Yulia Kyrpa, a Kyiv lawyer who specializes in banking and finance, said that “a lot needs to be done” in the nation’s banking sector to prevent large-scale fraud in the future.
Kyrpa, a partner with AEQUO law firm in Kyiv, chairs the banking and financing committee of the Ukrainian Bar Association and recently served on an advisory public council of the National Bank of Ukraine.
She spoke with the Kyiv Post on June 30, following the newspaper’s month-long investigation of the banking sector, published in the July 1 Legal Quarterly and regular edition of the newspaper.
Since at least 2008, unpunished criminal fraud, insider lending and unpaid loans have caused at least $11.4 billion in losses in the sector – losses ultimately paid for by Ukrainian taxpayers or private individuals and firms who simply lost their uninsured deposits. The three components of the losses include: $3 billion in state-insured losses, $5.2 billion in uninsured losses and $3.2 billion owed to NBU from bankers who failed to repay their refinancing loans.
The shakeout in the banking sector has whittled the number of banks from 180 to 100 in the last two years as the NBU and the state-financed Deposit Guarantee Fund have improved laws and tightened regulations. Before the shakeout is complete, the number of banks left standing may be as few as the top 20 banks, which account for 88 percent of the sector’s assets.
But Kyrpa said it’s too early to call the reforms a lasting success.
“I don’t think it’s irreversible,” Kyrpa said. “To become irreversible, they need to institutionalize the positive changes. Right now, in my view, they (NBU leaders) depend on specific people. Some are focused on reforms and as long as they support the changes and a fair, Western-style of communication, it works this way.”
“But it takes much longer than just two years for these changes to be implemented on the level of the entire institution, to create a corporate culture that would support such values and so on,” she said. “There are still many old-fashioned people who used to work with the previous regime and work according to their values. They are not proactive enough. They do not always work to the best interests of the NBU and investors in the banking sector.”
The NBU has highlighted three areas of big change:
1. Now the central bank knows the beneficial, or true, owners of financial institutions, unlike in 2014;
2. safeguards have been put in place to curtail insider or related-party lending, one of the biggest culprits in racking up the losses along with asset stripping by owners before their banks are declared insolvent; and
3. Owners are legally criminally liable for fraudulent losses.
Convictions needed
But simply changing laws and tightening regulations are not enough.
“It’s important to have some success stories, to have some cases where beneficial owners who brought their banks to insolvency by stripping assets and taking money out of the system will be brought to criminal liability,” Kyrpa said.
“Unless it’s done and until it’s done I don’t think that only the existence of law will be enough. The law needs not only to be in place but to be implemented in practice, when it’s perceived by the public as a working legal instrument,” she said. “Otherwise, it’s just a piece of paper which has no implementation and no consequences.”
Only recently were laws passed that “invented proper legal instruments to bring beneficial owners of failed banks to criminal and civil liability,” Kyrpa said. “This law still remains untested.”
The new laws also can be applied retroactively, “meaning that owners of failed banks can still be brought to liability if it gets proven they caused some criminal violations of the law,” Kyrpa said. “It remains to be seen how the Deposit Guarantee Fund will handle all those cases and bring owners of failed banks to liability.”
Outside experts needed
Kyrpa said that both the NBU and Deposit Guarantee Fund need to hire outside experts because the state agencies are not up to the task.
First, they were overwhelmed with the amount of financial losses and, secondly, until recently, they didn’t “have special units of experts who were able to investigate financial fraud, especially in most of the cases we are speaking of international financial fraud.”
The Deposit Guarantee Fund “wasn’t designed for that. They don’t have the internal capacity to start such procedures and trace assets worldwide. It’s extremely important to involve proper outsourcing services focused on asset tracing and recovery,” Kyrpa said.
On the positive side, the Deposit Guarantee Fund has finally set up a special unit solely in charge of liquidating assets of insolvent banks, she said. The process went slowly because many restrictions made it difficult to evaluate and sell the assets quickly, or individual bank liquidators were afraid to make decisions on their own because of the lack of transparency in involved in some asset sales. Here again, she said, experts should be brought in because assets and liabilities of insolvent banks have a “special methodology of their own.”
Additionally, civil and criminal proceedings run the risk of obstruction in courts.
“The Ukrainian court system is widely regarded as corrupt,” Kyrpa said. “To overcome these obstacles, it’s important to put extra efforts on this to involve the best experts with a proven track record on financial investigation.”
If blocked by the court, she said, the best recourse is often to complain to state authorities and alert the news media.
With teams of asset-recovery experts now being hired by the NBU and Deposit Guarantee Fund, Kyrpa said, investigations are starting to develop in the “right direction.”
But even under optimal circumstances, only 10 percent of stolen assets will be recovered. In Ukraine’s less than ideal circumstances, Kyrpa said the public can expect not much more than 5 percent to be recovered – or $570 million out of the estimated $11.4 billion in losses.
‘No consequences’
Kyrpa also said that the creation of a public registry of deadbeat borrowers could also significantly cut down on the number of unpaid loans and put banks on notice to improve their lending practices.
Such an idea is resisted by the NBU and others in the industry who value banking secrecy about the public’s right to know about unpaid loans for which taxpayers eventually pay.
“I would support this idea in the case of non-performing loans” Kyrpa said. “That’s the only possibility to decrease the amount of non-performing loans in the system. I think it would create extra discipline. It would make bad-faith borrowers sort of like persona non-grata like in the Western countries where, if you don’t repay a loan from the bank, you can’t have a proper job or borrow another loan or get any subsidies from state or whatever, depending on the country.
By contrast, in Ukraine, “in most of the cases, there are no consequences. Borrowers who sometimes cannot repay loans due to economic reasons know there will not be any significant consequences. They will not be excluded from society. That’s why they use these opportunities.”
Credit scores needed
In the West, most people know one all-important number: Their credit score as kept by such rating agencies as TransUnion and Equifax. The agencies monitor such credit factors as the amount of credit being used, payment history, derogatory remarks (for non-payment), age of credit history, number of accounts opened and number of credit inquiries that others have made. The system is so detailed and accurate that it gives the person – and [otential lenders – detailed information on balances remaining on credit cards and home mortgages. The scores range from 300 to 850.
The score determines whether a person is a good credit risk and will get a loan and whether the borrower is eligible for the lowest interest rate.
In Ukraine, such a system is not working and, oddly, Kyrpa said that banks are partly to blame.
“There were some initiatives to implement this credit bureau, but it never started working in an efficient way because banks don’t share this information,” Kyrpa said. “Ultimately there is no overall ranking for every borrower because information is not shared efficiently. There is still room for improvement in all areas. This involves sharing the information, assessing the borrowers and creating a certain score for them. I think banks sometimes don’t put proper information in the United Registry of Borrowers.”
With lending frozen, creating a functioning credit bureau is not a top priority of bankers, she said.
“This issue will become more relevant and more attention will be given to it when lending resumes again,” Kyrpa said. “Right now banks are focused mostly on recovery of loans previously granted or restructuring of those loans. I wouldn’t expect major changes until new financing resumes again.”
A big mess
The crisis exposed how unregulated the banks in Ukraine had been. “I would stay it was not controlled at all,” she said. “Nobody really controlled the process of bank establishment.”
Starting with the lack of NBU enforcement of laws requiring verification of the identities of true or beneficial owners of banks, the sector was destined for disaster.
“If we look at any other European country, it is unthinkable to work in such a blind environment where you don’t know the beneficial owner,” Kyrpa said. “It’s impossible to understand the real amounts of insider lending and loans granted to related parties.”
Yet another huge problem took place in a months-long gap between the time a bank’s finances became problematic and the time it was declared insolvent. Those problems were exacerbated by weak powers given to the NBU supervisor, or curator, of the troubled institution.
“They didn’t have a veto right. They couldn’t stop any transactions. They were only able to report to NBU if the bank was not performing to expectations or if they anticipated in violations of legislation,” Kyrpa said. “It resulted in the situation when former shareholders of insolvent banks stripped off all the assets in this banks in this period of time.”
The process was so poorly regulated, Kyrpa said, that bank owners sometimes even denied NBU access to documents.
Additional questions have been raised about the $3.2 billion in state losses from refinancing loans issued by the NBU to bankers who didn’t repay them. The non-transparent process of the NBU deciding who gets refinancing loans and on what terms and who doesn’t is controversial within the industry.
In the end, there are valid reasons to keep the refinancing decisions confidential to avoid market panic and a run on bank depositor, Kyrpa said. Refinancing banks that fail to repay the loans only add to the state losses, she said, while some bankers claim they failed because they weren’t granted refinancing.
“The discretionary powers of NBU lead to rumors and discussions,” she said. “It’s impossible to remove the discretion of the regulator. To limit such discussion, the NBU has to be seen as a strong and unbiased regulator.”
Financial illiteracy
Yet another regulation shortcoming – unsustainably high interest rates offered by banks on deposits – was exacerbated by Ukrainians’ “insufficient financial literacy.” IN contrast with many Europeans, who seek secure returns for long-term investment, many Ukrainians still look at bank deposits as a form of gambling, she said.
“In Ukraine, we managed to see a situation of the so-called deposit wars as banks competed in offering highest possible interest rates on deposits in banks,” she said. “The less reliable banks offered the highest interest rates, which actually was welcomed by the population.”
2020
The NBU has adopted a long-term strategy to guide its actions until 2020. If “nothing bad happens” before then, Kyrpa said, “perhaps these changes will work on the level of the entire institution and perhaps become irreversible.”
