OPINION November 16, 2018

Reforming the Financial Sector in Ukraine: Finishing the Job

Ukraine has made enormous progress over the past three years fixing its banking sector.  This is very welcome news, as debilitating weaknesses and rampant corruption in many banks played an outsized role in the crisis years of 2014-2016. Restoring of confidence in the sector will be central to sustaining the recovery currently taking root and providing the foundation for growth in the future.

Key reforms to reduce the scope for financial crime in banks included the withdrawal of insolvent banks from the market, disclosure of banks’ ultimate beneficial owners, enhancement of creditor’s rights and passage of legislation to strengthen corporate governance in state-owned banks.  A better functioning and more transparent banking sector is a major accomplishment, of which the country’s authorities can be proud.

Now is the time to turn similar attention to non-bank financial institutions to re-establish a dynamic financial sector in Ukraine and generate a flow of capital to productive enterprises.  This part of the financial sector has escaped scrutiny until now.  

The good news is the banking is expanding. But the challenge is to make this growth sustainable by establishing a regulatory system capable of ensuring sustainable profits for market participants while protecting consumers.

Look at the insurance industry. Some large insurance companies collect substantial premiums while making no insurance payments to the clients—zero.  Further, consumer loan rates from non-bank credit institutions often exceed hundreds of percent per annum.  And consumers are at risk since savings of clients of non-bank credit institutions are not covered by deposit insurance. These are just a few examples of fundamental weaknesses in the regulatory framework governing the non-bank financial sector.

The time for reform is now. Fortunately, the way forward is clear.  Two years ago, the Rada voted on the draft bill No2413a (the first reading) to consolidate disparate regulatory functions of the non-bank financial sector between the National Bank of Ukraine and the National Securities and Stock Market Commission. The legislation was designed to create solid ground to further increase confidence in the financial services market, strengthen protection and cut costs for consumers; reduce the number of supervisory authorities; cut fraud and corruption; and ultimately create a level playing field for competition and boost the financial services market, paving the way for private investment.

The regulatory model envisioned in the draft law, which moves Ukraine away from an approach that separates bodies responsible for banking, insurance and securities markets—is sound, based on international practice, and suitable for Ukraine at this moment in time.  Indeed, it is consistent with the approach followed by many markets for the past two decades. Currently, the financial sector regulatory architecture in at least 18 EU countries is based on partially or fully integrated regulatory models.  

This has been driven by the increasing sophistication, complexity and speed of financial market activity. The erosion of the boundaries between financial products, the emergence of financial groups and the transfer of financial risks between market segments have created possibilities for regulatory arbitrage and abuse.  The integrated regulatory model has been found to be best suited to deter and minimize those possibilities.

As the financial markets and regulatory practices develop in Ukraine, there could be a need to consider changing the regulatory model in the future. However the model proposed by the draft bill No2413a is considered to be a good platform for financial sector regulatory integration for the next 5 to 7 years. It would be a major improvement over the current regulatory arrangements, which lack independence and powers and have left the non-bank financial sector largely unsupervised, and the best way forward under the current circumstances.

It is essential to protect the rights of Ukrainian citizens to have access to high-quality financial services.  Therefore, it is important to ensure the existence of a strong regulatory framework and formation of a level playing field for all local and foreign financial institutions.  We hope that, after two years of waiting, the draft bill No2413a, which enables that, will be finally approved and implemented for the benefit of ordinary Ukrainians.

 

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AUTHOR: Satu Kahkonen

WEBSITE: World Bank in Ukraine

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