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Industrialbank: The Development of the Banks in Ukraine is Hampered by Imperfect Legislation

Creditors’ rights in Ukraine are not sufficiently protected, and people and companies cannot fully rely on the judicial system to make economic decisions, says Vladislav Verchenko, Deputy Head of the Supervisory Board at the Ukrainian Industrialbank. According to him, the rule of law and a strong legal system are necessary conditions for the development of the Ukrainian banking sector. Verchenko, a banker with Western education and Ukrainian roots, considers the Ukrainian market challenging and promising.

Vladislav Varchenko expertMr. Verchenko, you lived in Canada and have a Western education. Why did you decide to move to Ukraine?

I was born in the Soviet Union and came to Canada as a teenager. I lived in this country for more than 10 years, where I got to know the banking sector as a bank employee. Then I went to study in England, and after England, it happened that I moved to Ukraine. I had the whole post-Soviet space in mind because, at that time after I finished my studies, emerging markets were in trend. And I wanted to work in one of these markets. At a conference in London in 2009, I attended a presentation by an investment banker who presented Ukraine as a country with big economic potential. So I set my eyes on Kyiv, and after London, I came here. It is possible to say that I returned, although I was not born in Ukraine.

And where do you come from?

I was born in Tashkent, but all my roots are Ukrainian. After the revolution of 1917, my ancestors emigrated, and one family branch left for Central Asia before the revolution. So interestingly, I was brought back to Ukraine, and I am the only one here from my whole family. My parents live in Canada. I decided to continue my professional activities here, although the banking business attracted me when I was still in Canada.

What is your education?

I hold an MBA degree, and at the bachelor’s level, my specialization was International economics.

Industrialbank was created 30 years ago, it is even a bit older than the Ukrainian independent state. What are the main achievements of your bank during its existence? What can it be proud of?

I think that the very fact of its existence to this day is one of the important achievements in such a turbulent country as Ukraine and such a rapidly changing banking sector. In this market, it is difficult to survive. Because it is a competitive market, and, at the same time, a regulated market that operates according to imperfect rules. In particular, creditors cannot easily rely on the court system to make their lending decisions.

The existing imperfect judicial system and legal uncertainty make it difficult to work in the banking sector under such conditions. And the very fact that the bank was able to withstand various stages of economic decline, growth, again recession, revolutions and all political changes, indicates that the bank’s management supported by the supervisory board have been making the right decisions.

I mean, the management understands how to manage a bank in such a volatile environment. The latest reform – the so-called cleansing of the banking sector – took place after the last revolution in 2014, when the National Bank of Ukraine significantly enhanced the rules of the market, raised the requirements for the bank’s shareholders and disclosure of the bank’s owners.

Not every bank was able to survive, to pass this filter. As a result, the number of players on the market has significantly decreased, but Industrialbank has overcome all the regulatory hurdles and all the requirements imposed by the regulator and continues to develop.

More than half of the banks that are roughly the same age as Industrialbank have ceased to exist, right?

Absolutely right. The nature of banks in Ukraine is specific. It is different from the European banks because Ukraine has a different economic system. Here, before the cleansing of the banking sector, the model of so-called captive banks dominated – banks that were created to service to a large extent related financial and industrial groups.

Trust is a rare product in Ukraine. That’s why business people who were able to succeed in the ’90s or the noughties believed that it was also important to create a bank in order to service their business, their groups. They did not want to entrust money to other individuals because trust was undermined by the corrupt court system.

If you cannot rely on the law, the courts and fair trials – the chain of trust breaks down. Accordingly, business people preferred to create captive banks that serviced their businesses. But because all these banks did not work for the so-called market, not for the ordinary consumer of banking services, their business model turned out not to be sustainable. If their business collapses, then, in fact, the banking business for them seems to lose its meaning. And that creates risk for depositors.

After the revolution of 2014, the banking sector had changed significantly: the rules had changed, requirements had risen, the regulator actually forced the bank, as I say, to begin playing in the market: to start competing for market share, for an ordinary consumer, for business, etc. And many banks realized that they lacked the competencies and skills to live up to the new market standards.

The regulator set very strict requirements for the bank’s work because the capital that shareholders have to put up to support the bank must be real. A bank is a business where shareholder support is very important, because if your risk-management system doesn’t work well, then, in fact, a bank risks not only shareholders’ capital, but also depositors’ money. This is a social factor, this is the stability of the banking system and the economy as a whole.

Banking is, on the one hand, a simple business – in terms of product creation. But, on the other hand, it is a difficult one in terms of risk management. So, all the small banks that were created to serve their own groups did not have the skills or did not know very well how to manage risks. So, when the demands increased, and they were forced to play the market, many of them failed. But Industrialbank passed this stress test.

Did your bank pass this test, perhaps because it is also implementing Western standards of operation?

Also that. Once again, I would like to say that the role of the regulator here was also quite significant. The regulator demanded the introduction of the institution of independent directors, committees, i.e. to structure the entire management system in such a way that risk would be assessed adequately. Our bank immediately picked up on this, began to change the corporate governance system, and strengthened the Supervisory Board with independent directors.

The shareholders supported this reform. After its implementation, there is a clear separation of powers, what the management board should do and what the supervisory board can do. When the corporate governance system works, it is, of course, much easier to manage risks. That is one of the reasons why we passed this stress test. Proper HR policy and corporate governance have brought positive results. But this is an ongoing work, because there are constantly new challenges in the market, and it is very important that the Supervisory Board has different opinions and competencies, which will help the bank and its Management Board to make the right decisions.

Industrialbank is currently taking another test – the coronavirus pandemic. How has it affected the bank’s work? How has customers’ behaviour changed?

Of course, it has affected all the activities of the bank. We can say that a certain standby mode is seen in lending. We are being careful, and have revised our strategy to a more conservative tone against the background of the coronavirus.

Before the coronavirus, there were expectations that the economy would grow, and, of course, our bank formed a strategy and lent to customers on these positive expectations. But COVID-19 has affected the entire world economy, and Ukraine is very dependent on other markets, so certainly the expectations have changed. Under the current conditions, it is difficult to build a new high-quality loan portfolio. Therefore, we have reoriented a bit, and are now looking at mixing our strategy with buying smaller banks.

We understand that banks beyond top-20 by total assets in Ukraine struggle to find a competitive business model and compete with major players in the market. It was difficult for them even before the coronavirus. And although the cleansing was over, there are still banks out there that would be ready to leave the market. Not only the lack of a competitive business model but also the regulatory burden increase the costs of doing business. That’s why we have entered into several negotiation processes with different banks that are considering selling their assets. Against the background of the coronavirus, Industrialbank is very diligently assessing new borrowers, whose risk profile is quite difficult to assess now, but opts for acquisitions and mergers with other players in the market who already have a good quality working loan portfolio.

In 2018, The Economist wrote that the Ukrainian banking system has a high level of risk, but its degree is gradually decreasing. In your opinion, has it decreased?

Of course, it has. The National Bank has in one way or another carried out important reforms. It has also ensured macro stability: significantly reduce inflation and increase reserves – all this changed the general mood of stability and reduced country risk. Accordingly, when the country risk falls, this has a domino effect on the banking sector, among other things.

Although the risk has been significantly reduced, but, in my opinion, it is not yet enough for banks to feel comfortable in lending. Today, the imperfection of legislation on the protection of creditor rights is hindering the development of the banking sector. That’s why risks have not yet reached a level where bankers would really feel comfortable. So private banks play it cautiously. Whereas state-owned banks have a slightly different level of risk and can be more aggressive in lending.

They receive money from the budget and pursue a riskier strategy, not as conservative as it could be. They carry large portfolios of non-performing loans. So, it’s again a question of risk management, how well the managers of state-owned banks manage credit risk. Thus The Economist is right that the risk is still perceived as high in Ukraine’s banking sector.

What improvements are necessary for Ukraine’s banking sector?

I support the view that Ukrainian problems need to be solved with Ukrainian recipes. There is a very big temptation to borrow, copy-paste European legislation or regulations. This does not always solve the problem. Because the problems in Ukraine have different roots to those that appeared in Europe. Recipes that were prescribed by Western regulators solved their specific problems.

For example, in Ukraine, corporate governance reform has been a landmark reform in the banking sector. I think it’s the right thing to do, it significantly enhances and increases a bank’s competence in risk management. It reduces risks and should make depositors feel safe that they bring money to a reliable bank. But then again, everything has to be adjusted to the local context. It is important to make adjustments and study internal problems more thoroughly in order to implement optimal legislation.

But above all – judicial reform is crucial for Ukraine as a whole, not just the banking sector. It directly affects the business climate in the country. We are very much dependent, as bankers, on judicial reform and the actions of the regulator. As far as I understand, new changes will again be made to the capital adequacy. The requirements that the regulator will now impose are many times higher than those that exist in Europe. I believe that this will slightly hinder the development of the banking sector. So it is important to try and strike a balance between protecting depositors and ensuring that the banking sector grows as well, to fuel economic growth.

What educational projects has Industrialbank implemented?

We are not yet involved in any educational projects. In my opinion, it would be very useful to introduce financial literacy projects. I know that there are such programmes available together with USAID and IFC. I think we have the potential for cooperation here because financial literacy is important. It can greatly simplify costs for all economic agents. At the moment, we are not involved in such projects, but there is potential here for us.

Vladislav Varchenko expertPerhaps there is potential in one more area.  A global digitalisation process is now underway in Ukraine. What about your bank? How are things going with this? Has coronavirus also made some adjustments here – does the bank use more digital products?

Yes, of course. Even before coronavirus, we set a goal to reduce branches and physical presence in the country. Not only our bank, but many other banks have also significantly reduced their networks. Today’s consumer is different, the customer profile is changing. Today, you want to have a bank in your smartphone. We are running several projects to digitalise the bank, and we plan to do this constantly in the future. Digitalisation requires regular updating, ongoing understanding of your clients’ needs.

Yes, the coronavirus has made certain adjustments, budgets have been cut, and some projects have been slightly, let’s say, postponed. But we will be developing this direction nonetheless, and we have prioritized resources for further development in the area of digitalisation.

Is Industrialbank engaged in “green” lending?

We have had several projects in this area, but I can’t say that such loans are very common for our bank. We are also cautious in this area because the state regulates the tariffs. So, we are not actively involved in “green” lending, but we are monitoring the development there. We are not pioneers in such projects, let’s put it like this.

President Zelensky said a couple of months ago that one of the main tasks of the current authorities is to ensure that mortgage in Ukraine is 10% p.a. and less. Is Industrialbank ready to give loans at such interest?

On the one hand, yes, we are ready. But we have to understand what resources we have in order to lend. A mortgage, as you know, is a long term loan. To have such resources, the bank, the regulator, and also the President – all of us – have to work to create an atmosphere of trust, a level playing field, and reduce country risk. If banks could attract long-term resources, they would be happy to lend out mortgages.

Undoubtedly, this problem is already being resolved, i.e. trust in the banking system has increased significantly. However, the availability of a long-term resource remains a major constraint, not interest rates. We also consider mortgage lending as a priority area for ourselves.

I believe that there is a big potential for mortgage lending in Ukraine. I worked with mortgage lending in Canada for many years, and I know very well how lucrative this business can be. But today, the imperfection of legislation in terms of securing creditor rights and the lack of long terms funds makes it all a pipe dream for now.

Are there any changes or projects that Industrialbank was the first to initiate? Can you say that your bank was the first to do something?

We are not trendsetters in the market. We are rather adapters. Back in Canada, I understood that in the banking business, products are quite simple and easy to copy. This is not a secret Coca-Cola recipe that no one can repeat. Where a bank can get an edge – is in its customer service model. Good service is much harder to copy than a good product.

In order to be a trendsetter, to introduce new products, a bank should have a scale, large resources and marketing budgets. Being the first with a product just for the sake of a tick, probably makes no sense, because we are in the business of making money first of all. I cannot boast that we have invented some unique product and launched it on the market. We don’t set that goal, I’ll be honest with you. We are a medium-sized bank, and we are looking for our own niche. You can come out now with some fantastic products; you have to spend money on it. But big players will copy it instantly, it will be easy for them. So, we have to clearly understand our position in the market and be realists.

Natalia Richardson

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