Central banker who slayed ‘zombie banks’ meets too big to fail

| Bloomberg
Tomas Fiala , chief executive officer of the Kiev-based investment bank Dragon Capital, notes that Privatbank’s own data suggest more than a third of its loan portfolio has gone to companies in sectors such as oil, iron alloys and aviation, where Kolomoisky’s group dominates.

In two years as governor of Ukraine’s central bank, Valeriya Gontareva has shut down nearly half the country’s lenders, a financial purge with few modern precedents. But at a private dinner this spring with George Soros, she worried that it won’t be enough to banish permanently from Ukraine what she calls “oligarch banking.”

“What concerns us both is the dominant position of one particular bank,” the billionaire investor recounted in a recent interview. It “has more than half the banking business and is in the hands of an oligarch who is very powerful.”

That bank is Privatbank and it is controlled by Igor Kolomoisky, one of the wealthiest men in Ukraine. How Gontareva persuades Kolomoisky to sever Privatbank’s ties to the rest of his sprawling business empire will determine whether her drive to reform the banking system succeeds. Through a spokesman, Gontareva declined to comment on the conversation with Soros.

So far, her cleanup, which has eliminated banks with insufficient capital or that were suspected of criminality, is a rare success in Ukraine’s efforts to overhaul its economy and reduce the role of the tycoons who’ve dominated its business and politics since the country gained independence from the Soviet Union in 1991.

“I call these banks part of the oligarch banking practice,” she said in hour-long conversation at the bank’s pink and gray gothic headquarters. “The structure was quite simple. You borrow money from all the sources you can find, and afterwards you build your empire using this money.”

‘Here to Stay’

Gontareva, 51, said she wants to put an end to that. Instead of offering bailouts for banks hit by the economic collapse that followed the conflict with Russia, she’s given owners up to three years to come up with the money to cover the holes in their banks’ balance sheets, in large part by repaying the loans they made to their own companies. To make sure they do, she’s required them to pledge their assets -- including yachts and mansions -- as security. Kolomoisky’s Privatbank is by far the biggest in the program.

Fixing the banking system so it does what it’s supposed to -- channel savings into productive investment -- is critical to Ukraine’s hopes of economic recovery. The cleanup also is a condition of the $17.5 billion IMF loan program on which the government depends to pay its bills.

More than two years after a revolution was followed by Russia’s annexation of the Ukrainian region of Crimea and a Moscow-backed separatist rebellion in the east, Ukraine’s economy and political system are still reeling. Recovery is only just beginning after the conflict cost the country as much as 20 percent of gross domestic product. Bickering among politicians and their tycoon backers has stalled most efforts at reducing bureaucracy and corruption.

“Presidents, central bank heads, prime ministers and other officials come and go,” said Soros, who has advised reformist governments here since the early 1990s. “But the oligarchs are here to stay.”

Holding a third of retail deposits and handling more than half of all electronic transactions, Privatbank dominates the sector in a way no privately owned lender does anywhere else, according to Gontareva.

Too Big to Fail?

“If you close Privatbank, or people lose trust in it, millions of Ukrainians will be lined up outside not just its doors, but ours, too, trying to get their money out,” said Gerhard Boesh, first deputy chairman of the board at Raiffeisen Bank Aval, a unit of the Austrian bank and Ukraine’s fifth largest. “They have to compromise, but they cannot let the bank be run as it was,” a cash pump for the rest of Kolomoisky’s business empire, he said.

So far, Privatbank is making its payments according to the same rules as other banks, according to Gontareva. Kolomoisky, who made his fortune in oil trading and metals, did not respond to repeated requests for comment for this article.

Gontareva’s closure of 80 banks (and counting) has earned her plenty of critics, who see the cull as yet another opportunity for corruption and for one set of rich insiders to take assets from another. The overhauls also have yet to translate into increased lending. Abandoned branches and lifeless ATMs are a ubiquitous feature of Kiev’s streets.

“The central bank has ruined the banking system of Ukraine. Its policy has led to a lending freeze and to skyrocketing interest rates,” said Ihor Petrashko, a senior executive for one of the tycoons whose bank was shut down.

Gontareva’s has been a lonely fight. Prosecutors so far haven’t acted on a single one of the more than 350 reports of fraud and other alleged crimes she’s submitted as part of the bank closures.

‘Huge Achievement’

Still, bankers interviewed for this article, as well as Soros and international lenders working with the central bank chief, give her high marks.

“It is a huge achievement,” Aivaras Abromavicius, former economy minister, said of Gontareva’s efforts. “Along with the gas trade, banking was really the point of endless corruption in Ukraine.” Abromavicius quit earlier this year in protest at what he said were obstructions to his reform efforts from the president’s closest allies.

President Petro Poroshenko, himself a billionaire who owns a small bank and made his fortune in chocolate, appointed Gontareva in June 2014. A career banker, she ran an investment house that advised him on deals, a connection that made many skeptical that she would be impartial.

The country was at war. The central bank’s reserves had fallen below $10 billion. When Gontareva responded by letting the hryvnia float, her popularity plunged along with the currency. Inflation spiked as high as 60 percent.

Thanks to loans from the IMF and capital controls, Gontareva was able to steady the hryvnia and the central bank has even begun to buy dollars on the market to rebuild reserves. Inflation has slowed to single digits.

‘No Supervision’

Gontareva overhauled the regulator, officially known as the National Bank of Ukraine, as well.

When she arrived, it had a staff of 12,000, more than three times the number at the Bank of England, which manages an economy more than 25 times as large. What many of these people did -- apart from assembling chairs at the in-house furniture department -- was a mystery to the new governor.

“We had no monetary-policy division at all and no normal open-market operations.” The bank was, she said, “a medieval monster,” which fought back as she tried to change it.

Gontareva fired two-thirds of the staff and plans to bring the total number down further, to 2,500.

Her handpicked team, many of whom came from commercial banks, tackled a sector that had never really been regulated.

“It wasn’t poor supervision, but no supervision,” that Ukraine’s banking sector had for 24 years, said Gontareva.

She said 15 of the institutions she closed were “just money-laundering fronts. They had no lending activity at all.” Another 20 were “zombie banks,” which had no assets and simply transferred deposits to offshore accounts. Another five were shut because they refused to reveal who owned them.

Physical Threats

Many of the owners agreed to recapitalize their banks but then either wouldn’t or couldn’t pay, according to Gontareva. With retail clients’ losses partly covered by government deposit insurance, she shut the lenders down.

“Some of them threatened me physically,” she said. Her house was burgled.

The country’s no. 2 private lender, Delta Bank, was widely seen as too big to fail. But when its owner fell behind on the payment plan last year, Gontareva shut the bank down.

Missing documents meant it took regulators a year to sort out Delta’s operations, while asset values eroded. They found 150,000 fake loans totaling 4.5 billion hryvnia ($181 million) to former clients who knew nothing of them. “This was how management took money out of the bank,” said Kostyantyn Vorushylin, head of the Deposit Guarantee Fund.

Privatbank is in a different league. Praised for its high-tech retail business, there’s no suggestion it has engaged in the kind of deception found at Delta Bank.

When the finance minister said on television this spring Privatbank had “systemic problems” and was trying to evade the central bank’s rules, President Poroshenko came out with an official reassurance.

Pushed by Gontareva, Kolomoisky is only just beginning the process of disentangling the bank from the rest of his business empire.

‘Completely Transparent’

According to Privatbank, loans to Kolomoisky’s other companies amount to 8 percent of its portfolio, making repayment manageable. Others say the real figure is much higher.

Tomas Fiala, chief executive officer of the Kiev-based investment bank Dragon Capital, notes that Privatbank’s own data suggest more than a third of its loan portfolio has gone to companies in sectors such as oil, iron alloys and aviation, where Kolomoisky’s group dominates.

Gontareva declined to comment on the figure. Privatbank CEO Oleksandr Dubilet said in an e-mailed response to questions that the lender was “completely transparent in providing information on its loan portfolio.”

Kolomoisky also has far more clout than the other tycoons Gontareva has taken on. With an estimated fortune of $1.4 billion, he was one of the wealthy men appointed as regional governors back in 2014 to try to stabilize the country. When the war with Russian-backed separatists began, Kolomoisky created private militias that became among the most feared at the front.

Last year, when the authorities tried to restrict Kolomoisky’s influence over two nominally state-owned oil companies, the billionaire dispatched armed men and personally led the group that took over the headquarters of one, Ukrtransnafta. Later, in a showdown carried on national TV, Poroshenko removed him as governor. In April, however, Poroshenko had to rely on Kolomoisky’s cooperation to form a new government.

“He has people in parliament, a big bank and media assets that can change the course of elections,” said Svitlana Zalishchuk, a reformist legislator. “I think the President has no choice but to take Kolomoisky’s interests into account.”

Gontareva said she expects Kolomoisky to keep paying on time and is confident that she’ll be able keep Privatbank in line with the new, stricter rules for capital adequacy and related-party lending. The personal liability for any failure in Privatbank’s recapitalization he has now accepted is “unlimited” and enforceable in foreign courts, she said.

In late May, she ran into Kolomoisky in the hall at the National Bank, where he had come to sign more repayment guarantees. He joked that her reforms were “cleaning out the market for us.” People who were there said Gontareva was the only one who didn’t laugh.