Private banks are better than the state ones for the economy and the pockets of the tax payers

Private banks are better than the state ones for the economy and the pockets of the tax payers. So all state banks should be privatized – Hlib Vyshlinsky, CES executive director has presented the key results of CES upcoming research “What should the state do with its banks?” at the Ukraine Reform Conference (London, 6 July 2017)

Why bother talking about SOBs?

  • SOBs – 55% of assets, 61% of persons’ deposits, 51% of deposits of enterprises, 61% of branches, 73% of ATMs, 74% of cards (NBU data);
  • SOBs have higher share of problematic loans (62% for SOBs, 48% for foreign banks, 24% for Ukrainian private banks – NBU data);
  • During 25 years Ukraine spent USD 10 bn for the recapitalization of the state banks (more than USD 4 bn already spent on Privatbank).

What are the costs of SOBs for the economy?

The quality of risk management and collection of bad debts is worse in Ukrainian state-owned banks. This leads to a higher share of non-performing loans (confirmed by NBU data), which leads to the need for recapitalization at the expense of taxpayers.

In addition, there are risks of state capture as SOBs as well other SOEs are used by politicians to make money:

  • state banks can provide loans to businesspersons with political connections;
  • state banks actively lend to state-owned enterprises, which may have a negative impact on their financial performance;
  • there are also investigations of journalists regarding the procurement of SOBs;
  • SOBs can be used to finance budget deficits via purchases of government bonds (crowding effect).

Due to the presence of all these risks, it is better for the state to sell its banks if they provide the same services as private ones. In Ukraine all four state banks (Osachadbank, Ukreximbank, Privatbank, Ukrgazbank) are universal banks, hence, must be sold.

How to finance projects with social value that are not financed be private banks?

There is a hypothesis that so-called development banks can create an additional social value that is not created by private banks (market failure). For example, private banks may not be interested in financing long-term infrastructure projects, providing financial services in rural areas (financial inclusiveness). Therefore, there are ideas for creating on the basis of existing banks – development banks (first of all Ukreximbank).

In our opinion, IFIs must be used as development banks for Ukraine (EBRD, World Bank, IFC, etc). These banks are not subject to the political and corruption risks described above. We propose to transfer the function of financial inclusion to Ukrposhta (the network of banks covers only 65% ​​of the population, and Ukrposhta – 100%).

Can corporate governance reform be an alternative to privatization?

In the short term corporate governance reform (ownership policy, independent supervisory boards, level playing field) will help to minimize the political influence on the banks. But we should not overestimate its capability. Temporary relief does not guarantee from repeated captures in future.

In Ukraine the top managers of SOEs and supervisory board members risk not only their reputation and money, but while freeing seized SOEs from corruption, they may risk both their freedom (SBU) and life. There is always a risk that even currently independent managers and board members will be captured by vested interests in the future, either through bribery or physical threats.

Privatization and building independent regulators are the only sustainable remedies. Resolving for market failures should be done through conducting competitive auctions for provision of public goods (loans for developing infrastructure or access to banking services in the rural areas) among all banks.

The goal of privatization of SOBs should be to find the strategic investor (with long term development plan).

What to do with state banks until we find the strategic investors?

Finding strategic investor may take a while. Therefore, the state as an owner should have some strategy for its banks in the short run. We believe the state should pursue three major goals:

(1) (as a regulator) decrease its presence at the banking sector ( including no “too big to fail” in the future, minimize crowding out effects);

(2) (as an owner) specialize its banks (not letting them compete with each other);

(3) (as policy maker) correct for market failures — providing loans to develop public goods, financial inclusion.

Specialization implies getting rid of other non-core businesses. Hence, will decrease the overall presence of state banks at the market. Specilization may also imply focusing on correcting specific market failures.

We propose the following possible short term strategies for state banks:

Ukrgazbank: sell ASAP. It now specializes on energy efficiency projects, which it can do as private banks as well.

Privatbank: sell ASAP. It is the most technologically advanced bank, but we believe there is a risk of slowing down in development if stays in the hands of state for longer period of time. There is also a risk of bank capture by the vested interests of politicians. In order to sell bank the NPLs should be written off from its balance, possibly to a newly created asset management company for “bad loans” of SOBs.

Oschadbank: specialize on SME financial inclusion.

Ukreximbank: specialize on export-import operations, servicing international agreements of the government.

Ukrposhta: specialize on financial inclusion of population.