John Smyth: “Recent Developments in the Global Financial Markets have been Extraordinary”
— What is your opinion about the current situation in the global financial markets? Does the current situation really have so many negative aspects?
— In my opinion, the difficulties in the global financial markets are much exaggerated. Especially concerning the situation with the European financial sector. The mortgage securities crisis was actually born in the USA. It was a result of a very aggressive financial policy by mortgage operators including several big ones, such as Countrywide Financial that incurred huge losses and was bought out by the Bank of America.
John Joseph Smyth – a member of the International Mortgage Union’s council and chairman of the board of Empeira - Conformance and Performance Consultancy. Mr. Smyth is a professional consultant on corporate management issues with huge experience in the financial markets of Ireland and Great Britain. His experience is quite extensive: executive director of the First National Building Society / First Active plc, Past Chairman of the Irish Mortgage & Savings Association and the Irish Building Societies Association, Current Council member of the Institute of Directors in Ireland, Former Vice President of the European Mortgage Federation.
John Smyth is a Founding Council member of the Ombudsman Council for the Banking Institutions in Ireland (informal body for settling disputes between banks and their clients) and an independent director of several structures including Ukrainian Ukrgasbank. Thus, he has an opportunity to compare the actual state of affairs in different countries with the realities reflected in financial statements and not just from emotional comments on the news. Mr. Smyth shares his opinion on the world and Ukrainian banking system with ZN readers.
Their financial strategy was based on giving high-risk loans to borrowers with weak credit histories. The high risks of those loans defined their high profitability, which was quite attractive for the lenders and insured quick growth of the financial sector.
This practice, like in the USA, was used in some parts of Great Britain, but it didn’t spread to the entire European market.
Therefore, the fall of securities issued by American banks, which were seriously involved in high-risk mortgage loans and dealings with mortgage bonds, was not accidental. These operations caused many-billion losses and led to the bankruptcy of a very big investment bank, Bear Sterns. In the case with European banks, which, to tell the truth, turned out to be involved in subprime lending too, the lowering of European shares actually reflects the generally negative tone of the markets.
— However, several big European banks, for instance, Swiss UBS (Union Bank of Switzerland) and German Deutsche Bank also acknowledged huge losses from subprime lending. In the first quarter of this year, UBS’ losses from real estate operations and operations with financial products connected to American subprime mortgages were USD 19 billion, and total losses of the bank were USD 12 billion.
— Yes, UBS is one of the main examples, as well as Deutsche Bank. However, they don’t indicate a general European trend in this sphere since other big European operators, such as Unicredit, Royal Bank of Scotland, Banco Santander and BNP Paribas, were not involved in those type of operations as seriously as the key American players were.
— Analysts from Merrill Lynch have even raised their recommendations on European banks, assuming that the worst has already passed. However, can we trust those estimates considering that Merrill Lynch itself suffered serious losses in the subprime market?
— It is hard for me to asses the situation in the entire European Union. My opinion is based on the situation in Ireland, which is a comparatively small market in the European Union. In my country, banking shares were falling down due to excessive investments into real estate and mortgage lending, although these types of investments are supposed to be quite acceptable from the point of risks.
A lot of loans were given to businesses working in the construction sector. This process was enabled by a steady growth of the Irish economy during the last ten years. However, international investors lowered ratings of Irish banks assuming that the banks were too much dependent on the risks of investments into real estate, the market value of which was falling.
Nevertheless, as you noticed, the situation with European banking shares has been improving lately; investors’ confidence is growing. For instance, demand for newly issued preferred stock of Lehman Brothers was much higher than anybody could guess…
That’s why we can contend that a lot of investors are now looking for the opportunities to buy banking shares, which have started to grow.
The banking system is, undoubtedly, the base of any economy. If there are no banks, there is no economy. The economic growth of any country is impossible without an efficient baking system. Recent developments on the global financial markets have been extraordinary. My forecast is that the situation will improve by the second half of this year.
— Anyway, you have mentioned the fall of the market value of banking shares. How can this affect intentions of European operators regarding Ukraine and a possible purchase of local banks?
— I would say that many foreign banks are interested in the Ukrainian financial market, because they are short on space for further development in their domestic markets. A country with a population of around 47 million and with a quite rapidly developing economy is considered to be a market with perfect possibilities for growth.
Considering the size of Ukrainian economy and low level of the local market development, there will be a lot of influential players interested in coming there despite their past losses in capitalization. I’ll be surprised if we don’t hear about consolidation or purchase of some of Ukrainian banks this year.
— Could you mention specific names?
— As an independent director, I can’t divulge this information. Well, there are quite well-known names on this list. According to market experts, the Ukrainian banking sector is an object of a big interest today.
— You are well aware of the fact that the Ukrainian financial market is very much dependent on the international lending market. Could you forecast when Ukrainian banks will get an opportunity to access international markets and place long-term bonds, like those Russian Gazprom recently placed?
— In last quarter of 2007, Ukrgasbank intended to enter the Eurobond market. However, the collapse of international markets forced it to postpone these plans. We were not alone in this. One of the biggest Irish banks, AIB (Allied Irish Bank), had to postpone its intention to issue Eurobonds also.
Banks have stopped giving credits and lending funds to each other. During the past time, we have heard of only single cases of a long-term financing. Nevertheless, lending and the attraction of capital are the basis of the banking business. Thus, sooner or later, this process will resume.
The bad news is for potential borrowers – the market value of loans won’t reach its past level very soon. Ukrgasbank’s board monitors the situation on the global financial markets and is consulted by foreign financial advisors on this matter. We should be ready now – when the situation improves we will take the opportunity to place Eurobonds.
— What market value of loans could be acceptable for the financial institutions like Ukrgasbank? In other words, what price is your bank ready to pay for a loan?
— As an independent member of the supervisory board, I shouldn’t intrude into the sphere of the bank’s board authority. Our main task is to receive loans for the most suitable price. As it is known, in the end of 2007, despite financial crisis, Ukrgasbank could enter the market and refinance its previous syndicated credit. Thus, the task is to find the most optimal ratio between the terms, volumes and the price. Hope that foreign counselors will help us with this.
— Today, Ukrainian banks are quite often criticized for spending foreign loans on consumer crediting. Do you think it is normal when the amount of consumer loans is doubling for several years in a row? Is it necessary to take preventive measures in this situation?
— Here, almost everything depends on the level of asset diversification and quality of applied lending procedures that vary in different financial organizations. In Ukrgasbank’s experience, the most significant growth of the credit portfolio was in 2007, when the volumes of active operations increased by 2.3 times compared to the previous year. It is unlikely to reach that figure this year, even though the growth will continue. It will simply slow down to 50-60%.
Concerning the quality of assets, I would like to emphasize that Ukraine is a competitive market, and Ukrainian banks are segmenting their businesses. Our credit portfolio is also divided into several segments. For instance, there are a lot of people wishing to buy automobiles today. This can be considered as the desire of citizens to take missed or earlier unavailable opportunities.
On the other hand, the growing number of clients is a result of the expanding of banks’ retail chains. During the last several years, our retail chain has grown up and is going to grow. The same is happening with many other banks. The higher is the number of our clients, the greater are our possibilities to diversify the business. In my opinion, this process is quite normal and risks, at least in Ukrgasbank, are adequately controlled. As far as I know, Ukrgasbank isn’t giving unsecured loans (to purchase TVs, refrigerators and so on) when a lot of Ukrainian banks have started to give such loans recently.
—The retail chains of many Ukrainian banks are becoming inadequate at meeting real demand. Bank branches are being established very quickly and often thoughtlessly so that most of them work at a loss.
— It is certainly so. However, the process of growth is always accompanied with some “illnesses” that will actually help rationalize business in the future. When foreign banks come here, they will introduce their managerial experience and optimize the structure of the banks.
For instance, the total number of banking employees in Ukraine is much higher than in Western countries. There is a lack of qualified banking specialists, that’s why unqualified office workers very often receive jobs in Ukrainian banks. However, when the intensive growth of the baking sector in Ukraine is finished and banking business is rationalized, many people will become unemployed.
Another example is the fact that in Ukraine, there is a difference between the term “branch of the bank” and the term “department of the bank”. This is new for me. We don’t have anything like that in Ireland. We use an integrated approach and centralized accounting in the entire retail chain of the bank.
— Do the standards of bookkeeping and financial statements applied by Ukrainian banks comply with European standards?
— Concerning Ukrgasbank, its accounting is conducted in compliance with international standards. Delloitte&Touche is helping our bank with this. Additionally, the bank’s financial statements according to Ukrainian national standards are prepared with the help of other firm – Grant Thornton.
I would like to note that our bank has improved the quality of its financial statements lately. Some time earlier, Delloitte&Touche used to not only approve its audit but also to prepare the financial statements. Today, our employees prepare the statements by themselves, and Delloitte only approves them.
Any Ukrainian financial institution aiming to attract a strategic investor by issuing Eurobonds has to go through such procedures. Investors, certainly, would like the bank’s statements be prepared in the same form as they are prepared in their own banks. It is actually unusual to see two auditors that analyze the statements of a bank according to two different standards. However, this is a requirement of the law and another example of a more strict legislation.
— Is the creation of credit bureaus essential for the further development of the Ukrainian banking system?
Credit bureaus are vitally important for any economy. However, the creation of a credit bureau requires coordinated efforts of all financial institutions and banks.
In Ireland, the credit bureau is co-owned by all Irish banks. Any credit, any deal goes through the credit bureau’s database. This is a very effective system to help lower banking risks. This type or a similar system is also necessary for the Ukrainian market. As far as I know, this question is the key one on the agenda of the Ukrainian Banks Association.
— Standard & Poor’s recently described the situation in the Ukrainian banking system very pessimistically. In its survey, according to the quality of credit portfolios of the financial sector, Ukraine (as well as Georgia) occupies the last place among the NIS and developing European states. Do you support this point view?
— It is obvious that foreign investments improve the market and bring in positive structural changes. In my opinion, rating agencies are paying too much attention to the political risks in Ukraine when making their assessments. When they analyze the Ukrainian market from the outside, their estimates are disfigured by the Ukrainian political factor.
This agency has its own point of view; some other agency might state a different view. Incidentally, one of the agencies has already announced about reconsideration of its opinion on 22 Ukrainian banks. International investors, which have already entered the Ukrainian market, estimate Ukrainian risks and the entire banking system in more positive tones than Standard & Poor’s. The Ukrainian economy continues to grow and develop despite all the tension between those in power and opposition.
Additionally, the standards applied by the National Bank of Ukraine (its regulations and supervising procedures) are very high. As far as I know, the level of compliance of local banks with these requirements is also very high.
Regarding some neighbor-states with higher ratings, Ukraine is able to leave them behind in terms of economic growth and stability of banking system. For instance, I reference Hungary since I have some connection to companies there.
In my opinion, the current dynamic growth of the banking sector in Ukraine is full of risks but this is quite a normal process. The increase in incomes of the citizens will insure the increase in consumption, which, in its turn, will require additional banking resources. On the other hand, high incomes insure growth of savings, and this is also conductive for the development of the banking sector in Ukraine.