Why do banks sabotage the issuance of preferential loans to weapons manufacturers that are urgently needed by the Armed Forces of Ukraine?

Manufacturers of weapons for the Armed Forces of Ukraine need working capital, but banks are in no hurry to lend to them or do so on general business terms. Without solving this problem, supplies to the front will not increase.

Defense companies need additional funding to timely ship weapons to the front, overcome force majeure situations and quickly develop new equipment, which is urgently needed by the Armed Forces of Ukraine.

However, there are no preferential loans for manufacturers of military equipment in Ukraine. Unlike farmers and energy workers, the defense sector receives loans on general terms with high interest rates or seeks funds elsewhere.

The inability to take out a cheap loan from a bank is hindering the development of defense companies in the midst of a technical race with the Russian Federation.

Discussions on the creation of preferential lending programs for arms manufacturers have been ongoing since 2023. Then Prime Minister Denis Shmygal spoke about the possibility of including defense companies in the state program “5-7-9%”, and the head of the National Bank Andrei Pyshny even included them in the strategy for developing lending.

Although banks demonstrate high liquidity ratios and relatively large profits, there is still no widespread lending to the defense industry. The last time the authorities announced the introduction of relevant preferential programs was in March 2024, but, according to ED sources, the decision was stuck in the government.

Why do defense companies need loans?

To produce a weapon, a company must first receive an advance on the purchase of components. Typically, government customers - the Ministry of Defense, the State Service for Special Communications, the National Guard and others - provide an advance payment of 50-80% of the contract amount.

Given the size of the hole in the state budget, not everyone is able to obtain high advances from the state. Also, due to a lack of funds, force majeure with financing may occur. The ED is aware of a case where one of the departments, due to a lack of money, significantly reduced the amount of the advance after signing a large contract.

Since advances are not always enough to purchase components, defense companies have to seek financial leverage.

The need to raise additional money continues after the contract has been completed. The fact is that mostly short contracts are concluded with arms manufacturers in Ukraine, usually within the framework of the budget year. That is, the company ships products until December, and then waits several months next year for budget redistribution and the conclusion of new annual agreements.

During a contract lull, enterprises send workers to idle time. To maintain production, companies are forced to find money to pay salaries or rely on small orders from military units.

There are expenses that are not specified in government contracts and that are financed from the manufacturer’s pocket: the creation of prototypes, testing and the release of pre-production batches.

For example, the development of an armored car by the Inguar company cost $700 thousand, and NPO Praktika spends millions of dollars on the design of a new armored personnel carrier. According to surveyed electronics companies, the cost of developing “machine vision” for FPV drones costs hundreds of thousands of dollars.

Restoring workshops after missile or suicide attacks, relocating enterprises, purchasing generators and fuel also fall on the shoulders of manufacturers. Ukrainian Armored Vehicles told EP that $500,000 needs to be invested in the uninterrupted supply of electricity to the foundry.

To finance these costs, producers, logically, must turn to banks. However, there are no preferential lending conditions for defense companies, so they face a lot of problems. For example, the bank offered a loan to one of the manufacturers at an unfavorable 17% per annum, and refused to another due to war risks.

Therefore, military enterprises mainly cover the need for working capital from their profits, which could be invested in the development of production and new developments.

“Preferential loans would make life easier. We would optimize the supply structure, reduce costs, and scale production faster,” says Alexey Babenko, founder of VYRIY, a company that produces high-tech drones.

“During the periods between government contracts, we take direct orders from military units, but they only buy finished goods. One of the divisions is ready to buy drones from us for 20 million hryvnia, but there are currently no free operating funds for their production. If it were possible to take out a loan, we would borrow money for this project,” adds Vladislav Alekseenko, director of ISR Defense.

Why don't banks lend to defense?

It is impossible to say that banks do not lend to the military-industrial complex (DIC) at all. For example, Pivdenny Bank lent defense companies UAH 415 million in 2023, and in the first half of 2024 issued them loans for another UAH 315 million. The loan portfolio of defense industry enterprises at Oschadbank in 2023 amounted to UAH 6 billion, and this year it may grow to UAH 12 billion.

Other system banks that ED approached either do not have defense enterprises in their loan portfolios or refused to name the volumes of such lending. The National Bank does not maintain aggregated statistics on areas of bank lending.

At the same time, the figures announced by the banks are just a drop in the ocean of the needs of the defense industry during the war. It seems that defense enterprises and banks do not find a common language, although the latter are making record profits and have hundreds of billions of hryvnia available.

Banks have become perhaps the most profitable business in Ukraine thanks to free liquidity, which they do not use either to finance government spending through the purchase of bonds or to lend to the economy. But banks invest these funds in NBU certificates of deposit at 13-16% per annum.

It is not surprising that the National Bank’s monetary policy causes a lot of criticism, in particular among former central bank leaders. The NBU itself traditionally responds to this criticism with the need to maintain financial stability. Banks cannot direct all their available funds to lending to the defense industry for several reasons.

Firstly, the source of this money is the balances in the current accounts of businesses and households. In other words, the bank must have constant access to them in case customers want to withdraw funds from their accounts. Even if all banks direct money from certificates of deposit to loans, the excess liquidity of the banking system will not disappear, but will be redistributed between banks.

Secondly, banks are subject to strict requirements regarding the structure of their assets, because they manage depositors’ funds. According to NBU standards, to maintain stability, a bank must diversify investments: not invest all funds in lending to one sector or purchasing one type of securities.

Responsibility to depositors and supervision by the regulator make banks extremely cautious in providing loans. That is why, when issuing loans, they require borrowers to provide collateral and additional guarantees of money back.

At the same time, banks do not consider the defense industry a riskier sector for lending and impose the same requirements on defense companies as on other businesses.

“For us, a client operating in the defense industrial sector is no different from a client who is engaged, for example, in retail trade. The criteria are the same: acceptable creditworthiness and a detailed analysis of activities,” explains Elena Zubchenko, Deputy Chairman of the Board of Sense Bank.

Banks partly blame the arms manufacturers themselves for the insufficient volume of lending to the defense industry, calling them “young and infantile” companies that have no experience interacting with banks.

“Often these are companies that have only recently launched production, produced a certain amount of weapons and received their first contracts from the Ministry of Defense. Sometimes they don’t even have financial statements that they could show to the bank to confirm their solvency,” a top manager at one of the state-owned banks tells EP.

According to him, a common reason for refusal to provide loans to gunsmiths is inflated expectations. Thus, a borrower who produced a thousand drones wanted a loan of $0.5 million to produce a million drones per year, but did not explain how he would do this. Other reasons for refusal include the low business reputation of the company or its owner, the lack of contracts with the Ministry of Defense or even confirmation that the weapons they produce are approved for use.

How to increase lending to the industry

It's not just defense startups that have problems getting loans. Mature producers also face them. First of all, the issue of collateral gets in the way.

“Even large defense companies do not have the collateral to borrow to finance billion-dollar contracts. As a rule, property is valued at a 50% discount. Banks don’t take manufactured products as collateral because they don’t know what to do with them,” says Yulia Vysotskaya, director of NPO Praktika.

A partial solution for small private producers was found in the government.

“Private companies with revenues of up to 50 million euros per year can obtain bank financing through the government portfolio guarantee mechanism. Private defense industry companies can attract up to 100 million hryvnia with up to 80% of the loan transaction volume covered by a state portfolio guarantee,” says Deputy Chairman of the Board of Oschadbank Yuriy Katsion.

He adds that for the remaining 20% ​​of the loan, the borrower can provide the bank with a guarantee from the owner, a production line or other property. Unfortunately, many gunsmiths are not aware of such opportunities, so they do not apply for loans, the banker says.

The problem of collateral could be partially solved by factoring - the ability of the manufacturer to sell the state's obligations under the contract to the bank. Then the borrower now receives funds for the production of goods, and the bank receives the right to funds that the state will pay to the manufacturer in the future. However, such operations are now impossible.

“Firstly, the current regulatory legal acts do not contain provisions and clarifications regulating the procedure for consideration and acceptance by treasury authorities of budget obligations of fund managers that must be paid in favor of a person other than the counterparty under the contract.

Secondly, the treasury authorities do not have instructions or explanations regarding the possibility of changing payment details for registered budget obligations and making payments to another entity (third party),” explains Maxim Tsymbal, First Deputy Chairman of the Board of Pivdenny Bank.

Another obstacle to defense lending is the maturity of contracts, which affects the maturity of loans. Banks are afraid to give funds to the manufacturer for a period of more than a year, because they are not sure that in the next budget period the company will have an order from the state.

“It is necessary to introduce the practice of long-term contracts for defense products so that manufacturers can attract funds not only for the production of current products, but also invest in development on a long-term basis. There is a practice in NATO countries where agreements are concluded for three to five years, and sometimes for longer periods,” adds Tsymbal.

Authorization for arms exports will also facilitate lending, bankers add. Now there is only one buyer of weapons in Ukraine - the state. Consequently, the production volumes and turnover of gunsmiths depend on the solvency and needs of the government. In such conditions, lending becomes risky, because the borrower will not be able to sell his goods in the event of a sharp decline in demand, for example, if the war ends.

Permission to export arms will increase the number of buyers. Moreover, it can have a positive impact on the solvency of the manufacturers themselves, because they are already capable of producing much more weapons than the state can buy.

Finally, bank lending remains too expensive. Large banks are ready to lend to weapons manufacturers at 15-17%. A way out of this situation could be a state program for compensation of interest rates like “5-7-9%”.

The Ministry of Strategic Industry is preparing a decision

In May, the Verkhovna Rada adopted a bill, thanks to which the Ministry of Strategic Industry will be able to compensate banks for interest rates on loans that they provide to gunsmiths. Thus, the way was opened for the introduction of a program similar to “5-7-9%” for the defense industry. Weapons manufacturers will receive loans at low interest rates, and the state will compensate banks for the difference between market and preferential rates.

However, the parliament’s decision is only the first step; the government must still develop rules and mechanisms. The Ministry of Strategic Industry of the Russian Federation said that work on the program continues and the department will inform you as soon as it is ready to launch.

In March, Forbes wrote that the new resolution should have been implemented in the spring. There is still no solution. It seems that the development of the mechanism requires careful coordination with departments and it turned out to be more difficult than expected.