At the end of its history seven years ago, Ukrainian PrivatBank became the object of government intervention. On December 18, 2016, the bank was nationalized, despite the fact that its main owners were Igor Kolomoisky and Gennady Bogolyubov. The reason why the state made this decision and took control of the bank was due to serious financial problems and the threat of systemic instability for the country's economy. Government authorities took part in the nationalization of PrivatBank and intervened to protect the interests of clients and ensure the stability of the financial system.
When preparing the article, we used publications in Ukrainian and foreign media for different periods, Wikipedia data and information from the PrivatBank website.
PrivatBank was founded back in 1992 at the dawn of independence. It became one of the first commercial banks in Ukraine, eventually becoming the largest bank in the country and leaving even the state monster - Oschadbank - far behind.
At the time of nationalization on December 18, 2016, PrivatBank served the accounts of more than 22 million clients , approximately 60% of transactions and half of all payment cards issued in Ukraine. At that time, about 40% of the deposits of the entire banking system were concentrated in the bank.
Crisis phenomena in the bank
At a press conference in December 2016 on the topic of nationalization of PrivatBank, Valeria Gontareva, who headed the National Bank of Ukraine at that time, said that at a certain stage, NBU inspections revealed a lack of capital in PrivatBank. As of April 1, 2015, this shortfall amounted to 113 billion hryvnia . The reasons given were the crisis in the Ukrainian economy in general and the incorrect credit policy of PrivatBank in particular.
Thus, more than 97% of the corporate loan portfolio, which as of April 1, 2015 reached UAH 150 billion, were loans related to the company’s shareholders.
After inspections by the NBU, PrivatBank management drew up a plan for additional capitalization and reduction of insider loans. The bank shareholder provided a personal guarantee for this program. But the plan failed.
In 2016 alone, the National Bank held more than 30 meetings with the owners and management of the financial institution. The regulator has repeatedly extended the recapitalization period. But as of December 1, 2016, capital deficiency grew to 148 billion hryvnia , and the bank’s liquidity decreased significantly.
The bank did not meet the mandatory reserve requirement for almost a year. Overdue debt to the NBU on stabilization loans amounted to 14 billion hryvnia, the total debt was 19 billion hryvnia, noted Valeria Gontareva.
According to a study by the Center for Economic Strategy, the results of which were once published by Deputy Executive Director Maria Repko, PrivatBank’s business model until the end of 2016 was to finance corporate business through retail deposits. At the same time, the rates on hryvnia loans from PrivatBank were 4-8 percentage points lower than the rates on hryvnia deposits that the bank paid to the population. Currency rates also differed.
Instead of buying cheaper and selling more expensive, the bank did exactly the opposite - it took money from the population at a high rate and lent to companies at a low rate.
Rates on retail loans were much higher, so, for example, in 2015, PrivatBank’s external income (that is, income that the bank received directly from clients, not including intra-group settlements) from retail business was only a third less than income from corporate loans. Commission income from retail lending was more than three times higher than income from corporate business. And this is with a six-fold difference in the amount of assets.
Alexander Danilyuk, who was the Minister of Finance at the time of the nationalization of PrivatBank, stated that until a certain point, PrivatBank’s money was exclusively the money of depositors, ordinary people. These deposits were used to lend to the business of a group of companies affiliated with the shareholders of PrivatBank for the purposes of its owners. Eventually this led to problems, and the state was forced to protect depositors.
In principle, a situation in which loan rates may be lower than deposit rates is normal if there is significant capital that reduces the cost of the weighted average cost of resources. This is also possible if the scale of the bank’s risks is quite moderate, when the bank takes on the risks of currency differences and thus earns money. The bank can cover part of the expenses through commission income. But if these risks materialize, difficult times will come for the bank. Perhaps this is exactly what happened with PrivatBank.
According to analysts from the Center for Economic Strategy, if in 2013-2014 the bank could still cover the difference in rates due to cheaper borrowing of dollar resources abroad and differences in exchange rates, then in 2015 the cash flow from interest payments on loans was no longer enough to payment of interest on deposits.
Another version of events inside the bank, which is talked about by the NBU and the Ministry of Finance, is that PrivatBank collected deposits from the market and then issued loans to its companies. When the time came to pay interest, these companies simply received another loan from the bank, through which they repaid their obligations.
At the same time, the former owners of the bank provided auditors with information about an allegedly insignificant part of related parties in the loan portfolio. According to the financial statements of PrivatBank for the 1st quarter of 2016, compiled in accordance with IFRS requirements, the share of loans to related parties in the loan portfolio (before provisions) amounted to 6.1%. At the same time, the violation of the N9 standard, which at the bank (according to its press service) amounted to 38.5% at that time, was allegedly due to methodological changes by the NBU.
According to Zn.ua journalists, in the bank’s financial statements as of January 1, 2014, out of UAH 105.5 billion of the total hryvnia corporate portfolio, UAH 102.6 billion (97.5%) were issued in the Dnipropetrovsk region. In the currency part of the portfolio, the situation looked like this: of the total amount of $3.797 billion, $1.213 billion was accounted for by Cyprus, $2.550 billion was accounted for by the Dnepropetrovsk region. Other regions were allocated less than 1% of the foreign currency corporate portfolio.
Bank rehabilitation program and its non-fulfillment by shareholders
In April-December 2015, the NBU conducted a diagnostic of PrivatBank and determined the need for additional capital at UAH 113 billion . This assessment is based on the NBU’s assumption about the poor quality of loans, which the bank itself assessed in its reporting as completely reliable and not impaired. According to representatives of the regulator, most of these loans were issued to non-operating companies (that is, companies that did not have employees, the necessary equipment, and did not conduct any operations). These funds were then transferred to other businesses within the group.
Until January 2016, the findings of stress tests and the results of NBU research clearly showed that PrivatBank faced serious problems. The systemic importance of the bank made the situation especially complicated. Everyone understood that the potential liquidation of PrivatBank and the resulting capital shortage and risk of default by the bank’s corporate debtors would cause significant damage to the financial sector and the economy as a whole. The best option was restructuring. Therefore, in February 2016, the NBU, the board of PrivatBank and its owners agreed on a Restructuring Plan.
According to the Financial Recovery Program, the bank, by November 15, 2016, pledged to take a set of measures to increase its capital by UAH 94.5 billion . This was to happen through the restructuring of loans by transferring them to operating companies with revenue sufficient to service and repay the debt, posting real additional collateral, and repaying loans from related parties.
At the same time, Ukraine’s international partners and creditors were closely monitoring the situation. In the next memorandum of cooperation between Ukraine and the IMF at the end of 2015, the amount of UAH 152 billion was reserved for the issue of government bonds for the recapitalization of banks and the Deposit Guarantee Fund. More than 70% of these funds remained unused, prompting market participants to regard this amount as a “reserve” in case of problems at the country’s largest private bank.
However, over time, it became obvious that PrivatBank's management and shareholders did not comply with the terms of the restructuring plan: the deadlines were missed, and the corresponding restructuring of the loan portfolio was not carried out. Thus, in response to the regulator’s decision, in October-November 2016, PrivatBank carried out a rapid “transformation” of its loan portfolio totaling UAH 137 billion. In a very short time, the bank changed borrowers, collateral, rates, terms and currencies for 193 loans.
New borrowers - 36 companies - did not satisfy the auditor’s criteria regarding fully functioning and actually operating companies, and he classified the loans as impaired. Journalists and the new management of PrivatBank said that fictitious companies became the new borrowers. And the old loans issued to other companies were repaid, and there was no one to make claims on these assets.
At the same time, about 20% (41 billion UAH) of loans were issued to enterprises trading petroleum products, 18% (35.8 billion UAH) to companies working with ferroalloys, 12% (24.8 billion UAH) to industrial chemical enterprises. 6% (UAH 12.7 billion) - to airlines, 1% (UAH 2.7 billion) - loans to tourism enterprises and football clubs.
According to Vitaly Vavrischuk, the then director of the NBU financial stability department, after lengthy negotiations, the bank’s top management admitted that the real borrowers were other companies, and the “empty” companies were only intermediaries.
Obviously, “empty” companies, without income, employees, or production capacity, did not have the opportunity to pay off multimillion-dollar debts. How did PrivatBank assess the credit risks of such borrowers? In order not to determine reserves for loans to obviously insolvent companies, a simple scheme was launched - collateral was “drawn” on paper, which in real life had no value.
About 90% of borrowing companies provided the bank with collateral in the form of so-called property rights to goods. Companies entered into contracts with the same opaque firms for the supply of goods in the future. That is, if PrivatBank’s borrowers refused to repay the loans, then the bank would have the right to recover these goods from the borrowing companies after their delivery and for their further sale...
“Empty” companies did not even make any prepayments for those “future” goods, the property rights to which were pledged to the bank, and even theoretically could not pay for them. The total value of property rights to goods pledged under loans declared by the bank amounted to more than UAH 350 billion. The main products are petroleum products, manganese, ferroalloys.
In October 2016, the NBU, together with Ernst&Young, carried out a preliminary audit of PrivatBank’s ability to comply with new rules for assessing credit risk and rules for conducting transactions with related parties. As a result, an expected regulatory capital deficit of UAH 146.4 billion was identified.
This result and the fact that PrivatBank's management and shareholders apparently did not comply with the requirements of the Restructuring Plan meant that the NBU was obliged to declare PrivatBank insolvent . Subsequently, it could be withdrawn from the market in accordance with the provisions of the law on the Deposit Guarantee Fund of Individuals. However, the collapse of such a systemically important bank as PrivatBank threatened the entire financial system and economy. Ukraine's still very unstable economic renewal could be in jeopardy.
Logical ending - PrivatBank goes to the state
At the beginning of October 2016, the NBU received letters from the owners of the bank asking them to consider the possibility of voluntary nationalization.
Alexander Danilyuk, then Minister of Finance, commented on the essence of the letters from the ex-owners of PrivatBank: “The legislation of Ukraine provides for serious liability for bringing the bank to insolvency. The former owners of PrivatBank understood this. They were faced with an objectively difficult task - given the situation in the bank - to implement the program for additional capitalization, improve the loan portfolio, etc., agreed upon with the National Bank of Ukraine. They could not do this... It was important to find a solution that would not harm the bank. And this decision was the transfer to state ownership... The government decided to deposit a very serious amount into the bank. Therefore, they, the ex-owners, understanding their responsibility, gave an obligation to the government that within six months - by restructuring their corporate portfolio, adding collateral - they would compensate for the losses incurred by the state. But losses here are considered as a certain contribution to the stability of the system... The bank was brought to insolvency, this was recognized by the audit, by all international institutions monitoring the process. Obviously, there is responsibility for this. The letter was an initiative of the ex-owners of PrivatBank. They understand that they are obliged to restructure the portfolio and, in fact, compensate for the state’s losses. If they don’t do this, there are competent authorities in Ukraine and abroad (and the scale of the bank is colossal)...”
The Cabinet of Ministers made the decision on nationalization before receiving a letter of appeal from the ex-owners. And the letter was a kind of “insurance” against risks, the first of which was the risk of stopping the operating activities of the largest bank in the country.
Before the decision to nationalize PrivatBank was finally made, businessman and former co-owner of the bank Igor Kolomoisky had a conversation with US Ambassador Marie Yovanovitch, reported in December 2016. This conversation, as journalists’ sources note, was very difficult and became a “point of no return” in the story of PrivatBank’s transition from private to state ownership.
On December 18, 2016, the NBU declared PrivatBank insolvent. Immediately after this, the NBU approached the Cabinet of Ministers with a proposal to transfer this systemically important bank into state ownership.
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The nationalization of PrivatBank took place in several stages. First, the Deposit Guarantee Fund introduced a temporary administration into it, and then sold 100% of its shares to the Ministry of Finance for a conditional hryvnia. In order to cover the hole in capital of almost 150 billion hryvnia, the Ministry of Finance issued government bonds in the amount of 116 billion hryvnia. The rest was covered thanks to funds kept in PrivatBank by persons associated with former shareholders and management - through the so-called “bail-in” operation.
A joint statement by the Ministry of Finance of Ukraine and the National Bank of Ukraine dated December 19, 2016 regarding the nationalization of PrivatBank stated: “The state decided to enter the capital of PJSC PrivatBank... Unfortunately, the bank’s problems have been accumulating for many years and have worsened recently. Their main reason was the bank's unweighted credit policy, which led to the bank's loss of capital. For more than two years, the National Bank worked with the shareholder to develop and implement a recapitalization plan. However, the plan was not implemented. At the same time, the National Bank of Ukraine has established that today PrivatBank’s total need for capital is UAH 148 billion. The National Bank of Ukraine, realizing all these problems of PrivatBank PJSC and taking into account its importance as a systemic bank for the health of the financial sector and the country's economy as a whole, could not wait any longer and classified the bank as insolvent. As a result, the regulator approached the government with a proposal to transfer this systemically important bank into state ownership. The shareholders also sent a letter to the Cabinet of Ministers of Ukraine with a request for the state to enter the capital of PJSC PrivatBank.
