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“The team was recently visible advising on a number of pharmaceutical cases. Sources agree that the team is “moving in the right direction” and are particularly impressed by its work in the pharmaceutical sector”.

 

Lending as One of the Potential Risks of 2018. Risks for Banks and Depositors

12.02.2018

Oleksandr Vygovskyy, attorney at Ilyashev & Partners Law Firm

Source: ZN.ua

A significant number of non-performing loans is one of the main threats to the banking sector. According to the NBU a substantial share of the troubled loans in the banks’ portfolios has become one of the key internal risks of the banking sector in recent years.

The banking system transition to the international practice of determining the non-performing loans and the introduction by the banking regulator of new requirements for the assessment by the banks of their credit exposure under active banking transactions made it possible to assess the real level of troubled loans given by Ukrainian banks. The result is impressive: the share of such loans (58% in July 2017) is the worldwide largest in the history of observations! By contrast, it is worth mentioning that, according to the NBU, the countries having the highest historical maximums of the share of non-performing loans were, for example, Afghanistan with its 50% and Nigeria with 38% in 2010, and the Equatorial Guinea with 28% in 2016. It should also be noted that the share of loans overdue for more than 90 days (that is, those with faint hope for return) constitutes almost 80% of all non-performing loans. And this is despite the fact that Ukraine’s credit activity rates are one of the lowest in Europe: the loans-to-GDP ratio is only 3.6%.

The underlying reasons for the above are different, including economic recession, population’s low capacity to pay, high level of real (effective) interest rates on loans, the servicing of which is beyond the strength of many borrowers, and high credit risks, requiring the banks to form additional reserves for such loans. The considerable legal risks associated with credit transactions should also be taken into account, since the creditors’ rights in Ukraine are poorly protected both at the legislative and law enforcement levels, which, in particular, hampers the development of lending and the availability of credit funds.

In addition, it is important to understand that the existence of troubled loans in the bank also presents a significant risk for the depositors of this bank, since falling behind the schedule of incoming payments from the borrowers may jeopardise the ability to make regular deposit payments.

Meanwhile, there is no hope that the improvement in the economic situation in the country will reduce the number of troubled loans. According to the NBU’s Financial Stability Report, if the economy improves, the quality of the loan portfolio will noticeably improve as well, but the majority of non-performing loans will never be serviced again. And if there is no rapid economic growth, and hryvnia exchange rate continues to drop (which seems more realistic), then the portfolio of troubled loans will remain a source of inherent risks for the banks. According to the regulator, banks should more actively deal with troubled loans using the restructuring and debt remission mechanisms.

As soon as in the first half of 2018 the NBU will oblige banks to provide action plans aimed at dealing with bad debts. In addition, in order to test out the banking sector the NBU introduces an annual evaluation of the banks’ activities through stress testing: all banks, whose total assets altogether constitute at least 90% of the total assets of the banking sector, will undergo the relevant checks. However, the most effective results in this field can be expected in case of adoption in 2018 of the draft Law of Ukraine On Debt Management Activities, developed by the NBU with the support of the EBRD.

Today, when dealing with bad debts, banks tend to negotiate the restructuring with borrowers, write them off or sell them at a discount (ie, below their value). Due to the ineffectiveness of the judicial system, the recovery of troubled loans by the bank itself may not be possible or take a lot of time. The adoption of the aforementioned draft law, in addition to existing opportunities, will allow banks to sell their troubled loans to the specialized financial institutions — debt management companies. In the future it is these companies that will settle the issues of debt repayment, interacting directly with the debtors.

The aforementioned draft law is aimed at legal support for the activities of the debt management companies in Ukraine, the establishment of an appropriate competitive environment in the secondary credit market and the improvement of regulation related to the transfer of receivables. The adoption of the said law will provide the banks with real opportunity to clear their balances from the “toxic” loans more quickly, which will lead to an improvement in their financial position, the release of additional resources previously used as reserves, and the revitalization of the credit market as a whole.

The final adoption of draft law No. 7114-d – which provides for the creation and maintenance of the NBU’s credit register – would definitely help to improve the situation in this segment of the banking services market. The credit register, existing in many countries around the world, is an information system collecting data on credit transactions of the financial institutions and the state of their implementation. The banks will be able to use this information when assessing the level of credit risk before granting a loan and timely learn about the problems of a potential borrower with servicing of other loans. This will decrease the likelihood of granting loans to the bad borrowers and will reduce the number of troubled loans in the future.

In conclusion, it should be emphasized once again that the problem of a significant number of non-performing loans is one of the main threats to the banking sector in 2018. It presents a significant risk for both the banks themselves and their depositors and other creditors, undermining the stability of the country’s banking system in general. To solve it, it is necessary, among other things, to improve the current legislation of Ukraine and introduce new tools for dealing with bad debts that will help banks to clear their balance of “toxic” loans and improve the status of their loan portfolios.

 
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