Traps and pitfalls for banks selling NPLs in Ukraine

18 June 2021 - Publication

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The COVID-19 pandemic caused a deep economic crisis in Ukraine due to lockdown measures, including the closure of most businesses, which almost halted economic activity altogether except for the key sectors such as agriculture, pharmaceuticals and food. The pandemic also had a significant negative impact on the banking sector and the financial well-being of Ukrainian citizens. An important indicator for assessing the banking system’s financial stability and maintaining public confidence in banks is the percentage of non- performing loans (NPLs).

As of the beginning of 2021, the NPL ratio in Ukraine was 41%, among the highest in the world. Since 2018 the NPL ratio has gradually shrunk, declining by 7.4 pp in 2020. However, the ratio is still very high and that is a burden for the banking sector, especially the state-owned banks, that comprise more than 70% of it. Usually, NPLs are very attractive targets for investors. But an NPL ratio this high negatively affects the investment attractiveness and profitability of financial institutions and threatens the country’s financial system.

On April 13, 2020, NBU approved the Regulation On Defining Criteria for Writing Off Impaired Financial Assets of Banks against Expected Loss Provisions, encouraging banks to be more active in cleaning their balance sheets and restructuring, selling, or writing off their NPLs. The good news is that state- owned banks have recently been allowed to sell NPLs at a discount. Until April 15, 2020, actions to sell or write off NPLs at a discount could have negative consequences for the bank’s management, such as the risk of criminal prosecution. Nowadays state-owned banks make heavy use of such opportunities and auction their NPLs at a discount. But they should still abide by the following rules:

The sale should be carried out by conducting open and transparent bidding (auctions) according to the Dutch auction model, which provides for an automatic step-by-step reduction of the initial (starting) price of the lot;
the banks should verify the information about the buyer and confirm that the buyer is not a debtor, the ultimate beneficial owner of a debtor, the mortgagor, the guarantor or a related person;
The initial (starting) price of the lot and the minimum selling price must be determined in accordance with the requirements established by the current legislation of Ukraine.Nevertheless, all procedures (decision to sell a particular loan, price-fixing, etc.) shall remain transparent and unified to avoid any accusations in the future.

It goes without saying, that all banking sector problems in Ukraine, namely the high NPL ratio, and the COVID-19 pandemic-related uncertainty are associated with a weak rule of law. National judicial and legal frameworks definitely influence the banks’ NPL strategy and their ability to reduce NPLs. There are also many particulars of legal proceedings connected with the NPL workflow for various kinds of assets that banks should take into account. These may include the average total cost and length of such proceedings, typical financial outcomes, and so on. Developing the relevant expertise needed for the specific NPL model is also a must for all banks. That is why it is advisable to hire qualified and independent legal advisors and property appraisers with dedicated NPL expertise and experience to handle specific NPL-related tasks: sale transactions, restructuring, etc.

Such transactions always include a great number of legal and practical issues, which should be assessed.

Today, it is very important to maintain the efficient dialogue in the “state-society-business” system and implement international best practices to improve the economic climate in Ukraine.