notes that although the revised version of the bill is more successful than the original idea, when, at the initiative of the country’s chief “fiscal” Dmitry Getmantsev, it was proposed to introduce an additional 5 percent taxation of banks’ interest income. However, according to the analyst, one should not expect that doubling the tax rate will lead to a corresponding doubling of contributions to the budget.
“State banks already transfer a large part of their net profits to the budget, and higher tax deductions will mean a reduction in dividends. Banks will have incentives to recognize real losses from the war, and this is, first of all, a deterioration in the quality of loans after January 1, 2024. After all, when calculating the amount of increased income tax, losses from previous years will not be taken into account,” says Demkiv.
It is clear that bankers, in turn, are even more pessimistic about the government’s new initiative.
Chairman of the Board of Unex Bank Ivan Svitek is convinced that the government’s initiative to increase taxation of banks will have negative consequences for the entire domestic economy.
In a commentary to UNIAN, he noted that a healthy and capitalized banking system is one of the main drivers of Ukraine’s post-crisis recovery. He also recalled that although banks are increasing their profits, they are also suffering from the war, like other business entities. If before February 24, 2022, the level of problem loans in the banking system was estimated at 27%, then in August of this year it had already risen to 39.3 percent. Banks cover these loans with their own capital.
“Obviously, this requires additional capitalization. The additional profit received by the banks could be used in this process and at least partially resolve the issue of additional capitalization. Moreover, it is important that the highest profit indicators and the highest shares of NPL (non-performing loan level - UNIAN) in loan portfolios are concentrated in state-owned banks,” he explained.
According to the banker, if, due to the increased tax, part of the income is “taken” from financial institutions, they will be forced to look for funds for additional capitalization in other sources. In the case of state banks, we are talking about the state budget.
In addition, Svitek pointed out that an undercapitalized banking system is less active in terms of lending, tends to overestimate risks, is overly conservative, and performs worse in redistributing resources in the economy. All this will result in a slowdown in economic recovery.
“We need to take into account hundreds of other volatile and difficult to predict parameters, but all other things being equal, the more capitalized the banking system is, the more dynamic the country’s economic recovery will be. The cheaper and more comfortable lending will be for all economic entities. From this point of view, the additional profit that the banking system receives should be considered as an investment in the future,” he added.
Cost of banking services
There is no doubt that banks will not easily part with their excess profits, so it seems that it is worth preparing for the consequences, first of all, not so much for bankers as for their clients, that is, all Ukrainian citizens.
According to financial analyst Mikhail Demkiv, double taxation could lead to banks reducing deposit rates.
“I would expect the impact of higher tax rates on clients to be more on the liability side. Banks will cut deposit rates in a rate cut cycle, and higher income tax contributions will push banks to cut even a little more,” he said.
The expert also adds that an increase in tax could lead to an increase in commission rates in the banking system. That is, the use of banking services will become more expensive for Ukrainians.
At the same time, analysts and bankers agree that we should not expect an increase in the price of loans for the population in the near future.
“Currently, competition for clients in the banking sector, especially in the lending segment, is so great, and the rates are so high, that any attempt to compensate for the decrease in profits in this way will only worsen the situation,” notes Demkiv.
Executive Director of the Center for Economic Strategy Gleb Vyshlinsky agrees with this opinion and is confident that under current circumstances, an attempt by banks to worsen lending conditions in response to new tax conditions will significantly reduce the demand for this banking product, which will be unprofitable, first of all, for the financial institutions themselves.
“Essentially, this is a tax on excess profits due to the high discount rate and large base of customer resources at 0%. But if the rate is left even after the situation changes, this may reduce the attractiveness of the banking sector for investment and competition in it,” he adds.
...Thus, we have a traditional model for the Ukrainian economy - the idea seems to be correct, justified and even supported by international experience, but its implementation, as always, may not lead to the results that are expected. Doubts are also added by the fact that banks are receiving excess profits now, and it is proposed to tax them next year, when it is unknown what the situation on the market will be. Therefore, now it seems rather like the authorities are faced with the task of reacting, but they are doing this solely for show, and not for the sake of real improvement of the situation. And when decisions are made this way, expect trouble.
