In 2022, Ukraine's largest financial donor was not the US, EU or IMF.
Oddly enough, it was Ukraine itself, or rather the National Bank, which in 2022 lent the government UAH 400 billion.
The NBU remains the largest domestic creditor of the state today. In total, the government owes the central bank almost 700 billion UAH and annually spends tens and even hundreds of billions to service this debt.
Budget debts to the National Bank look like transferring money from one “pocket” of the state to another. The fact is that the income that the NBU receives from the Ministry of Finance as interest payments becomes part of the central bank’s profit, which is then transferred back to the budget.
However, in reality this is not always the case. For example, in 2024, more than 80% of the funds that the state will transfer between its “pockets” will be lost along the way.
Who actually makes money from the government’s debts to the National Bank and why does the budget lose twice on this?
How much does the government owe the NBU?
To cover the state budget deficit with the help of internal resources, the government issues domestic government loan bonds (OVDPs). In Ukraine, this instrument is considered the most reliable, which is why it has become an important element of the financial market.
However, even banks do not invest as much in government bonds as the regulator. The latter has bonds totaling UAH 690.7 billion at its disposal - 45% of the country’s total internal debt.
To understand why the government owes so much money to the NBU, it is enough to remember 2022. In the first months of the great war, tax revenues fell sharply and expenses rose. There were not enough funds in the budget, and international partners were not yet ready to provide the funding Ukraine needed. It was at this moment that the National Bank came to the rescue, to which the government sold bonds worth UAH 400 billion.
By purchasing assets, in particular government bonds, the National Bank creates money and puts it into circulation. This process is called emission, and popularly called “printing” of money.
Government bonds issued in 2022 are the largest part of the budget debt to the National Bank. To issue them, it was even necessary to change the law on the National Bank, which prohibits “printing” money for budget needs, and also to adopt a special government resolution.
The amounts and terms of securities issued in 2022 are as follows: UAH 280 billion - floating rate (at the level of the average NBU discount rate for the 12 months preceding payment), repayment in 2033-2036, 2038-2040 and 2052; UAH 120 billion - rate 11% per annum, repayment in 2037.
The regulator purchased the remaining government bonds that are in the NBU portfolio in previous years. The amounts and terms of these securities are as follows:
- 2014 - UAH 12 billion, rate - 12.5% per annum, repayment will take place in 2024;
- 2015 - UAH 35.25 billion, rate - 11.18-12.5% per annum, repayment in 2025-2029;
- 2016 - UAH 17.8 billion, rate - 9.81-9.95% per annum, repayment in 2030-2031;
- 2017 - UAH 223.46 billion, the rate for government bonds for UAH 78.29 billion is 8.17-11.3% per annum, for the rest - the inflation rate plus 2.2%, repayment in 2025-2047.
Government bonds issued in 2017 are the result of repurposing or restructuring. Then the government exchanged bonds with a total value of UAH 220 billion for new ones, but with different maturity dates, in order to evenly distribute payments on them over time and not create a significant debt burden on the budget.
How much is the government's debt to the National Bank worth?
Government bonds in the NBU portfolio are a debt, which means they need to be repaid. Given its size, this could be a real problem for the government in the future. However, fortunately, the redemption of these bonds is almost evenly spread over time until 2052.
“Of course, the NBU’s portfolio is large and accounts for almost 46% of all government bonds in circulation. The largest volume of repayments will occur in 2037, when 120 billion hryvnia of war bonds will be repaid. But in general, the repayment of bonds in the portfolio is distributed over a long period and will not create any problems for the budget,” notes Taras Kotovich, senior financial analyst of the ICU group.
These debts must not only be repaid, but also serviced, that is, interest must be paid. The size of payments for most of the government’s debt to the NBU, amounting to UAH 425.18 billion, is floating and depends on the level of inflation and the discount rate. In other words, it is quite difficult for the Ministry of Finance to predict the future volume of payments.
According to the calculations of the National Bank, in 2023 the government must pay it UAH 120.75 billion in interest on government bonds. Of this amount, UAH 81.15 billion are coupon payments on government bonds issued in 2022, the remaining UAH 39.6 billion are coupons on bonds of previous years.
In 2024-2025, government payments to the NBU will be lower, since the discount rate and inflation to which such payments are tied will be lower.
From one pocket to another?
At first glance, the government’s debts to the National Bank are a transfer of money from one “pocket” of the state to another. According to the law, the NBU must transfer almost all profits received during the year to the budget.
In 2023, the NBU transferred almost UAH 72 billion of profit to the budget based on the results of 2022, which fully compensated for coupon payments by the Ministry of Finance in favor of the regulator for that year. However, this situation will not repeat next year.
According to the law on the state budget for 2024, the treasury for 2023 will receive only UAH 17.7 billion in profit from the NBU. This is despite the fact that this year the Ministry of Finance paid the NBU more than UAH 120.75 billion in interest on government bonds. That is, on the way between the “pockets” of the state, more than 100 billion UAH will be lost (85% of government payments to the NBU).
Where were 100 billion hryvnia lost?
To answer this question, you need to track the money that the government received from the central bank through government bonds in 2022. As mentioned above, every time the NBU buys bonds from the Ministry of Finance, it creates new money.
The issue of NBU money in 2022 led to an increase in excess liquidity in the banking system. In other words, banks have accumulated an “extra” half a trillion hryvnia (at the peak, in July 2023, the amount reached UAH 579 billion). It is almost impossible to get rid of these surpluses, no matter what measures banks take.
For example, if banks spend all excess liquidity on purchasing government bonds, then the volume of this liquidity will not change. The government will use it again to finance expenses and it will return to the banking system.
Also, banks cannot issue loans for “extra” funds. Firstly, during a war there is too little effective demand for such a resource. Secondly, given the risk of non-repayment of these funds, many banks could go bankrupt. Thirdly, bank lending will also not change the total amount of liquidity in the system - funds will simply flow from one account to another.
Perhaps the only way to remove excess liquidity from circulation is to place it in the National Bank. This happens with the help of certificates of deposit (CD), which banks buy from the NBU. However, withdrawing funds from circulation has its price. It is measured in percentage that banks receive for transferring their funds to the regulator.
The profitability of the DS depends on the discount rate. The rate on overnight DS (they store the majority of excess liquidity, the circulation period is one day) is equal to the NBU discount rate (16%), and on three-month DS (banks are allowed to invest in them depending on the volume of time deposits that clients open with them) is the discount rate plus 4 percentage points (currently 20%).
On November 9, banks held more than UAH 492 billion in NBU certificates of deposit, of which UAH 195 billion were three-month “deposit certificates” with a rate of 20% per annum.
According to the National Bank, by November 5, UAH 73.5 billion had been spent on paying interest on certificates of deposit. The regulator refused to estimate what the amount of payments to banks might be based on the results of the entire 2023, noting that “this issue is too sensitive.”
“Forecast volumes of DS and payments on them are not public information, given its sensitivity, which is due to dependence on many factors, including those beyond the direct influence of the NBU (for example, the government receiving financial assistance from international partners, its conversion into hryvnia and the direction into the banking system),” the NBU responded.
The budget loses twice
If we summarize the movement of money that the NBU created during the issue, we can conclude that a significant share of it will be “lost” in the profits of commercial banks. Of the UAH 120.75 billion that the Ministry of Finance will pay to the National Bank for government bonds, about UAH 88 billion of payments on certificates of deposit may end up in banks this year.
Payments by the NBU on certificates of deposit became one of the key prerequisites for the record profitability of the banking system. The day before, the National Bank reported that in just nine months of 2023, banks received UAH 110 billion in profit. It is clear that at the end of the whole year its size will increase even more thanks to stable payments under the State Insurance Fund.
“Mathematically, NBU payments to banks (on certificates of deposit) eat up its income, which it receives from government bonds. It turns out that the Ministry of Finance pays twice for the policy of high rates: both because of the high rates on government bonds (both those that belong to the NBU and those that belong to other market participants), and does not receive dividends from the National Bank,” explains the head of the analytical department of Concorde Capital Alexander Parashchy.
It is not surprising that the Ministry of Finance is not happy with this situation. Over the past two years, they have made at least two attempts to reconsider their debt to the NBU.
In the summer of 2022, deputies almost approved a norm that obliges the NBU to automatically transfer interest income from issued government bonds to the budget within ten days after receiving them. And when preparing the 2024 budget for the second reading, the Ministry of Finance included an article in the document that allows the government to carry out another reprofiling of government bonds owned by the National Bank.
Both attempts were unsuccessful, so commercial banks will continue to enrich themselves from budget debts to the central bank. True, the NBU does not see anything wrong with this.
“The funds earned remain in the system due to the ban on private banks from distributing profits during martial law. Therefore, this profit remains with the banks to increase their stability and support further active lending. Only stable banks are able to serve the economy and return deposits to the population and support the country’s recovery,” the NBU responded.
The regulator adds that the current monetary policy, thanks to which banks are getting rich, has made it possible to avoid further money emission in 2023, and also preserved the stability of the hryvnia. After all, if the NBU had not absorbed the excess liquidity of the banking system, it could have migrated to the foreign exchange market, “burned” gold and foreign exchange reserves and led to a significant devaluation of the hryvnia.
Which exit?
Is it really true that only large businessmen who own Ukrainian banks are enriching themselves from the debts that the budget was forced to take from the National Bank? Yes, but partially.
The largest owner of banks in Ukraine is the state. It is in state banks that most of the excess liquidity of the banking system is concentrated, because social benefits, salaries of public sector employees and cash support for the military are paid mainly to accounts opened in Privatbank and Oschadbank.
Although state banks earn the most from the excess liquidity of the banking system, they will transfer most of such income back to the budget in the form of dividends next year.
Non-state banks, which also accumulate excess liquidity, cannot withdraw their profits. They will use these funds to cover the losses caused to the banking system by the war. However, here too the state found a way to return what it had. To achieve this, parliament decided to introduce a tax on excess profits for banks.
“The operational design of the inflation targeting regime gives banks additional unpredictable income when the key rate increases. Therefore, many countries introduce windfall tax (tax on unpredictable income) in various forms. This applies not only to banks, but also to other companies (for example, resource companies) that have received unpredictable income for certain reasons,” explains Sergei Kolodiy, chief manager for macroeconomic analysis at Raiffeisen Bank.
Recently, parliament passed in the first reading a bill that proposes to increase the profit tax rate for banks from 18% to 36%. If it is finally approved, the new tax will go into effect from next year and will apply to the profits that banks will receive in 2024.
“This idea is a little late, because next year bank income will not be so significant: interest income will decrease much faster than expenses. But it’s definitely not meaningless; some Western countries already apply such a tax,” adds Paraschiy.
Therefore, in 2023 the state will actually subsidize the banking system. True, such a subsidy will not only support the stability of Ukrainian banks in war conditions, but will also allow them to earn good money.
