VZCZCXRO3837
PP RUEHIK RUEHLN RUEHPOD RUEHSK RUEHVK RUEHYG
DE RUEHKV #0140/01 0231555
ZNR UUUUU ZZH
P 231555Z JAN 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 7131
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUEHZG/NATO EU COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 02 KYIV 000140 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EUR, EUR/UMB, EEB/OMA 
 
E.O. 12958: N/A 
TAGS: EFIN EREL ETRD PGOV PREL XH UP
SUBJECT: FAULTLINES IN UKRAINE'S BANKING SYSTEM 
 
Sensitive but unclassified.  Not for internet or distribution 
outside the USG. 
 
¶1.  (SBU) Summary.  IMF representatives indicated to us that 
the first diagnostic audits of Ukraine's banking sector were 
completed on January 22.  In the IMF's view, the audits show 
that none of Ukraine's seventeen largest banks has enough 
capital to meet an expected deterioration of loan portfolios. 
 While the IMF assumes foreign-owned subsidiaries will be 
able to raise enough capital to meet their expected 
shortfall, domestic banks may be hard pressed to do the same. 
 
 
¶2.  (SBU) The IMF and the World Bank expressed particular 
concern about regulatory and governance weaknesses at the 
National Bank of Ukraine (NBU), as more and more banks may 
require recapitalization or resolution in the near future. 
One key analyst expressed separately on January 23 that, 
despite the magnitude of potential bank failures and the need 
for immediate preventative action, Ukraine's financial 
watchdogs have thus far proven unable to generate an adequate 
policy response.  End summary. 
 
IMF and World Bank Anxious 
-------------------------- 
 
¶3.  (SBU) At a meeting of IMF, World Bank, and USG 
representatives on January 22, the IMF's Engen Akcakoca told 
us that Phase I diagnostic studies of Ukraine's seventeen 
largest banks had been completed.  The IMF team led by Ceyla 
Pazarbasioglu, which arrived in Kyiv this week for the first 
formal review of Ukraine's performance under the $16.4 
billion Stand-By Arrangement (SBA), assumes that capital 
infusions will be required in all of Ukraine's largest banks, 
including seven subsidiaries of foreign banks, according to 
Akcakoca.  The IMF expects that foreign-owned banks will 
receive capital from parent institutions, while domestic 
banks will rely primarily on shareholders and the NBU to meet 
increased capital requirements. 
 
¶4.  (SBU) External auditors are now reviewing Ukraine's next 
largest group of seventeen banks under a so-called Phase II 
diagnostic study.  Their findings will be presented to the 
NBU on February 24.  Phases III and IV of the diagnostic 
study, encompassing Ukraine's medium and small-sized banks, 
will be due at the end of May 2009.  The NBU plans to use a 
simplified methodology for Phases III and IV, to be developed 
by the IMF's Akcakoca and likely funded by an EBRD grant. 
 
¶5.  (SBU) According to the IMF's Stand-By Arrangement, the 
NBU is to examine the auditors' reports and determine if, and 
how much, extra capital is needed at individual banks to 
absorb an expected deterioration of loan portfolios.  If 
existing shareholders are unable or unwilling to provide the 
additional capital, the NBU and GOU are to establish a 
mechanism for the GOU to recapitalize and/or take control of 
failing banks.  However, foreign donors are concerned that 
little progress has been made in creating such a mechanism. 
At the January 22 meeting, World Bank country director Martin 
Raiser pointed out that the NBU and GOU have not yet even 
established bank recapitalization and liquidation units. 
 
¶6.  (SBU) While the Phase I-IV diagnostic process appears 
fine on paper, IMF and World Bank officials further worry 
that many banks could fail prior to the completion of Phase 
II-IV audits and before adequate legal, regulatory, and 
governance structures have been put in place.  There is 
growing consensus, according to Raiser, that the 
international donor community itself should develop 
procedures for the recapitalization, restructuring, 
administration, and liquidation processes, since Ukraine's 
institutional and policy oversight bodies are sorely lacking 
in capacity and leadership.  Raiser concluded, "We may have 
to design this for them," and he applauded the willingness of 
the IMF and U.S. Treasury to provide immediate technical 
assistance. 
 
¶7.  (SBU) Raiser decried the lack of transparent financial 
disclosure and reporting in Ukraine, since this may scare off 
potential private investors and force the GOU to undertake a 
"series of nationalizations."  In addition to advocating new 
regulations for mergers and acquisitions, the IMF's Thordur 
Olaffson, in turn, revealed that the Fund had demanded 
published statements on banks' asset quality from the NBU. 
He said that the NBU had agreed to implement a framework for 
asset quality disclosure by the end of January, but that this 
 
KYIV 00000140  002 OF 002 
 
 
was a "large legal undertaking" which may not be completed 
before the IMF team departs on February 6. 
 
Leading Analyst Also Worried 
---------------------------- 
 
¶8.  (SBU) On January 23, Edilberto Segura, former World Bank 
country director and current President and Chief Economist at 
the Bleyzer Foundation, separately told us that NBU officials 
are now "so scared, they don't even know what to do."  Segura 
said that, using IMF methodology, about 30 percent of loans 
could be classified as bad (i.e. "non-standard" or "doubtful" 
or "a loss").  However, the NBU continues to state officially 
that bad loans constitute just 1.5 percent of banks' loan 
portfolios.  Segura believes that Minister of Finance Viktor 
Pynzenyk has been "stripped of power" within the government, 
even though "he understands the gravity of the situation." 
Likewise, the Ministry of the Economy "lacks both a 
fundamental understanding of the problem and the means to 
cooperate" with other government agencies.  Segura's 
Foundation and its affiliate SigmaBleyzer, one of the leading 
private equity players in Ukraine, have resorted to holding 
closed door briefings, drawing up financial sector 
contingency plans for key members of parliament and the 
government's monetary council.  Segura said that the IMF 
should draw on its previous experience in Nigeria, where it 
held emergency workshops to train government officials and 
lawmakers on anti-crisis policies for the financial sector. 
 
¶9.  (SBU) Comment. The completion of the first diagnostic 
study of Ukraine's largest banks was an important milestone 
in the fulfillment of the IMF's conditionalities.  The NBU 
and GOU must now use their newly acquired information to 
swiftly recapitalize, or liquidate, banks.  From discussions 
with the international donor community and private analysts 
that corroborate other information we have heard, it appears 
the NBU and GOU are still unprepared for the next step of 
implementation.  They may not have the luxury of waiting much 
longer, if the state of the banking system is as dire as some 
fear.  As it undertakes a review of Ukraine's performance in 
the months since the SBA was announced, the IMF team will 
need to hold Ukraine to its commitments, while at same time 
helping it develop the means to put them into action.  End 
comment. 
 
TAYLOR