Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. P7226UA

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE

EXECUTIVE DIRECTORS

ONA

PROPOSED FINANCIAL SECTOR ADJUSTMENT LOAN

IN THE AMOUNT OF US$ 300 MILLION

TO

UKRAINE

FEBRUARY 24, 1998

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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CURRENCY EQUIVALENTS/EXCHANGE RATES(as of February 18, 1998)

Currency Unit = HrivnyaUS$1 = 1.9541 UAHUAH = US$ 0.5117

WEIGHTS AND MEASURES

Metric System

FISCAL YEAR

January 1 - December 31

Vice President: Johannes F. LinnCountry Director: Paul J. SiegelbaumSector Director: Lajos BokrosTeam Leaders: Alan Roe/Marie-Renee Bakker

FOR OFFICIAL USE ONLY

ABBREVIATIONS AND ACRONYMS

BRD - Bank Resolution DepartmentBSD - Bank Supervision DepartmentCAS - Country Assistance StrategyCPAR - Country Procurement Assessment ReportEBRD - European Bank For Reconstruction and DevelopmentECU - European Currency UnitEDAL - Enterprise Development Adjustment LoanEDP - Export Development ProjectEFF - Extended Fund FacilityESW - Economic And Sector WorkEU/TACIS - European Union Program of Technical Assistance for the CISEXIM - State Export-Import Bank of UkraineFSAL - Financial Sector Adjustment LoanFSP - Financial Services ProjectFSR - Financial Sector ReviewFSU - Former Soviet UnionGDP - Gross Domestic ProjectGNP - Gross National ProductGosbank - Former USSR State BankIAS - International Accounting StandardsIBRD - International Bank For Reconstruction and DevelopmentIFC - International Finance CorporationIMF - International Monetary FundJEXIM - Japanese Export-Import BankKBV - Karbovanets (Former Ukrainian Local Currency)MOE - Ministry Of EconomyMOF - Ministry Of FinanceMPP - Mass Privatization ProgramMU - Monitoring UnitNBU - National Bank Of UkraineSBA - Standby ArrangementSMEs - Small And Medium Sized EnterprisesSPF - State Property FundSSCM - Securities and Stock Market CommissionSTF - Systemic Transformation FacilityTA - Technical AssistanceTOR - Terms of ReferenceUAH - Hrivnya (Ukrainian Local Currency)UBPR - Unified Bank Performance ReportUSAID - United States Agency for International Development

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

UKRAINE: FINANCLIL SECTOR ADJUSTMENT LOAN

Loan Summary .............................................i

INTRODUCTION .............................................. 1

I. THE ECONOMY ...............................................

IL THE COUNTRY'S ADJUSTMENT PROGRAM ............................................. 10

]m. THE PROPOSED LOAN ............................................. 11

Rationale and Objectives .............................................. 11Benefits and Risks ............................................. 12Coordination with the IMF and Project Sustainability ............................................. 13Board Conditions, Tranche Triggers and Supervision ............................................. 14Implementation ............................................. 21Financial Arrangements ............................................. 22Environmental Impact ............................................. 22

IV. RECOMMENDATION ............................................. 22

ANNEXES

Annex 1 Key Economic IndicatorsAnnex 2 Status of Bank Group Operations and Status of IFC OperationsAnnex 3 Timetable of Key Processing EventsAnnex 4 Memorandum on Financial Sector Development PolicyAnnex 5 Policy Reforms Program MatrixAnnex 6 Country at a GlanceAnnex 7 Donor Assistance in Financial Sector Development in UkraineAnnex 8 External Financing

TABLES

Table 1 Overview of Banking Sector Structure, January 1, 1998Table 2 Ukraine Monetary Survey, 1995-1997

FIGURES AND BOXES

Box 1 Landmarks of Financial Sector Development in UkraineFigure 1 Nominal Interest Rates, 1993-1997Figure 2 Real Interest Rates, 1994-1997

UKRAINE: FINANCIAL SECTOR ADJUSTMENT LOAN

LOAN SUMMARY

Borrower: Ukraine

Amount: US$300 Million

Terms: Single Currency Loan, at the Bank's standard US$ LIBOR-based interest rate, with a proposed 5-year grace period and a20-year maturity.

Commitment Fee: 0.75% percent on undisbursed credit balances, beginning 60days after signing, less any waiver.

Objectives and Description: The main objective of the loan is to underpin Ukraine'smacroeconomic reform program with a comprehensive set ofpolicy measures intended to strengthen the financial sector,with a special emphasis on the banking system. The loanwould reinforce the reform measures being undertaken underother Bank adjustment and investment operations bypositioning the banking system to play a lead role in financingthe investment needs of all sectors of the economy,particularly the newly emerging private sector.

Benefits: The implementation of structural reforms in the bankingsystem will reinforce Ukraine's stabilization and otherstructural reforms by helping to ensure that a growing part oftotal lending is made by better-capitalized banks. By takingexplicit measures to reduce the risks which banks are allowedto accept, the loan will also help to make a possible crisis inthe banking system less likely. Finally, the up-frontstrengthening of banks and the elimination of bad lendingpractices should reduce the size of the eventual claims on theGovernment budget if and when banks fail, and so will have apositive fiscal benefit in the longer term. The positive effecton Government saving may also be accompanied by improvedprivate savings performance as confidence in banks increases.

Risks: A general risk facing all adjustment operations in Ukraine isthat the macroeconomic stabilization is still fragile and aresurgence of high inflation fueled by the inability to fundlarge budget deficits cannot be ruled out. Such a developmentcould lead to further repressive pressures on the banks, whichcould undermine many of the positive changes, which the loanseeks to advance. A more specific risk relates to thecomplexity of many of the component issues and the relatively

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limited technical depth in the NBU and elsewhere to championparticular policy measures through to effectiveimplementation. A third risk is that the institutional structuresfor implementing this loan are poorly developed especiallywhere they involve active cooperation between differentagencies of Government. This risk is particularly significantin those areas of the loan where some short-term fiscal cost isrequired to deliver improvements supported by the regulatoryauthority for banks. Finally, there is the possibility of the lossof policy commitment due to a lack of consensus betweendifferent constituencies of the Ukrainian administration.

Schedule of Disbursement: Three tranche disbursement, the first immediately after loaneffectiveness (expected in March 1998); the second and third--provided the macroeconomic framework remains satisfactory--when the policy actions specified in this document have beenimplemented (expected in December 1998 and June 1999,respectively).

Rate of Return: Not Applicable

Poverty Category: Not Applicable

Project ID Number: UA-PE-40560

The World Bank Financial Sector Team (comprising Marie-Renee Bakker, Ragini Dalal, AngelaPrigozhina, Lalit Raina, Alan Roe, and Martin Slough--ECSPF) wishes to thank the Ukrainianauthorities, and in particular, their counterparts in the Presidential and GovernmentAdministrations, Ministry of Finance, the State Property Fund, and the National Bank ofUkraine, for their collaboration in preparing the proposed Financial Sector Adjustment Loan.The Team would also like to thank their colleagues in the International Monetary Fund's UkraineTeam for their collaboration and to express its gratitude to the Peer Reviewers of this operation,Messrs. David Scott, FSD and Gerhard Pohl, ECSPF; and to Paul Siegelbaum, ECC 11, andMarcelo Selowsky, ECAVP, for their overall guidance and support.

ii

REPORT AND RECOMMENDATION OF THE PRESIDENT OF THEINTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THEEXECUTIVE DIRECTORS ON A PROPOSED FINANCIAL SECTOR ADJUSTMENT

LOAN TO UKJRAINE

Introduction

1. I submit for your approval the following report and recommendation on a proposedFinancial Sector Adjustment Loan to Ukraine for US$300 million to support the Government'sfinancial sector reform program. The loan would be at the Bank's standard US$ LIBOR-basedinterest rate with a maturity of 20 years, including five years grace.

I. THE ECONOMY

Background

2. Although Ukraine has enjoyed considerable success in the monetary aspects ofstabilization since the hyperinflation of 1993 and 1994, this stabilization rests on weakfoundations. Reasonable price stability was achieved in 1996, with inflation settling at less thanthree percent per month in the last half of that year. Inflation in 1997 was only about 16 percentas compared to over 10,000 percent in 1993. This success on the inflation front enabled theauthorities to introduce the new currency--the Hrivnya (UAH)--in September of 1996 and tostabilize the nominal exchange rate quite successfully thereafter. Unfortunately, stabilization inUkraine has been based almost exclusively on monetary restraint and cash management, withoutsufficient structural reform to achieve a sustainable fiscal balance and restore growth. As aconsequence, the economy's real productive performance has been very poor. SinceIndependence in 1991, Ukraine's economy has not seen even one year of positive growth.Official statistics show a decline in real GDP of 3.2 percent in 1997 -- the eighth year in a rowthat GDP has gone down. This trend spans all major sectors, and the overall cumulative declinein the formal sector now exceeds 60 percent since Independence.

3. The structural reform program in support of the macroeconomic stabilization effort hasenjoyed moderate successes. Price structures are now largely liberal, as is foreign trade. Theprivatization of small- as well as medium- and large-scale enterprises has proceeded at asatisfactory pace since the end of 1994.

4. Today, the major challenge facing Ukraine is how to restore the confidence of itsfinanciers, domestic and international, as well as multilateral. Plainly, a program of broad anddeep structural reforms is needed to do this, complementing a dramatic fiscal austerity programto deal with the immediate fiscal pressures. The Government recognizes this need. Theproposed loan, together with the simultaneously presented Second Enterprise DevelopmentAdjustment Loan (EDAL II), are intended to support the Government's efforts to achieve thisgoal.

1

The Situation In The Financial Sector

Sector Structure

5. The financial sector in Ukraine consists of a complex mass of mainly small, unregulated,and inexperienced organizations operating as banks, trust funds, insurance companies, pensionfunds, commodity dealers, credit unions, and broker/dealers. However, the banks, which are themain subject of this present operation, still dominate the sector in terms of total assets and thevolume of business transacted. They are also heavily involved, through subsidiary companiesand in other ways, in many of the more significant investment trusts, brokerages, and othercapital market institutions.

6. Before the liberalization brought by Perestroika in 1989, the Ukrainian "banking" sectorwas merely comprised of various Ukrainian departments of the USSR Gosbank, including theUkrainian branches of the savings bank and the foreign trade bank. Although specialized byfunction, these "banks" were little more than channels either for the allocation of credit resourcesdetermined by central planners in Moscow or, in the case of the savings bank, for the collectionof household savings deposits, also for centralized reallocation. At that time, they used few ifany of the conventional skills of modem commercial banks and, in particular, had little need tomake evaluations of credit proposals, manage assets and liability structures, or concernthemselves with risk management.

Box 1: Landmarks of Financial Sector Development in UkraineTill 1998 Banking in Ukraine as departments of the USSR Monobank system.1989-91 Liberalization allows creation of first commercial banks in FSU.1990 Reorganization of USSR Gosbank into 5 specialized banks.March 1991 Law on Banks and Banking Activity creates two tier banking

structure.December 1991 Independence of Ukraine creates independent state banks.October 1991 Establishment of first stock exchange.September 1992 Karbovanets established as temporary substitute currency.December 1992 Ukraine quits ruble zone and establishes separate monetary policy.February 1993 Ukrainian Interbank Currency Exchange created.January 1994 National Electronic Payments System created.1995 First treasury bills issued.September 1996 Currency reform and introduction of the Hrivnya.

7. As of late-1997, there were about 230 organizations registered as banks by the NationalBank of Ukraine (NBU). Twenty-one of these banks are in various rehabilitation programsorganized by the NBU and a further 44 are earmarked for liquidation. Despite the rapid growthof the newly created private banks during the last few years, the five Former Soviet Union (FSU)specialized banks continue to dominate the Ukrainian banking system, although in all cases theyhave evolved new methods of operation, new products, and better qualified management in linewith the needs of the market economy. They are the Prominvest Bank-the industrial bank;Bank Ukraina-the agricultural bank; Ukrsots Bank-the social sector bank; the State Export-Import Bank (EXIM}-the foreign trade bank; and Oschadny Bank-the savings bank. Thesebanks are all seeking to develop as universal banks and have not been required to maintain theearlier limitations on their functions. The last two of these banks are still wholly Government-

2

owned, while Prominvest Bank, Bank Ukraina, and Ukrsots Bank are notionally private with aminority ownership stake held by the Government.

8. The data in Table 1 confirm the continued domination of the state-owned and fonnerstate-owned components of the banking system 3. However, a great deal has changed and ischanging. In the period from 1990 onwards through 1993, permissive laws on bank entryencouraged the establishment of more than 250 new private banks, most of which were initiallyset up with very little capital, often to service the banking needs of narrow groupings of state-owned enterprises in the productive sectors. Table I indicates that by the beginning of 1998 themore successful top-layer of these new banks had significantly eroded the market share of thestate and former state banks.

Table 1: Overview of Banking Sector Structure: January 1,19984Name of Bank Statutory Total

Capital Capital Total Assets Total Lending Profit for Year Deposits(min UAH) (min UAH) (min UAH) (min UAH) (min UAH) (mln UAH)

State/Former State-Owned Banks (exceptExim): 295.62 1531.88 10746.76 3442.24 259.46 1591.76Share of Total 20.9% 45.9% 47.6% 47.2% 28.2% 51.2%Private Banks w/Share Capitalgreater than 20 minUAH: 276.53 573.81 5774.27 1681.97 260.12 668.27Share of Total 19.6% 17.2% 25.6% 23.1% 28.2% 21.5%Private Banks w/Share Capitalgreater than 6 minUAH/less than 20min UAH: 430.70 739.05 3992.37 1411.81 278.48 526.14

Share of Total 30.5% 22.2% 17.7% 19.3% 30.2% 16.9%Private Banks w/Share Capital lessthan 6 min UAH 323.36 395.14 1513.50 582.29 98.91 248.85

Banks w/ 100%Foreign capital 88.01 94.56 554.11 178.72 24.21 75.56

Share of Total 6.2% 2.8% 2.4% 2.4% 2.6% 2.4%Totals 1414.22 3334.44 22581.01 7297.03 921.18 3110.58(in min UAH):Totals (in miln USD) 725.2 1709.9 11580 3742.1 472.4 1595.2

These three banks are corporatized, claim to be almost wholly private, but in fact are owned and controlled mainly by state-enterprises and their employees. All these banks are large, continue to be unified nationally and, while in most cases seeking tobecome more universal, continue to have dominance in their specialized markets. They all retain some monopoly power and untilrecently achieved wide margins, part of which were dissipated in lending to loss-making enterprises for "social" reasons. In varyingways, most of these large banks remain encumbered by explicit or implicit obligations to the state which undermines theircommercial roles (Ukreximbank is an exception).

2 Initially in 1992, these banks were corporatized in a spontaneous fashion with large state enterprises acquiring the majority stakesin the banks which serviced their particular sectors. But in 1993, the Govemment ordered that all state-enterprise shares in thesebanks be transferred to the Ministry of Finance. This transfer was avoided by the banks through a variety of devices whereby theshares were transferred to the employees of the client enterprises and to the employees of the banks themselves. This has left theeffective govemance fragmented and ineffective.

3 Fuller detail on the make-up of an earlier version of Table I is in the Ukraine Financial Sector Review, Report No. 14526 UA.

"Ukraine: Financial Sector Risks," January 1, 1998.

3

9. Other important changes have occurred with the transition. First, increases in minimumcapital requirements have slowed the creation of new banks by ending the virtually costless entryinto the sector.5 Beginning in February 1996, the NBU acquired the full authority to licensebanks. Through 1996 and 1997, it carried out a re-licensing process for existing banks andthereby subjected many of these to more demanding conditions for continued operation. Themore successful of the new entrants have no difficulty in meeting these conditions but theprocess is having the effect of shaking out the more marginal banks. This is clearly a verypositive development for the general health and stability of the sector.

10. Second, the extreme inflation of the period through 1995 has sharply reduced the realmagnitudes of bank liabilities, assets, and capital, which is evidenced by the relatively smallUSD amounts in the table. It is true that during the two years of relative stability to 1997, theUSD magnitudes shown in Table 1 approximately doubled.6 However, Ukraine, like mostcountries in the FSU, still has a total banking sector the size of which is equivalent to about onemedium-sized Western bank. Although many banks do carry a significant amount of non-performing loans on their balance sheets, the problem this creates is not large either in absoluteterms or relative to the country's GDP (not greater than 2% of GDP). The additional capitalsums needed to underpin the present level, or increased levels, of banking activity are relativelysmall and some of the longer established banks are demonstrating the ability to build new capitalto compensate for their bad debt overhangs.

11. As the large debt erosion occurred, savers have had to accept large losses in the realvalues of their savings. Credibility in, and respect for, banks has been diminished as aconsequence. This is of particular relevance for the savings bank in view of its continueddominance of the total, now much reduced, of household deposits. The bank's large branchnetwork and staffing (60,000 persons) is not commensurate with its present business volume. Itsaspirations to develop as a universal bank are also questionable. However, since the bank is wellplaced in terms of its broad national coverage, its restructuring as a lower cost organizationcapable of offering improved services and products to its traditional clients is one essentialelement of the strategy for achieving a recovery of household savings.

Sector Performance

12. Banking system performance itself merely reflects performance in the real economy. InUkraine, the large decline in real output in the formal economy, the rising importance ofinformal business, and very high inflation through 1995 were clearly damaging from this point ofview. In particular, the near hyperinflation from 1992 and through the early months of 1995 (20percent per month) resulted in highly negative real rates of interest which favored bdrrowers butdiscouraged lenders (see Figure 2). This, in turn, caused a substantial decline in the volumes ofreal credit in the system just when high inflation was also encouraging a significant shortening ofcredit maturities. Nonetheless, most of the banks established during the period of excessivelyliberal entry from 1991 to 1994 survived during the latter period on the strength of high marginson domestic currency business, profits earned from foreign exchange speculation, and from otheropportunities created by inflationary distortions. However, the improved macroeconomic

5From January 1, 1997, all banks were required to have at least ECU 500,000 of capital; from July 1, 1997, ECU 750,000; and fromJanuary 1, 1998, ECU I million. These represent the latest of several increases in the minimnum capital since 1993.

6 Nomina UAH magnitudes have not kept pace with inflation but have nonetheless grown fast enough to outpace the limitednominal devaluation of the exchange rate.

4

stability achieved from end-1994 to late-1997 reduced lending margins and eliminated some ofthe easier routes to profitability.7 The fiscal stresses of end-1997 and the pressures on the banksassociated with their, by then, large holdings of Treasury Bills served to intensify this squeeze onbanks. These factors together have initiated and perpetuated the shake-out of the more marginalbanks already mentioned and have placed a high premium on sound banking as the basis forlong-term survival.

13. Interest rates in Ukraine are now mainly market determined although the NBU maintainssome administrative influence through its control of its own refinancing rate, which has becomethe main reference rate in the system. Until recently, there was a strong statutory link betweenthe NBU refinance rate and bank lending rates, but this has now been removed. Even wherethere is continued direction of credit by the Government, the information available suggests thatthis credit is now on-lent at rates at least equal to the refinance rate. This is given some supportby the fact that the average lending rates of banks through much of 1995-97 were higher than therefinance rate (see Figure 1).

Figure 1: Nominal Interest Rates (Quarterly, Ql 1993 - Q3 1997)

35

30

25

15.{s0

n a mt V ) m O xO q: % 1. r- r-0%i 0% 0% 0%i 0% 0% 0% 0%i 0%i 0% 0% 0% 0i 0% c 0% 0% 0% 0%

. Comm. Banks Nominal Interest on Credits (Weighted Average)

Comm. Banks Nominal Interest on Deposits (Weighted Average)

Nominal NBU Refmance Rate

7The banks' spread between the monthly weighted average lending and deposit rate of interest fell from 6.6 percent in the firstquarter of 1995 to 2.7 percent in the second quarter of 1997. The banks offset this in part by allowing an increase in the loan todeposit ratio from 88 percent in the first quarter of 1995 to 107 percent in the second quarter of 1997. This increase in the loan todeposit ratio helped to reduce the immediate liquidity squeeze created by declining interest margins.

5

14. Although nominal interest rates were trending down for much of 1995, 1996, andthrough mid-1997, inflation declined somewhat faster. From October 1997, interest rates roseagain to much higher levels (almost 50 percent in some Treasury Bill auctions) in response to theextreme difficulties of financing the fiscal deficit after the collapse of financial markets in partsof East Asia. Hence, real interest rates on bank loans, already positive in 1994, remainedgenerally positive through most of 1995, 1996, and 1997 (see Figure 2). Deposit rates were alsoslightly positive in real terrns in most months of 1995 and 1996 but negative through the lastmonths of 1995 and early 1996. These occasionally negative returns to depositors combinedwith the continued volatility of inflation, caused expected inflation to remain higher thanmeasured inflation and, together with the exceptionally poor growth performance of theeconomy, helps to explain the banking system's poor record on deposit mobilization. Asummary of some of the more general movements of the main indicators of financial sectoractivity can be found in Table 2.

Figure 2: Real Interest Rates (Quarterly, Q3 1993 - Q3 1997)30

% 20 - -10

20°- , ,, I, I_,ll_WI_.l_I10

-30-40

% quarterly

93Q3 94Q1 94Q3 95Q1 95Q3 96Q1 96Q3 97Q1 97Q3

Real Interest Rate on CreditsReal Interest Rate on Deposits-NBU Real Refinance Rate

15. These data indicate that the stabilization achieved in the period 1995 through end-1997and the generally positive real rates of interest during that period were not sufficient to achievemuch recovery in the scale of banking sector operations although a few individual banksperformed quite well. In particular, both the domestic money supply and its local currencycomponent remained low relative to GDP. Similarly, on the assets side of the account, the totalof domestic non-government credit relative to GDP remained low after falling sharply in earlieryears. By end-1997, credit outstanding to non-governmental organizations was still theequivalent of only 10 percent of GDP of which only 6.3 percent was in the form of localcurrency credits. The intensified pressures on banks caused by the fiscal stresses in late-1997and early- 1998 made it even more difficult for them to support the credit needs of the enterprisesector. At the same time, inter-enterprise arrears and arrears of payments to the Government hadgrown to become far more important sources of financing than bank credit.8

a In the early part of 1993, the outstanding commercial bank credit to the non-government sectors easily exceeded payments arrears.By early 1994, inter-enterprise arrears were twice or even three times higher than total bank credit. By the end of 1996, inter-enterprise arrears totaled UAH 73 billion (payables) or UAH 48 billion (receivables), as compared to only about UAH 7 billion of

6

16. From a purely statistical point of view, it seems likely that the low level of bankingactivity shown in Table 2 may continue or even fall further. In particular, the 1997 NBUregulation on loan classification and loan loss provisions in banks, and the introduction ofInternational Accounting Standards (IAS) in January 1998, will likely increase such provisionsto almost US$1 billion equivalent (twenty times the amounts historically recorded in theUkrainian accounts), consequently reducing bank capital and lending capacity.

Table 2: Ukraine: Monetary Survey 91995 1996 1997 (est.)

UAH.D UAH GaP - A GD. Net domestic 7,773 14.3 10,302 12.8 14,098 15.0

assetsNetdomestic 9,863 18.1 13,611 16.9 17,873 19.0

credit _ _ _ _ _ _ _ _ _ _

Net credit to 3,989 7.3 5,974 7.4 8,500 9.0Gov't _ _ _ _ _ _ _ _ _

Credit to 5,873 10.8 7,636 9.4 9,373 10.0Nongov't

In domestic 3,402 6.2 4,719 5.9 5,909 6.3currency

In foreign 2,471 4.5 2,917 3.6 3,464 3.7currency

Broad Money 6,930 12.7 9,363 11.6 12,021 12.8Hrivnya broad 5,353 9.8 7,646 9.4 10,405 11.1

moneyForeign 1,577 2.8 1,717 2.1 1,616 1.7

CurrencyDeposits

17. Reform definitely has begun in the sector, notwithstanding this pessimistic background.In particular, the better banks have rapidly understood the essential requirements of banking in anon-inflationary environment and have been active in seeking advice and new partners to meetthese requirements. All the state and former state banks shown in Table 1 are now involved inone way or another with foreign technical partners. Bank Ukraina and Ukrsots Bank are workingunder technical assistance arrangements established as precursors to the Bank's plannedFinancial Services Project (FSP). Prominvest Bank is participating in an institutionaldevelopment program designed to qualify it for access to an EBRD credit line. In the context ofthe Bank's Export Development Project (EDP), which was approved by the Board in November1996, EXIM is working in a twinning arrangement with the JEXIM Bank of Japan. Finally, thesavings bank has received support from various donors for its first IAS audit, the preparation of astrategic restructuring plan, and management training. Within the tier of larger private banksshown in Table 1, seven to eight banks are benefiting from institutional development programsarranged by EBRD in the context of its Small and Medium Sized Enterprise (SME) line of credit

outstanding bank credits. In August 1997, the figure was UAH 93 billion in payables and UAH 66 billion in receivables ascompared to approximately UAH 12 billion in outstanding credit.

9For 1995 and 1996, the figures in this table represent UAH equivalents, as the UAH was only introduced in late-1996.

7

operation which was approved in 1994. Although these arrangements are still in theirpreliminary stages, and some may fail to produce results, almost no bank of any real significanceis now without external assistance and guidance of some sort.

18. Banks generally have tried to be more flexible in their portfolio and other decisions ascircumstances have changed. In some periods, this has helped to protect their earnings andreduce their risk exposures. For example, the exposure of banks to lending activities diminishedthrough 1996 as the profitability of this business declined and the associated risks, as measuredby the incidence of non-performing loans, became greater. This was particularly true of FOREXlending which declined from over 30 percent of bank portfolios in 1995 to less than 20 percentby end-1996. In November 1997, very stringent restrictions on open foreign exchange positionsintensified this trend. Also in 1996, most banks began to invest in Treasury Bills as theavailability and yield of such investments made them increasingly attractive. By end-1996, 19percent of the aggregate portfolio was in investment vehicles and Treasury Bills where thebanks, at least temporarily, could enjoy high yields (approximately 30 percent at that time) onthe safest of their assets. This trend continued through end-1997. The total Treasury Billholdings of banks amounted to UAH 930 million by early 1997 and grew rapidly throughSeptember of the same year. Thereafter, the fiscal funding stresses of October 1997, and therapid upward movement of Treasury Bill rates associated with this problem, caused at leasttemporary new problems for some banks as the liquidity of the instrument diminished and largecapital losses were locked into their balance sheets. If these immediate difficulties can beovercome, banks in general will continue to upgrade their operations to recognize that futureearnings are becoming more and more dependent on the delivery of financial services and lessdependent on the margins on traditional lending. Those banks that have been able to make sucha switch are already improving their risk and earning profiles.

19. Additionally, the mismatch between the current size of the banking sector and theevidently growing need for more and better banking services as the private economy expands,has created a large potential for new investment in the Ukrainian financial system. Those localbanks that emerge from the current shakeout as serious banks with reasonable cost structures andmanagement are expected to attract additional capital to consolidate and expand their operations.Furthermore, the consolidation, the continuation of monetary stability, and further banking sectorreforms undertaken by the authorities should constitute a powerful magnet for significantvolumes of foreign investment in the sector, the first installments of which are already evident.Although there are currently only six fully owned foreign banks in Ukraine and fourteen jointventures, there is visible interest from many more foreign banks. Initially, this is expected to bemanifest in the licensing of some of the large Russian banks which already have well developedclient networks involving Ukrainian business. They alone could significantly change thecompetitive environment in the sector.

20. In spite of the obvious setbacks associated with the post October 1997 fiscal crunch, afurther basis for cautious optimism derives from the performance of some of the bankspreviously thought of as possible sources of systemic distress. Prominvest Bank, for example,which is the largest and arguably the most problematic of the former state banks, seems to haveremained solvent and profitable through the first two years of relative inflation stability in spiteof a large overhang of bad loans from the previous years. It has achieved this by virtue of a verystrong position in the country's payments system, and due to conservative lending policies inwhich the successes of its many healthy clients in key defense and other industrial sectors havecross-subsidized the losses on outstanding loans to less healthy enterprises. Bank Ukraina has

8

made major changes in the staffing and organization of its credit departments in response to theweaknesses detected by its technical assistance partners. Neither Prominvest Bank nor BankUkraina can be assessed as financially strong, especially after the problems of October 1997,which are yet to be reflected in the results of bank audits and on-site examinations. But, neitherdo these banks now succumb as readily to the political pressures for directed lending as once wasthe case, though those pressures certainly remain.

21. Similarly, the rehabilitation and closure of marginal banks has been achieved without thesystemic damage that might have seemed likely before the event. In part, this is because themajority of banks which have exited the system have been small, or because the larger banksamongst them, such as Inko Bank and Grado Bank, have collapsed while they were still small inabsolute terms. The limited success in deposit mobilization has been a bonus from this point ofview; few if any of the departing banks had been entrusted with significant amounts ofhousehold deposits to lose.

22. In short, there is some reason to be hopeful that the consolidation in banking which isnow beginning can lead to the emergence of banks which are larger, more robust, and more ableto provide a broad range of financial services. While the consolidation process itself imposescosts on the system, these costs will be small if consolidation is achieved in large measure whilethe majority of banks are so tiny and so little involved in mobilizing deposits from the public.The small size of the present system--relative to the incipient demand for banking services--isalso a strong inducement for new investment and new entry from banks that observe the growingunmet demand. This is evident, for example, in the early Ukrainian Eurobond issues and theassociated need for reliable depository, clearing and settlement, and other services associatedwith these issues.

23. From the perspective of Government policy, the priority is the continuation of soundmonetary policy and a liberal economic environment that encourages active foreign involvementin the financial as well as in productive sectors. Beyond this, there is a need for measures whichwill reinforce the stronger banks through more informative accounting, better tax arrangementsas regards the provisioning of bad loans, and a more reliable regulatory environment sustainedby a technically adroit central bank. Good banks have nothing to fear and much to gain fromtransparent accounting, serious loan provisioning, and competent bank supervision. These samemeasures will also serve to sustain the consolidation process and give the signal to weak banksthat they have little future.

9

II. THE COUNTRY'S ADJUSTMENT PROGRAM

24. The proposed FSAL is Ukraine's first adjustment operation in the financial sector, andone in a series of adjustment operations designed to support the Government's program ofstabilization and structural reform begun in October 1994. It addresses several of theacknowledged weaknesses of the Ukrainian banking sector, and lays the groundwork for theimproved arrangements in domestic banking necessary to support other components of economicreform.

25. The Bank's first adjustment operation in Ukraine was a Rehabilitation Loan for US$500million approved in December 1994 and fully disbursed by the end of 1995. This was followedby an Enterprise Development Adjustment Loan (EDAL I) for US$300 million approved on June27, 1996; an Agricultural Sector Adjustment Loan for US$250 million approved on October 17,1996; and a Coal Sector Adjustment Loan for US$300 million approved on December 11, 1996.

26. The reform program supported by the FSAL is directed mainly at the banking sector.Complementary institutional and regulatory reforms for capital market institutions are supportedthrough EDAL I and EDAL II with further influence coming from the reform of pensions to beincluded in one of a series of Public Administration Reform Loans currently under preparation.The program acknowledges the extremely small size of the Ukrainian banking sector; the fragileand transitional situation of most of its component banks; and the, as yet, inadequate institutionalcapacity and skills in the NBU to provide adequate regulation of the sector. The program seeksto address these problems in order to increase the safety and capacity of the sector.

27. Three main types of reform will be supported by the FSAL.

* Legal Framework for Banking Activity. These include, above all, thosemeasures necessary to confirm the authority of the NBU itself not only formonetary stability in a macroeconomic sense, but also for the safety of thebanking sector. These actions call mainly for the adoption of the new draftLaw on the NBU, now before the Parliament, and for a new Law on Banksand Banking Activity.

* Informational and Regulatory Basis of Banking. These include the reformof accounting arrangements for banks; improved definitions of majorconcepts such as "capital" for prudential purposes; and improved NBUprocedures for the supervision of banks and interventions in problem banks.

* Structure of the Sector. These include the further steps needed to liquidatemarginal banks, as well as decisions about the future role of the savings bank,and the appropriate role, during the transition, of institutions such as depositinsurance.

28. The specific measures which the Government intends to take to give effect to thestrategy of reform are summarized in its Memorandum on Financial Sector Development Policy(Annex 4). These measures are detailed below with, in each case, a brief explanation of themotivation for their inclusion and phasing. An overview can be found in the Policy Matrix(Annex 5).

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III. THE PROPOSED LOAN

Rationale and Objectives

29. Both the 1996 CAS and the 1998 CAS Progress Report (to be presented to the ExecutiveDirectors with the proposed operation) identify strengthening the financial sector as one majorcomponent contributing to strengthening the private sector, a key objective of the Government'sreform program. The FSAL has been designed in close coordination with the IMF's ongoingStand-By Arrangement (SBA) and planned Extended Fund Facility (EFF), and it will disburse inparallel with funds from the other adjustment loans listed above, including the simultaneouslyproposed EDAL II.

30. The financial sector reform program does entail significant fiscal costs to theGovernment, as is evidenced by the budgetary impact associated with the introduction of taxdeductibility of loan loss provisioning, the repayment of Government guaranteed/directed loanson the balances of the three former state banks (Prominvest Bank, Bank Ukraina and UkrsotsBank), the costs (including those for the bank's first ever IAS audit) associated with therestructuring of the savings bank, and the creation of a viable deposit insurance scheme. Theproposed loan will also provide a significant proportion of the external balance of paymentssupport necessary to achieve the macroeconomic targets defined later in this section and, at thesame time, help to mitigate the direct budgetary costs of the financial sector reform programenvisaged.

31. The proposed FSAL does not contain a technical assistance component. However,relevant and complementary technical assistance to banks is contained in the Bank's EDPalready under implementation and the planned FSP, as well as in a comprehensive set of paralleloperations financed and implemented by other donors. The Bank's FSAL played a key role incoordinating these donor programs by providing a policy framework for financial sector reformand development. (Details of this technical support are provided in Annex 7).

32. Implementation of the policy reforms reflected in this loan began during loanpreparation, which started with an identification mission in May 1996, and progress is alreadyevident. A set of comprehensive appraisal, negotiations and Board presentation conditions havealready been met (see Annex 5 for details), and the second and third tranche will be disbursedbased on satisfactory implementation of the conditionality described below. The NBU will bethe main implementing agency for the project, but other agencies of Government including theMinistry of Finance have an important part to play in implementing the reforms.

33. The broad outlines of the strategy on which the reform program for the financial sector isconstructed emanate from the Bank's Financial Sector Review (FSR) completed in June 199510and continually refreshed subsequently. This strategy involves both bottom-up directinstitutional strengthening of individual banks or groups of banks (EDP, FSP and EBRD's SMEline of credit operation), and top-down pressures on bank performance by developing animproved legal framework, bank accounting reform to support improved regulation andsupervision, a framework for the restructuring of banks, and specific restructuring actions in asub-set of banks once the capacity and skill base of the NBU is sufficiently strengthened toenable it to play a lead role in this area (FSAL).

10 Ukraine, Risks and Transitions: A Review of the Financial Sector, (in 2 volumes), Report No. 14526 UA, June 30, 1995.

11

34. Lessons learned from Previous Bank Involvement: The FSAL is the first adjustmentloan in the financial sector in Ukraine. Experience from FSAL-type operations in other countriesin the region has shown that a sound financial sector policy framework, with the core objectiveof strengthening the banking system, is an essential prerequisite for financial sectordevelopment. The Financial Institutions Development Loan and Enterprise and Financial SectorAdjustment Loan in Poland, and the Financial and Enterprise Sector Adjustment Loan inRomania have demonstrated that strengthening the legislative authority and mandate of thecentral bank, supported by enhanced supervision capacity including on-site and off-sitemonitoring and enforcement powers, is necessary to instill banking sector discipline and tounderpin reforms. In addition, parallel policy and regulatory development in the areas of prudentcommercial bank capital and lending guidelines, accounting reform and tax deductibility of loanloss provisions have, in tandem with central bank institutional development, created thenecessary environment and laid the foundations for a healthy banking sector. These efforts haveto be followed by initiating the portfolio restructuring of troubled banks, including liquidation asnecessary. The overall delivery of technical assistance and greater absorptive capacity of therecipient country is ensured by extensive coordination of supportive bilateral donor efforts. Allof these lessons have been incorporated in the FSAL design and have formed the basis for thedevelopment of the policy matrix for this operation.

Benefits and Risks

35. Benefits: The implementation of structural reforms in the banking sector will reinforceUkraine's stabilization and other structural reforms by helping to ensure that a growing part oftotal lending is made by the better capitalized banks. By taking explicit measures to reduce therisks which banks are allowed to accept, the loan will also help to make a possible crisis in thebanking sector less likely. Better and stronger banks in turn will be an important element insupporting the restructuring of newly-privatized enterprises and ensuring that there is a risingvolume of credit available for the investment needs of such enterprises as well as for newly-created private businesses. In this way, the loan will complement other Bank operations whichare focused more directly on the enterprise sector. Finally, the up-front strengthening of banksand the elimination of bad lending practices should reduce the size of potential claims on theGovernment budget if and when banks fail, and so will have a positive fiscal benefit in the longerterm. The positive effect on Govermnent saving may also be accompanied by improved privatesavings performance as confidence in banks increases.

36. Risks: A general risk facing all adjustment operations in Ukraine is that themacroeconomic stabilization is still fragile and a resurgence of high inflation fueled by largebudget deficits cannot be ruled out. Such a development could lead to further repressivepressures on the banks, which could undermine many of the positive changes that the loan seeksto advance. This concern has been intensified by the post October 1997 fiscal financingproblems which contributed both directly to the liquidity and other pressures on certain banks,but which also elicited certain policy responses not entirely helpful to bank soundness.

37. A more specific risk relates to the complexity of many of the component issues and therelatively limited technical depth in the NBU and elsewhere to champion particular measuresthrough to effective implementation. This risk has been lessened somewhat by the NBU'scommitment during loan preparation to strengthen its management team, especially in the BankSupervision Department, and by the favorable reaction that has elicited from other donors

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notably, the IMF, USAID, and EU/TACIS, to commit additional technical personnel to assist thelocal technical staff. This will ensure that there will be a sound underpinning of external adviceand training in all major areas of the loan, such as accounting reform, bank resolution and bankliquidation, to back up the policy commitment. This will not eliminate this particular problembut it should reduce it to acceptable proportions.

38. A third risk is that the institutional structures for implementing this loan are poorlydeveloped, especially where they involve active cooperation between different agencies ofGovernment. This risk is particularly apparent in relation to those areas of the loan where someshort-term fiscal cost (Ministry of Finance) is required to deliver improvements supported by theregulatory authority for banks (the NBU). Previous Bank adjustment projects have demonstratedthe difficulty of extracting local currency budget funds to support particular aspects of the reformprogram. This risk is mitigated by the loan's design, with some of the issues which requiresubstantial budgetary outlays--the introduction of tax deductibility of loan loss provisions andthe audit of the savings bank--having been fulfilled as pre-Board conditions. However, the issuearises also in relation to the reduction of the stock of Government guaranteed or directed loanson the books of the three former state banks, the establishment of a viable system of depositinsurance and the obvious costs to be incurred in a fully viable restructuring program for thesavings bank.

39. Finally, there is the possibility of the loss of policy commitment due to a lack ofconsensus between different constituencies of the Ukrainian administration. The relationshipbetween the Government and the Parliament remains an uneasy one and the upcomingParliamentary elections (March 1998) further enhance the existing uncertainty in this respect.Elected representatives (MPs) have sometimes tended to regard the banks as exploitative andwell-endowed organizations, which, far from being as fragile as the FSAL's design assumes, areindeed robust, and in little need of assistance. Other MPs are deeply suspicious of the NBU andare unwilling to accord it the independence of action which the project regards as necessary todeliver sectoral reform. Others again see the banks as having a clear-cut role to provide softcredits to state-owned enterprises and to fulfill other social objectives. They could resist therestraint on banking activity that is an implicit early consequence of the proposed reforms. Theonly mitigation to these political risks is through the building of strong technical capacity in theNBU, and through the insistence on legal reforms which will indeed provide the NBU with areasonable degree of independence of action to drive through the reforms which the loan seeks tosupport.

Coordination with the IMF and Project Sustainability

40. The project has been developed in close coordination with the IMF program in Ukraineand is backed by conditionality in the IMF's ongoing SBA and planned EFF. Additionally, theIMF and the Bank have been cooperating closely in supporting the NBU's efforts to strengthenbank regulation and supervision, as evidenced -by a recent decision to place a semi-permanentIMF advisor in the NBU's Bank Supervision Department who will coordinate the efforts ofseveral other donor-financed advisors already on-site. The Bank's own "top-down/bottom-up"approach to lending for financial sector reform will further ensure project sustainability.

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Board Conditionas, Tranche Triggers and Supervision

(i) Measures Implemented Before Board Presentation

41. Maintain a Program to Ensure Macroeconomic Stability. The authorities remainedbroadly in compliance with the IMF Stand-By Arrangement approved on August 25, 1997, assubsequently modified.

* the consolidated budget deficit for 1997 was UAH 5.19 billion which is higherthan the program target of 4.31 (4.5 percent of GDP), but was the subject of awaiver;

* the NBU's Net Domestic Assets during 1997 was below the program target ofUAH 7.190 billion;

* the cumulative build up of international reserves through 1997 at US$240.7million exceeded the program target;

* the increase in base money during 1997 amounted to UAH 2.177 million asagainst an indicative program target of UAH 2.090 billion;

- the 1997 growth of non-concessional external debt amounted to US$894 millionwhich was substantially below the program target; and

- the stock of budgeting arrears on wages, pensions, and social benefits was at end-1997 UAH 2.614 billion which was below the program ceiling of UAH 2.700billion.

42. Maintain Interest Rate Policy to Ensure Mainly Free and Positive Real Rates. Through1997, both deposit and lending rates were largely free and both remained broadly positive in realterms. During the last six months of 1997, the average commercial bank lending rate was 3.43percent and the average deposit rate was 1.4 percent (both rates are in real terms). The onlysubstantive change is that in September 1997, an NBU directive abolished the statutory linkbetween the NBU refinance rate and commercial bank lending rates. As is clear from the 1996data shown in Figure 2 above, the previous existence of this link had not prevented theachievement of positive real rates on bank credits in the average.

43. The NBU Conversion to LMS. By late-1996, the NBU had created separate Controllersand Statistics and Reporting Units--the former to be responsible for all the NBU accounting andfinancial controls. Central Operations of the bank is the key to the IAS conversion since itaccounts for 85-90 percent of all NBU transactions. For Central Operations, the General Ledgerwas completed on an IAS basis by end-1996 and the consolidated balance sheet by April 1997.Central Operations transferred fully to an IAS basis of accounting by late- 1997. The conversionwill roll out to the NBU branches in the 26 other oblasts throughout 1998.

44. Commercial Bank Reporting to the NBU The process of rationalizing the 70 or morereporting forms formerly required of the commercial banks is almost completed and a small setof new forms, all on an IAS-compatible basis, were formally accepted by way of an NBU decreeon May 30, 1997. The new forms were mandated for use by the commercial banks beginningJanuary 1, 1998.

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45. The Commercial Bank Conversion to LAS. A new IAS-based Chart of Accounts based ona mixture of Czech, Russian and Belorussian experience was finalized in May 1997 andapproved by international experts at the end of May. The NBU gave it official approval in July,and it began to be piloted immediately. A coding system to enable some banks to adapt to IASvia coding amendments and additions to the Gosbank system has been designed to avoid delayswhich might otherwise occur due to software difficulties including the affordability of Westernsoftware packages. EU/TACIS and USAID programs are in place to assist banks to make theconversion, and the changeover occurred on January 1, 1998 as anticipated.

46. Improve Arrangements for Loan Loss Provisioning. Measures that have been takentoward improving arrangements for loan loss provisioning include the following:

* on September 29, 1997, the NBU Board approved a new regulation (No. 323)on loan-loss classification and provisioning including arrangements toincorporate the financial condition of borrowers into the classification.

* Parliament approved a new Corporate Income Tax Law including a revisedArticle 12 dealing with the tax treatment of loan loss provisions, whichbecame effective on July 1, 1997. This new Article provides for taxdeductibility for specific loan losses, but not for general loan loss provisions.It requires banks to make immediate provision for "lost" loans but defines anexplicit phase-in period up to July 1999 for remaining classified loans. Bankscan provision up to 40 percent of their loans (including guarantees and otheroff balance sheet commitments) and benefit from tax deductibility on all suchprovisions. This percentage applies till end-1999. This arrangement meansin practice that the serious underprovisioning of the Ukrainian banks shouldbe substantially corrected by mid 1998. The phase-in is designed to softenthe losses of budget revenue associated with this change.

47. Reorganize and Strengthen Bank Supervision in NBU In June 1997, the Board of theNBU endorsed detailed proposals for reorganizing the Bank Supervision Department asproposed by its resident Technical Advisory Team and the Bank. This reorganization isdesigned to focus the work on the "process" of supervision involving all the componentelements of the information and interventions available to the NBU. By way ofimplementation, the NBU has:

* appointed a new senior manager at the level equivalent to Vice-Governor andreporting directly to the Governor;

* established an advisory team, including resident foreign experts, to help thenew manager with the definition and transition to the new organization;

* has initiated programs for on-site inspections for three large banks that areconsidered to be facing difficulties. Two of these examinations arecompleted; and

* agreed arrangements with the Securities and Stock Market Commission(SSMC) for supervising the securities business of banks.

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48. As a condition for Board presentation, the NBU Board approved a consolidated strategydocument for the Bank Supervision Department (BSD) with the following elements:

* the further development and refinement of the legislative and regulatoryframework for bank supervision;

* the implementation of a supervisory process which reviews the activity ofbanks on a consolidated basis;

* the assessment of the effectiveness of the measures taken and thereaftermaking necessary changes in the supervisory process;

* the creation of a uniform management information system for banksupervision;

49. Improve Off-Site Surveillance of Banks. An improved version of NBU's core prudentialregulation, Regulation No. 10, was adopted in December 1997 responding to the criticism ofprevious prudential standards. Among other things, this regulation introduces a reviseddefinition of bank capital that is consistent with new loan-loss provisioning arrangements, andstrengthens the procedures for controlling the insider and connected lending of banks includingtheir direct exposure to investments in non-financial businesses. Improvements include thefollowing:

- five capital regulations, all of which are in accordance with BIS norms;* seven risk regulations;- three regulations of bank open FX positions; and- three weighted FX position regulations

50. These improvements are expanded upon in detail in paragraph 13 of the Memorandumon Financial Sector Development Policy.

51. Develop a Unified Bank Performance Report and Early Warning System. In addition tothe improvement in prudential regulations already noted, the NBU has developed an earlywarning system, a Uniform Bank Performance Report (UBPR), as well as quarterly reportingforms that summarize the information of the financial performance of all the commercial banks.As a result of the conversion to IAS, the off-site department has started to revise the UBPR andother reporting forms to comply with IAS. The UBPR includes current as well as time series,ratio, and other information about each bank as well as comparisons with similar banks. Theearly warning system displays lists of banks showing unfavorable trends or falling belowacceptable thresholds. Necessary staff training is being provided. The early warning reportswill be reviewed regularly by the Vice-Governor responsible for banking supervision as a basisfor redirecting the efforts of the off-site inspectors and the enforcement teams as necessary. Inaddition, financial analysis was prepared to help scope the on-site examinations of the threelarge former state banks, which began with the Bank Ukraina examination in May 1997.

52. Improve Arrangements for On-Site Examination of Banks. On-Site InspectionGuidelines were developed and approved in 1996. These guidelines provide for inspectingbanks on the basis of a CAMEL rating system. Throughout 1997, the NBU implemented aprogram of regional training on the on-site inspection guidelines based on CAMEL ratings.

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These guidelines are mandatory for use by the bank supervision inspectors during on-siteexaminations. Additionally, the NBU has prepared programs of priorities for on-siteexaminations of banks for the next two years. These programs specify the scope ofexaminations to be undertaken, the degree of branch coverage which is required, and thecontents and level of detail expected in examination reports. At the present time, detailed workis focused on larger banks, particularly Prominvest Bank, Bank Ukraina, and Ukrsots Bank.The examination of these banks, with inputs from foreign experts, was initiated, and in somecases completed, between June and December 1997. The NBU is committed as part of thisreform program to have completed on-site inspections of banks accounting for 60 % of totalbank assets by the end of 1998.

53. Improve Licensing (Entry) Procedures for Banks. Since early 1996, the NBU hasobtained full responsibility for this function and has finalized the criteria which banks need tomeet to obtain and retain licenses. A detailed system of graduated licenses is in place and is usedactively to restrict banks from activities where their competencies are in question. During 1996,the NBU put 45 of the country's 229 banks into various categories of restricted license,rehabilitation, closure, or liquidation.

54. To bring the statutory capital of the Ukrainian commercial banks up to internationalstandards, the NBU intends to continue its work aimed at raising banks' minimum statutorycapital requirements, including for problem banks and the banks that will be unable to complywith the requirements for increased statutory capital.

55. Establish Enforcement Capacity and Procedures (including Exit) to Address ProblemBanks. In September 1996, the NBU established a specialized Bank Resolution Department(BRD) within the BSD and progressively increased its staffing to 23 persons. By September1997, the NBU had signed specially designed Enforcement Resolutions for three banks, whichwere drafted with the assistance of external advisers. Subsequently, Enforcement Resolutionshave been signed for another 21 banks in the BRD which are subject to rehabilitation. For allother banks in the BRD, a decision has been taken that they need to be liquidated. A timetablefor the liquidation of these banks has been developed and specific action steps for itsimplementation have been agreed upon as second and third tranche conditionality. A new Lawon Banks and Banking Activity, which concretizes NBU power in relation to bank liquidation,has been prepared by the NBU, will be reviewed by foreign experts in the near future and isexpected to be submitted to the Parliament by mid 1998. The caseload of the BRD will transferfrom the current method (based on off-site assessment) to a new method (based on on-siteexaminations). Supervisory profiles will be developed for all banks remaining under thesurveillance of the BRD.

56. Take Action to Assess the Capacity and Define the Role of the Savings Bank. Theseactions include the following:

* Detailed terms of reference for a three-stage program of audit, includingdiagnostic review were finalized and agreed with the Savings Bank and theMinistry of Finance in May 1997. The Government appointed an authorizedperson to manage the contractual arrangements for the audit in April 1997,bidding documents were issued, and an audit contract was signed with PriceWaterhouse in July 1997. Audit results for end- 1996 year were completed byOctober 1997.

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* Pending the results of the audit, the NBU has restricted the license of thebank to prevent further exposure to corporate lending.

* The Prime Minister signed a draft of the Decree establishing a SupervisoryCouncil (headed by the Minister of Finance) for the Savings Bank on May 13,1997. This condition is vital to fill the vacuum of strategic decision-makingthat previously has held back any progress with reform of the Savings Bank.

57. As a condition of Board presentation, the Savings Bank's management and the newlycreated Supervisory Board have agreed on a concept paper outlining the main elements of astrategic restructuring plan. Agreement on the implementation of specific elements of this planby second and third tranche has been reached.

58. Government-directed loans made byformer state banks. As a condition of negotiations,and as a key element of the rehabilitation of the larger banks, a schedule has been developedidentifying the amount of Government directed loans (those guaranteed or lent againstdocumented Government instruction) and the timetable for their repayment. As a condition ofBoard presentation, this action was supported by the issuance of a Cabinet of Ministersresolution to ensure the actual implementation of this schedule.

59. Property Swap. Under a 1995 Presidential Decree, the three former state banks wereforced to issue shares to the Government in exchange for the title to the Government-ownedbuilding they were occupying. As a condition of negotiations, the State Property Fund, holdingthese shares on behalf of the Government, has developed a plan for their divestiture, including adetailed timetable and a description of the sales methods to be used. This plan envisages fulldivestiture of the remaining state shares in the three banks by the end of 1998. The plan has beenformally adopted and is already under implementation.

60. Establish Intervention Mechanisms to Prevent Systemic Spillover from IlliquidityProblems in Larger Banks. In response to prospective liquidity problems in several larger banks,the NBU as a condition of9Board presentation developed a special vigilance program to limit thedangers that this might otherwise cause in the banking system as a whole. This program includes

* an NBU Board Resolution to establish contingency planning for large bankfailures as an identifiable NBU activity with its own working group togetherwith an agreed timetable for the finalization of detailed contingencyarrangements.

* the presentation to the Bank of a paper summarizing present NBU emergencyprocedures to deal with sudden and unexpected problems in larger banks, andthe identification of the main weaknesses in these existing procedures.

* an NBU commitment to recruit appropriate short-term external advice to helpit review existing procedures and define necessary improvements.

* the establishment of a working group on contingency planning.

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61. Make Preparations for the Introduction of Deposit Insurance. The NBU has abandonedplans for a deposit insurance scheme to be mandatory for all banks. Instead it has commissionedin-depth technical assistance to support the preparation of a soundly funded scheme which willexclude banks which do not meet certain basic standards of reporting and soundness.

(ii) Measures To Be Completed Prior To Second Tranche Release

62. The Macroeconomic Environment for the Financial Sector. The authorities willmaintain a macro-economic framework consistent with the program as deternined on the basisof indicators agreed upon by the Government and the Bank and will achieve progress in carryingout this program. Interest rates will remain largely free and generally positive in real terms.

63. The Legal Framework for Banking Activity. Achieve passage of the "Law on TheNational of Bank of Ukraine" in the Parliament to ensure the reasonable independence of thatbank. The draft Law was approved in first reading in October 1997.

64. The Government will submit a new Law on Banks and Banking Activity to theParliament which will include specific and detailed arrangement for all substantive interventionsin banks presently authorized by NBU Regulation 11511. These arrangements will include thedefinition of procedures and authority for the conservatorship and the liquidation of banks.

65. The revised deposit insurance law will be finalized and approved by the NBU Board(including exclusions, administrative arrangements, pay-out procedures and a means of fundingsuch a scheme), and submitted by the Government to Parliament.

66. Improve Arrangements for Loan Loss Provisioning The NBU shall require banks to fullyprovision in their books all loans classified as "loss" without regard to tax deductibility.

67. On-Site Examination of Banks. On-site inspections in banks accounting for 60 percentof total bank assets will have been completed and reports will be available.

68. Improve Licensing (Entry) Procedures for Banks. All banks not meeting the higherminimum statutory capital requirements applicable from January 1, 1998 will have had theirlicenses removed, seriously restricted, or will have been put into liquidation, as the case may be.

69. Restructure the Savings Bank The following sub-set of the components in the agreedstrategic restructuring plan will have been implemented:

* the registration of the savings bank as a joint stock company with 100 percentof the shares owned by the state;

* the strengthening of the credit function, including the establishment ofappropriate loan approval ceilings for the bank's branches;

* the restructuring of its loan portfolio, and* the finalization of a detailed plan for the creation of a treasury function.

1 As of February 1998, NBU Regulation No. 115 has been re-named Regulation No. 38.

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70. Specific Interventions in Former State Banks. The NBU shall review the performance ofthe bad loan workout departments of the three former state banks and take appropriate measuresto improve their recovery of bad loans.

71. Government Guaranteed/Directed Loans. Repayment of Governmentguaranteed/directed loans on the balances of the three former state banks will have beenimplemented as per the applicable Cabinet of Ministers Decree. Additionally, the Governmentwill take appropriate measures to reduce the stock of Government guaranteed/directed loans onthe books of these three banks to UAH 125 million.

72. Problem Banks. The Govermment will approve a liquidation manual, initiate a programfor the training of relevant personnel, and initiate procedures for liquidation of no less thanthree insolvent banks as pilot liquidations. EU/TACIS has already confirmed assistance in thisprogram, which is slated to begin in September 1998.

(iii) Measures To Be Completed Prior To Third Tranche Release

73. The Macroeconomic Environment for the Financial Sector. The authorities willmaintain a macro-economic framework consistent with the program as determined on the basisof indicators agreed upon by the Government and the Bank/IMF and will achieve progress incarying out this program. Interest rates will remain largely free and generally positive in realterms.

74. The Legal Framework for Banking Activity. The new Law on Banks and BankingActivity will be adopted by the Parliament and signed by the President. The new Law willinclude specific and detailed arrangement for all substantive interventions in banks presentlyauthorized by NBU Regulation 115. These arrangements will include the definition ofprocedures and authority for the conservatorship and the liquidation of banks.

75. Deposit Insurance. Parliament will adopt the Law on Deposit Insurance, and theauthorities will implement the deposit insurance scheme called for in the Law. The Ministry ofFinance will ensure that sufficient Government funding for the new scheme is available asevidenced by inclusion of proper allocations for this purpose in the Government budget, beforethe scheme is operationalized.

76. Government Guaranteed/Directed Loans. The Govermment will have taken appropriatemeasures to reduce the stock of Government guaranteed/directed loans on the books of the threeformer state banks to UAH 100 million.

77. Improve Arrangements for Loan Loss Provisioning. The NBU shall have required banksto fully provision classified loans in accordance with the timetable in Regulation 323, andconfirm this through on-site inspections.

78. Restructure the Savings Bank The following sub-set of the components in the agreedstrategic restructuring plan will have been implemented:

* the initiation of the rationalization of the branch network;* the operationalization of the treasury function, and

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* the finalization of an information technology strategy, a product developmentand marketing strategy, and a human resource development policy.

79. Problem Banks. The NBU's BRD will have initiated the relevant administrative andother (including judicial) procedures as applicable for the liquidation of at least half of the totalnumber of insolvent banks in the BRD caseload.

Implementation

80. Administration of the loan will be the responsibility of the FSAL Monitoring Unit (MU)located in the Ministry of Finance. The MU's main responsibility will be to monitor, inconjunction with the NBU, the implementation of the Loan program and provide progress reportsto the Government and the Bank every three months after Board approval. The progress reportswill contain an evaluation of the progress made on the policy reform program and will indicateprogress made towards fulfilling tranche release conditions. These reports will be sent to theBank every three months in English. The MU will also assist periodic Bank supervisionactivities, and prepare Ukraine's contribution to the Project Completion Report within six monthsof the closing date. The Project Manager will be located in the Ministry of Finance.

Financial Arrangements

(i) Disbursement

81. Once the loan is approved by the Board of the World Bank, the Government will openand maintain a Special Deposit Account at the NBU. Upon Bank notification of tranche release,the Government will submit a simplified withdrawl application, against which the Bank willdisburse the Loan proceeds into the Deposit Account. The Project Manager will be responsiblefor submitting to the Bank the simplified Application for Withdrawal form upon receivingclearance from the Bank that all conditions have been met for a tranche release. If after depositin this account, the proceeds of the loan are used for ineligible purposes as defined in the LoanAgreement, the Bank will require the Government either to (a) return that amount to the accountfor use for eligible purposes or (b) refund the amount directly to the Bank, in which case theBank will cancel an equivalent undisbursed amount of the loan.

82. The proposed FSAL proceeds will be disbursed against satisfactory implementation ofthe adjustment program, including compliance with stipulated tranche release conditions andachievement of a satisfactory macroeconomic framework. Disbursements will not be linked toany specific procurement actions or imports; hence, evidence thereof will not be needed tosupport disbursement requests. Procurement requirements are not relevant to the plannedtranched disbursements. Loan funds will not, however, be eligible for certain purposes as notedabove.

(ii) Reporting and Auditing

83. The Project Manager in the Ministry of Finance will maintain records of Loan activities,disbursements, and such other files as may be appropriate for audit purposes. The Borrowershall arrange for periodic audits of the project, as indicated by the Loan Agreement andsupplementary Bank communications on audits. The Bank retains the right to require anindependent audit by auditors acceptable to the Bank.

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Environmental Impact

84. In accordance with the Bank's Operational Directive on Environmental Assessment (OD4.01, Annex E), the proposed operation has been placed in category "U" and does not require anenvironmental assessment.

IV. RECOMMENDATION

85. I am satisfied that the proposed loan would comply with the Articles of Agreement ofthe Bank and I recommend that the Executive Directors approve it.

James D. WolfensohnPresident

by Caio K. Koch-Weser

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ANNEX 1Page 1 of 3

Ukraine - Key Economic Indicators

Actu21 Estimate ProjectedIndicatar 1993 1994 1995 1996 1997 1998 1999 2000

iNational lCCOUOt5

(as % GDP at currentmarkiet prices)

Gross domestic product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Agriculture 20.0 13.2 12.1 10.5 ..

Industry' 34.1 39.1 34.2 31.2 .. .. ..

Services' 38.3 30.4 34.6 39.1 ..

Total Consumption 6412 68.1 76.5 79.7 83.8 82.4 82.0 81.7Gross domestic fLxed 24.3 23.5 23.3 20.S 19.3 19.1 18.7 18.5invescnent

Gover-unent inves=t .. .. .. .. ..

Privace investment .. .. .. ..

(includes increase instocks)

E'xports (GNIFS)b 25.9 35.4 47.1 45.5 40.4 40.0 39.1 38.6Impor.s (G}NFS) 26.2 38.6 50.2 47.9 45.3 43.3 41.5 40.6

Gross domestic savings 35.8 31.9 23.5 20.3 16.2 17.6 18.0 18.3

Gross national savings .. 31.7 22.7 20.2 ..

MIdemorandum items

Gross domestic product 32,731 36,756 37,008 44,007 48,207 51,427 55,190 58,733(USS miilion at currtmtprices)Gross national product per 2,380 1.910 1,630 1,180 ..

capita (USS, Atlas method)

Real annual growth rmtes(%, calculated ftam 1995prices)

Grass domestic product at -14.2% -23.0% -12.2% -10.0% -3.0% -2.0% 0.0% 1.0%market pricesGross Domestic Income .. .. .. -8.8% -5.0% 0.7%/ 1.0% 1.7%

Real annual per capitagrowth races (%, calculatedfrom 1995 prices)

Gross domestic product at -14.2% -22.6% -11.6% -9.7% -2.7% -1.7% 0.3% 13%market pricesTotal consumption .. .. .. .. ..

Private consumption .. .. .. .. ..

(c23tinued)

23

ANNEX 1Page 2 of 3

Ukraine - Key Economic Indicators

(Continued)

Actual Estimate ProjectedIndicator 1993 1994 1995 1996 1997 1998 1999 2000

Balance of Pavrnents(USSm)

Exports (GNFS)b 15,850 14,713 16,436 20,346 19,480 20,569 21,98 22,678Merchandise FOB 12,796 12,111 13,647 15,547 14,952 15,951 16,749 17,586

Imports (GNFS)b 16,755 16,044 17,643 21,468 21,817 22,23 22,920 23,837Merchandise FOB 15,315 14,471 15,945 19,343 20,169 20,572 21,189 22,037

Resource balance -905 -1,331 -1,207 -1,122 -2,337 -1,6S4 -1,323 -1,160Net current trnafers 120 200 200 .. 770 300 225 169(including ofEcial curnttransfers)Current account balance -854 -1,395 -1,515 .. -2,163 -2,021 -1.785 -1,747(after otEcial capital grants)

Net private forei:g direct 200 91 266 526 437 550 589 630investmentLong-term loans (net) 709 -1,065 -347 -482 -176 -901 1,553 1,108Official 307 98 385 241 -93 -619 -525 -208

Private 402 -1,163 -732 -723 -83 -282 2,078 1,316Other capital (net, including -92 2,510 867 .. 2,311 2,327 408 509

errors and ornissions)

Change in resenresd 37 -141 729 -83 -409 44 -765 -500

tW'emorandum irem.sResource balance (% of -2.8% -3.6% -3.3% -2.5% 4.S% -3.3% -2.4% -2.0%GDP at current marketprices)Real annual growth rates(1995 prices)

Merchandise exports 2.7"h -7.3% 9.8% .. ..

(FOB)Prirary 9.9% *.

Manufactures .. 9.8% .. ..

Merchandise imports 25.6% -7.4% 7.4% .. ..

(CIF)

Public finance(as % of GDP at current

market prices)'Current revenues .. .. 37.6 36.9 36.9 33.9 31.8 30.7Current expenditures .. .. 39.3 39.3 41.1 37.9 32.7 31.4

(Condntma

24

ANNEX 1Page 3 of 3

Ukraine - Key Economic Indicators(Continued)

Actual Estimate ProjectedIndicator 1993 1994 1995 1996 1997 1998 1999 2000

Current account surplus (i) .. *. -1.7 -2.4 -4.3 -4.1 -0.9 .0.7or deficit (-)

Capital expenditure .. 3.4 1.1 1.1 1. 1 1.3 1.6Foreip financing .. .. 2.7 2.1 0.0 0.0

Monetary indicatorsM21GDP (at current market .. .. 26.2 34.2 44.2 50.1 56S5prices)Growth of M2 (%) .. .. .. 92.9 44.3 27.1 24.0

Private sector credit growth/ ..

total credit growt (h)

Price indices( 1995 =100)Merchandise export price 123.5 126.0 129.3 .. ..

index

Merchandise import price 123.5 126.0 129.3 .. ..

indexMerchandise terms of trade 100.0 100.0 100.0 .. ..

indexReal exchange rate 243.7 33.3 4.5 .. ..

(USSILCU)'Real interest ratesConsumer price index 5371% 891.1% 376.8% -94.9% 30.0% 12.0% 10.00% 10.0%(% growth rate)GDP deflator 3334% 954.4% 415.8% 64.1% 15.3% 14.3% 10.0% 8.0%/6(% erowth rate)

a. If GDP components are estmated at factor cost, a footnoote indicating this fact should be added

b. 'GNFS' denotes 'goods and onLfactor services.'c. Includes net urequited tfrAzsfem etcluding oflicial capital gants.d. Includes use of IMF resources.e. Should indicate the level of the govannent to which the data refer.f. 'LCU" denotes "local c;=ecy units.' An incres in USS/LCU denotes appreciation.

25

St:itils of * 1,r1B. i Gcroln Opelrationis ill UkraineIBRD Loans nid Il)A Credits in the Operations Portfolio

Differenice Betweenexpected

Original Amount in USS Millions and actualLoan or Fiscal disbursements a/

Project ID Credit Year Borrower Purpose

No. IBRD IDA Cancellations Undisbuirsed Oriq Frm Rev'd

Number of Closed Loans/credits: 2

Active LoansUA-PE-40564 1RD41180 1997 GOVERNMENT OF UKRAINE COAL SECAL 300.00 0.00 0.00 150.00 150.00 0.00UA-PE-44444 IBRD40980 1997 UKRAIIIE ELECTRICITY MARKET 245.40 0.00 0.00 169.44 123.89 0.00UA-PE-44444 IBRD409B1 1997 UKRAINE ELECTRICITY MARKET 71.60 0.00 0.00 71.44 123.09 0.00UA-PE-44851 IBRD41070 1997 S1ATE EXPORT/IMPORT BANK EXPORT D)EVEL.OPMEIIl 60.00 0,00 0.00 57.69 -?.15 -2.75UA-PE-44051 IBRD41071 1997 STATE EXPORT/IMPORT BAIJK EXPORT DEVEl.oPMEIrT Itl.0U 0.01) 0.00 0.02 -2.15 -2. 15UA-PE-45940 IBRD40970 1997 UKRAINE SOCIAL PROTECT. sUPP 2.60 0.00 0.00 2.60 2.20 0.00UA-PE-9113 IBRD41030 1997 UKRAINE AGRICULTURE SECAI. 300.00 0.00 0.00 150.00 150.00 0.00UA-PE-35814 IBRD40570 1996 UKRAINE E1JTER. DEV. ADJUST. 310.00 0.00 0.00 9.40 1.21 0.00UA-PE-44110 IBRD40160 1996 GOVERIIMENT OF UKRAINE COAI. PILOT 15.91 0.00 0.00 10.47 5.16 0.00UA-PE-38820 IBRD38650 1995 GOVT. OF UKRAINE HYDROPOWER REHAB. 114.00 0.00 0.00 100.96 37.16 0.00UA-PE-9117 IBRD38910 1995 GOVT. OF UKRAINE AGRIC. SEED DEVELOPM 32.00 0.00 0.00 31.11 28.62 .12UA-PE-9106 IBRp36140 1993 MIHISTRY OF FINANCE, UKRA INSTI1UTION BUILDINIG 27.00 0.00 0.00 11.61 11.61 11.61

Total 1,488.41 0.00 0.00 772.74 631.24 6.230~

Active Loans Closed Loans TotalTotal Disbursed hEBRD and IDA): 714.12 500.00 1,214.12

of which has been repaid: 0.00 0.00 0.00Total now held by I8RD and IDA: 1,480.41 500.00 1,908.41Amount sold 0.00 0.00 0.00

Of which repaid : 0.00 0.00 0.00Total Undisbursed 1 772.74 0.00 772.74

a. Ilitended disbursements to date minus actual disbursements to date as projected at appraisal,b. Rating of 1-4: see OD 13.05. Annex 02. Preparation of Tiaplelejitationk SunMairy iForm 5903. Followiu.j the FY94 Annual Review of Portfolio performance (ARPPI, a letter

based system will be used IHS - highly Satisfactory, S - satisfactory, U unsatisfactory, IIU - lighly unsatisfactory): see proposed Improvements In Project andPortfolio Pertormance Rating Methodology (SecM94-901), August 23, 1994.

Note:Disbursement data is updated at the end of the first week of the month.

Generated by thie Operations Infonmation System (01)

ANNEX 2Page 2 of 2

UkraineSTATEMENT OF IFC's

Committed and Disbursed PortfolioAs of 31-Dec-97

(In US Dollar Millions)

Committed DisbursedIFC IFC

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic1994/96 Ukraine VC Fund 0.00 3.50 0.00 0.00 0.00 2.10 0.00 0.00

Total Portfolio: 0.00 3.50 0.00 0.00 0.00 2.10 0.00 0.00

Approvals Pending Cormnitmnent

Loan Equitv Ouasi Partic

1998 CREDITANSTALT- 5.00 2.36 0.00 0.00UK

1996 FUIB 10.00 6.50 0.00 0.00

Total Pending Comnmitment: 15.00 8.86 0.00 0.00

Generated by the Operations Infonnation System (OIS) on 02/02/98

27

ANNEX 3

UKRAINE: FINANCIAL SECTOR ADJUSTMENT LOAN

Timetable of Key Processing Events

Identification May 30, 1996Preparation October 21, 1996, March 17, 1997Preappraisal June 30, 1997Appraisal November 26, 1997Negotiations February 11, 1998Board March 19, 1998

ANNEX 4

Page la of II

CABINET OF MINISTERS OF UKRAINEM Hrush evsky St., 12/2, Kyiv-008, Ukraine Tel.: (380 44) 293 5227, Fax: (380 44) 293 2093

24 February, 1998 No.27-504/9

Translation *fom Ukrainian

Paul SiegelbaumCountry Director for Ukraine and BelarusThe World Bank

Dear Mr. Siegelbaum,

Please find enclosed the Memorandum of the policies for enterprise development and theMemorandum of the financial sector strategy, which highlight our program ofprivatization, capital markets reform, accounting, bankruptcy, deregulation, bankingsector reform.

Provisions of the memoranda confirm the continuation of Ukrainian strategy for theconsolidation of a stable macroeconomic environment, as an important prerequisite of theeconomic reform program implementation.

We ask the World Bank to support our enterprise and financial sector reform programsthrough the allocation of the Second Enterprise Sector Adjustment Loan, in the amount ofUS $ 300 million and the Financial Sector Adjustment Loan, in the amount of US $ 300n-fillion.

Sincerely,

Vice Prime Minister of UkraineS. Tigipko

29a

24-FEB-98 16:13 FROM: KabminUKR ID: 0442933132 PAGE 2

ANNEX 4Page lb of II

KAEBHET MIHICTPIB CABINET OF MINISTERSYKPA3XHH OF UKRAINE

M. Hrushevsky St.. 12/2. Kiyv-008, Ukraine Tel.: (380 44) 293 5227, Fax: (3S0 44] 293 2091

- 24 ADtoro 19 98 M 27-504/9

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29b

ANNEX 4Page 2 of 11

Translatedfrom Ulkrainian

UKRAINE: FINANCIAL SECTOR ADJUSTMENT LOAN

Memorandum on Financial Sector Development Policy

Dear Mr. Wolfensohn,

1. Ukraine has established and sustained generally sound macroeconomic policies since 1994.The first agreement with the IMF was concluded in October 1994 and assisted the Cabinet ofMinisters (henceforth the Government) in reducing the fiscal deficit to an estimated 5.4 percent ofGDP by year end 1997 with a cash deficit of 5.8 percent of GDP in the same year. Thecomplementary World Bank Rehabilitation Loan helped to launch the programs of privatization andliberalization. The Government has persevered successfully with tight fiscal and monetaryprograms since then and is conunitted to doing so in future. These programs have resulted infurther reductions in the inflation rate to 16 percent in 1997. They have also created the conditionsnecessary for the successful introduction of th, national currency - the Hrivnya. Since itsintroduction in September 1996. the Hrivnva itself has showvn a reasonable degree of stability - inthe region of UAH 1.76 = US$ 1 1.89 (Dec. 1996), 1.868 (Sept. 1997), and 1.899 (Dec. 1997) andis gradually re-establishing the confidence in the local currency which was lost during the era ofhigh inflation prior to 1994.

2. Largely due to recent developments in international capital markets. bv the end of 1997 theprospects for external financing at reasonable terms had deteriorated significantly. Thesedevelopments aggravated the difficult macroeconomic situation in December. as a result of whichthe Government had to rely on additional National Bank of Ukraine (NBU) financing of stateexpenditures. Nevertheless, the end-December IMF targets on net domestic assets (NDA) and netinternational reserves (NIR) of the NBU are estimated to have been observed. Problems in globalfinancial markets, coupled with internal factors, also created pressures on the Hrivnya. In order tostrengthen the program of economic reforms. the Government has started to exercise better controlover expenditures. To allow more flexibility and to protect the level of reserves, the exchange rateband has been widened to UAH 1.8-2.25 per U.S. dollar. The NBU will conduct a tight monetarypolicy and use interest rate policy to support the band, and closely monitor developments inmonetary aggregates and inflation.

3. Ukraine's transition to a market economy has also seen a sustained effort to privatize themajority of the medium and larger enterprises in the economy, and to establish private ownership asthe dominant modality amongst smaller enterprises. Specifically, between January 1995 andFebruary 1998, a total of 7000 medium and large enterprises had transferred at least 70% of theirshares to private ownership, and more than 8,700 since privatization began in 1992. By the samedate more than 90% of formerly state controlled small enterprises had been privatized.

4. At the same time, and vith extensive help from the donor communitv, the NBU has madeconsiderable strides in establishing the basic institutional arrangements for regulating a modernmarket oriented banking system to support the rapidly expanding private sector. However, thestresses on banks associated with the dramatic drop in inflation, and on their client enterprisesassociated with privatization and economic recession, have revealed the fragility of many of the

30

ANNEX 4Page 3 of 11

banks' financial conditions and the potential systemic dangers which arise from this. Hence, as amain component of the next phase of economic reform. the Government and the NBU havecommitted themselves to a more intensive program of financial sector reform. This is designed toconsolidate the institutional steps already put in place during the last few years and to take furtherspecific actions to minimize the likelihood of a major financial crisis in the future. Thiscommitment was articulated clearly in President Kuchma's speech to the Verkhovna Rada onMarch 20, 1997 and again in a speech to the Cabinet of Ministers on July 22, 1997 as well as in thePresidential Decree of January 21, 1998 "On Introducing Austerity on Budget Expenditures andother Government Expenses, and Measures for Ensuring Receipt of Budget Revenues andPreventing a Financial Crisis". It is in this context that we request World Bank support through theFinancial Sector Adjustment Loan (FSAL) for a comprehensive program of reforms.

5. This reform program for the financial sector has a number of main elements. First, it willprovide a stronger legal framework for regulating and supporting banks and in particular, through acomprehensive Law on the NBU, will clarifv the independent role of the NBU as the responsibleauthority for this work. Second, it will put in place accounting and related reforms to ensure thatthe quality of the informnation generated. and reported by the banks is not only more transparent butalso compatible with generally accepted international standards. Third, it will improve the qualityof the regulation and supervision of the commercial banks. Finally, it will begin the task ofaddressing some of the deep-rooted structural problems of the sector including the existence in thesystem of several seriously distressed banks. the treatment of the overhang of bad loans from thepre-reform period, and the role of major specialized financial institutions, notably the OshchadnyiBank.

Part One: Improving the Legal Framework for Banking

6. Continued monetary stability, as the main underpinning of a stronger financial sector willinvolve continued vigilance by the NBU to prevent excessive money creation as well as anincreasing sophistication of the methods of monetary control which it employs. Greater stability inbanking will also call for more proactive and decisive NBU interventions in problem banks than hasbeen possible in the past. In the context of these two priorities, the Government and the NBUrecognize that it is essential to promulgate the new Law on the NBU, which confers adequateauthority on the NBU, and at the same time establishes legal arrangements which are compatiblewith good international practice, especially those in the European Union. Above all, it recognizesthat past practices whereby the Government attempted to interfere in the day-to day lending andother activities of the banking system are no longer acceptable and that the NBU Law needs to bedefined in such a way as to make this clear. To this end, as envisaged in the draft Law, theambiguity found in earlier drafts about the role and authority of the National Bank's Council wouldbe removed. In particular, the law would give the Council authority over a limited range of higherlevel decisions. and it qualifies the veto which the Council can utilize in relation to some decisionsof the NBU Board.

7. The draft Law also defines clearly the tight restrictions which now apply to NBU financingof the state budget at the behest of the Verkhovna Rada. Specifically, with the exception of somenecessary transitional arrangements, the Law also contains provisions that prohibit the NBU fromproviding direct credits to finance the expenditures of the state budget. This is in recognition of thefact that the monetization of budget deficits has been one of the major sources of inflationarypressures in the past, and now needs to be limited if low inflation is to be sustained.

31

ANNEX 4Page 4 of 11

8. Finally, the draft Law defines the basic authority of the NBU to intervene in problem banks(especially Article 68). It is the intention of the Government and the NBU to supplement theseprovisions with more detailed articles in the new Law on Banks and Banking Activity which is inthe final stages of preparation, and also with detailed NBU regulations. The Law on the NBU wasgiven its first reading in the Verkhovna Rada in October 1997 and is expected to be approved by theend of 1998. The new Law on Banks and Banking Activity will be submitted to the VerkhovnaRada by end 1998 and is expected to be approved by mid 1999.

Part Two: Making the Information Flows from the Commercial Banks More Reliable

9. The Government has recognized that the Gosbank accounting system made it impossible toassess the true financial situation of the NBU itself and the financial health of commercial banksmore generallv. This deficiency of the accounting framework has seriously undermined the work ofbank supervisors, as well as the ability of potential clients of banks to make informed decisions. Toaddress this deficiency, the NBU has continually implemented a program of development of a newbank accounting concept (chart of accounts and accounting directives) compatible withInternational Accounting Standards (IAS). In July 1997 a first version of the new chart of accountsfor banks and the NBU was prepared. After accounting directives and recommendations on taxreporting had been issued in the last half of 1997, banks could maintain their accounting records incompliance with IAS. IAS-based accounting was required of all commercial banks and the NBU byJanuary 1. 1998. wvhich was proof of the NBU commitment to accounting reform.

10. This work has been conducted with significant financial support of the IMF, EU-TACIS,the British Know-How Fund, USAID and the Central Bank of the Netherlands. For exarnple, EU-TACIS financed consultations on the NBU conversion to IAS, given by the NBU's internationalauditors Coopers & Lybrand. In the commercial banking sector 15 selected pilot banks (9 of whichare based in the regions) were given technical advise on accounting and reporting issues by expertsfrom Price Waterhouse (financed by EU-TACIS for 11 banks in Kyiv, L'viv, Odessa, Illichivsk,Symferopil, Kharkiv, Dnipropetrovsk, and Chernihiv) and IBTCI (financed by USAID for 4 Kyiv-based banks). Also, a coordinated training program for trainers and bank and private accountants inKyiv and the regions was launched.

11. The NBU is fully committed to further accounting reform implementation in 1998 and theinprovement of reporting and accounting procedures for commercial banks and the NBU.Instructions on accounting procedures and records will be issued by the end of the current yeartogether with the directives on the preparation of annual reports in compliance with IAS. Reportforms for commercial banks will be further improved in 1998. These activities will be supported byexperts from EU-TACIS, the British Know-How Fund, and the IMF in cooperation with the NBUthrough the EU-TACIS pilot bank project launched to meet the needs of the largest Ukrainianbanks. The NBU will verify, through routine on-site inspections of banks, that the IAS accountingconversion has been correctly implemented, and take appropriate enforcement action against anybank in non-compliance.

12. Loan loss provisioning in Ukraine started in 1996 in compliance with the Resolution of theNBU Board dated January 31. 1996 #20 "On Amendments to the Policy "On Formation Procedureand Size of Insurance Funds of Commercial Banks'"' However, this work was not systematic, andloan loss provisions formed by banks did not cover total impaired loans. The percentage ofimpaired loans was quite significant at that time and therefore the existing provision amounts wereinsufficient to cover potential losses in full. A new Law on Corporate Income Tax was passed on

32

ANNEX 4Page 5 of 11

July 1, 1997. Under this Law, commercial banks can make loan loss provisions from their expensesfor a transitional period: 40% of aggregate loans - by January 31. 1999, 30% - by January 31,2001; 20% - from January 1, 2002 onwards. To develop a consistent approach to loanclassification and provisipning in the banking system of Ukraine, the NBU passed a Resolution "Onthe Formation and Use of Reserve for Possible Loan Losses of Commercial Banks" # 323 datedSeptember 29, 1997. The NBU understands the importance of this issue for further stabilization ofthe banking system of Ukraine, and therefore, it is committed to the improvement of the existingregulations for commercial banks in this area. To this end, the NBU has further developed thepolicy "On the Formation and Use of Reserve against Possible Loan Losses of Commercial Banks"in order to adapt it to LAS. The range of operations to be covered by provisions has been increased,including bills of exchange, factoring, leasing, guarantees, and correspondent accounts. The NBUBanking Supervision Departnent monitors the formation and use of provisions by commercialbanks on the basis of prudential reports as well as on-site examinations of commercial banks. Apolicy on formation and use of provisions against possible losses from operations with accountsreceivable, securities. and investments by commercial banks is to be developed during 1998.

13. The new language of the Instruction #10 "Commercial Bank Prudential Regulations andAnalysis" was adopted by the NBU Board on December 30. 1997 (Resolution #469). It isconsistent with LAS and sets forth 21 prudential regulations that commercial banks must follow.Among these there are:

five capital regulations, all based on definitions which are in accordance with Bank ofInternational Settlements (BIS) norms as follows:

* minimum capital requirement (Hi);

* minimum authorized capital requirement (H2);

* solvency ratio (H3);

* capital adequacy ratio (H4);

* bank capital category (H5): all banks are subdivided into three categories; a bankis limited in the amount of any capital distribution depending on its assignedgroup; the procedure of capital distribution is set forth in banks' Letters ofIncorporation;

seven risk regulations:

* maximum exposure per single borrower (H9): borrowers that have the samefounders. shareholders, or partners with more than 35% of qualified interest aretreated as a single borrower for regulatory purposes: the benchmark for H9 is nomore than 25% of bank capital;

* maximum aggregate large credit exposure regulation (H10): the maximumbenchmark for H10 is eight times bank capital:

33

ANNEX 4Page 6 of 11

* maximum loans and guarantees per single insider (H 1I): the terrns for insiderloans shall not be different from general lending standards: maximum allowedunsecured loan to a single shareholder (partner) shall not exceed 50% of his/herequity investment in a bank's authorized capital; the maximum benchmark forHI I is 5% of bank capital,

* maximum loans -and guarantees to all insiders (H12): the benchmark for thisregulation is no more than 40% of bank capital;

* maximum outstanding interbank loans (H13): the benchmark for this regulationis no more than 200% of bank capital;

* refinancing ratio (H14): the benchmark for this regulation is no more than 300%of bank capital: and

* equity investment limitation (H15): this regulation limits equity investments incompanies and non-state debt to a maximum of no more than 50% of bank capital;

* three regulations of bank open FXposition, as follows

* general bank open FX position limitation (H16): It is calculated as a ratio ofbank's general open FX position to bank capital. The benchmark for thisregulation is no more than 40% of bank capital:

* long (short) open FX position limitation in each currency (H17): the benchmarkfor this regulation is no more than 20% of bank capital: and

* long (short) open FX position limitation in all precious metals (H18): thebenchmark for this regulation is no more than 10% of bank capital,

* three weighted FXposition regulations, where bank open FX positions in all currenciesare weighted bv a ratio depending on the remaining time to maturity, as follows:

X weighted open FX position (Hl9): the benchmark for this regulation is no morethan 50% of bank capital;

* long (short) weighted open FX position in convertible currency (H20): thebenchmark for this regulation is no more than 30% of bank capital; and

* long (short) weighted open FX position in non-convertible currency (H21): thebenchmark for this regulation is no more than 15% of bank capital.

The new version of Instruction # 10 has ceased the validity of old FX Operational Procedures, i.e.the prohibition for a bank to have an open FX position has been dismissed and uniform consistentregulations were adopted applicable to all currencies, including precious metals.

34

ANNEX 4Page 7 of II

Part Three: Improved Bank Supervision and Licensing

14. In 1995, the NBU started building the bank supervision infrastructure vhich was to be thebasis for the development of methods and procedures, organization, laws and regulations, trainingprogramns, and information systems to ensure efficient and timely bank supervision. Thedevelopment of bank supervision has made significant progress. However, its control over thestability of the banking system is still insufficient. Considering the need to improve and furtherdevelop bank supervision, the Board of the NBU approved a Resolution "On Stabilization andEnsuring the Safety of the Banking system in Ukraine and Improvement of Bank Supervision of theNBU" dated June 9, 1997, #180. The Resolution started the reorganization of the NBU's banksupervision function. Four new departments were established: Registration and Licensing, Off-SiteSupervision, On-Site Inspections, Problem Bank Resolution, as well as a Division of BankSupervision Coordination. This raised the status of the bank supervision function and improved thedecision-making process. To improve bank supervision methods, an Advisory Committee of BankSupervision and Regulation headed by the Vice-Governor of NBU responsible for bank supervisionwas established. Experts from bank supervision departments work in close cooperation vithtechnical advisors financed by USAID. EU-TACIS and other donors. The steps that have beentaken ensure that the NBU meets its goal of an integrated bank supervision system and decisionmaking process based on the results of all bank supervision departments and control over specificcommercial banks. The NBU Board has approved a strategy to further improve NBU bankingsupervision. The strategy sets priorities %%ith time frames and persons responsible for itsimplementation.

15. In relation to off-site inspection. in addition to the improvement in prudentialregulations already noted, the NBU has developed an early warning system. a Uniform BankPerfornance Report (UBPR) as well as quarterly reporting forms which summarize the inforrnationof the financial performance of all the commercial banks. This information is to be presented bothto the NBU Board and the concerned bank supervision department. As a result of the conversion toIAS, the off-site department has started to revise the UBPR and other reporting forms to complywith IAS. The UBPR includes current as well as time series, ratio and other information about eachbank as well as comparisons with comparable banks. The early warning system displays lists ofbanks showing unfavorable trends or falling below acceptable thresholds. Necessary staff trainingis being provided. The early waming reports will be reviewed regularly by the Vice-Govemorresponsible for banking supervision as a basis for redirecting the efforts of the off-site inspectorsand the enforcement teams as necessary. In addition, financial analysis was prepared to help scopethe on-site examinations of the three large former state banks, which began, with the Bank Ukrainaexamination, in May 1997.

16. As regards on-site inspections, the On-Site Inspection Guidelines were developed in 1996and approved by the December 30, 1996 Resolution of the Board of Governors of the NBU #344.These guidelines provide for inspecting banks on the basis of a CAMEL rating system. Throughout1997. the NBU implemented a program of regional training on the on-site inspection guidelinesbased on CAMEL ratings. These guidelines are mandatory for use by the bank supervisioninspectors during on-site examinations. Additionally, the NBU has prepared programs of prioritiesfor on-site examinations of banks for the next two years. These programs specify the scope ofexaminations to be undertaken, the degree of branch coverage which is required, and the contentsand level of detail expected in examination reports. At the present time, detailed work is focused onlarger banks and especially Prominvest Bank. Bank Ukraina, and Ukrsots Bank. The examinationof these banks. with inputs from foreign experts, was initiated, and in some cases completed,

35

ANNEX 4Page 8 of 11

between June and December 1997. The NBU is committed as part of this refonn program to havecompleted on-site inspections of banks accounting for 60 % of total bank assets by the end of 1998.

17. As regards bank licensing, the NBU since early 1996 has obtained full responsibility forthis function and has finalized the detailed criteria which banks need to meet to obtain and retainlicenses. A complex system of graduated licenses is in place and is used activeiy to restrict banksfrom activities where their competencies are in question. During 1996, the NBU put 45 of thecountry's 229 banks into various categories of restricted license, rehabilitation, closure, orliquidation. The Resolution of the Verkhovna Rada of February 1, 1996, #25/96-BP "OnImplementing the Law of Ukraine On Amendments to the Law of Ukraine On Banks and BankingActivity" established the following minimum levels of statutory bank capital:

ECU 100 thousand June 1, 1996ECU 250 thousand October 1, 1996ECU 500 thousand January 1, 1997ECU 750 thousand June 1. 1997ECU I million January 1, 1998

18. Commercial banks had to meet these requirements by the stated deadlines. The banks thatwere likelv to have problems meeting these requirements were notified by the NBU in advance.Subsequent to the deadlines the NBU will close. force the merger or revoke the licenses of banksthat do not meet these requirements. In accordance %Nith this requirement, on January 4, 1998 thelicenses of twvo banks that did not pay and register the required statutory capital were revoked. Inorder to bring the statutory capital of the Ukrainian commercial banks up to international standards,the NBU intends to continue its work aimed at raising banks' minimum statutory capitalrequirements. including for problem banks and the banks that will be unable to comply withincreased licensing requirements for the amount of their statutory capital. In addition, in October1997, the NBU submitted a proposal to the Verkhovna Rada to make amendments to the current"Law of Ukraine On Banks and Banking Activity" in the section concerned with giving the right toestablish minimum capital requirements for commercial banks to the NBU.

Part Four: Dealing with Problems in Particular Banks

19. The Government and the NBU are fully committed to work toward a strengthening of thecountry's banking system and an improvement in the system's capacity to serve the needs of thegrowing private sector, both domestic and foreign-owned.

20. Bank Restructuring - Establishing the Capacity. Bank supervision has adopted a systemof criteria for defining problems in the financial and credit activity of commercial banks whichincludes a listing of indicators based on a CAMEL rating system, which makes it possible to statethat there are problems and higher risks in the activity of certain commercial banks. Within thebank supervision function of the NBU, the Bank Resolution Department (BRD) has been set up. Itis made up of two units: the Financial Rehabilitation Unit and the Bank Liquidation Unit, and has astaff of 23 people.

21. The On-Site Inspections Department together with the BRD plan to take the followingmeasures:

36

ANNEX 4Page 9 of 11

* to conduct on-site examination of the problem banks that have not been examined formore than txwo vears by the end of 1998;

* to review banks not currently in the BRD, to determine which banks have problems intheir operations which might warrant transfer to the BRD; this will be done on thebasis of an off-site analysis by September 1998: thereafter the caseload of the BRDwill graduallv switch over fully to an on-site basis of referral.

* to conduct on-site examinations of the foregoing banks in order to make a decisionwhether they should or should not be transferred to the category of problem banks.

22. By September 1997, the Governor of the NBU has signed specially designed enforcementresolutions for three banks. These are seen as pilot operations to test the effectiveness of theprocedures of the BRD and increase the familiarity of the BRD staff with those procedures. ByFebruary 1998, the NBU had developed strategies and signed enforcement resolutions for another20 banks in the caseload of the BRD. Banks unable to achieve satisfactorv performance andcompliance with prudential regulations after a reasonable passage of time will be required toundergo deeper reorganization. or be liquidated. A detailed procedure manual on the liquidation ofbanks has been drafted and the NBU intends to formallv adopt and operationalize this manual byend 1998. The Law on the NBU and the new Law on Banks and Banking Activity will consolidatethe legal basis for these interventions.

23. The NBU has established a special working group to prepare an outline of a set ofcontingency measures to be applied to the largest banks which pose a systemic threat to the safetyof the banking system. The NBU is committed to designing detailed contingency arrangements todeal with difficulties in the largest banks. which will include at least four main elements: intensifiedon-site inspection designed to obtain all relevant facts about each bank's finances: restrictions onbank behavior which could cause an overflow of its problems to other parts of the sector: strongerNBU pressures on each bank to improve its management practices and governance; and explicitprograms to defend and revise the capitalization of each bank but vithout explicit capital injectionfrom state sources. These arrangements will be in place by end 1998.

24. The Oshchadnyi Bank. The Government as the sole owner of the Oshchadnyi Bank isconmmitted to clarifring the structure and role of that bank and heightening the security which thebank can offer to its millions of depositors. To this end, the Government has created a newSupervisory Council for the bank to be responsible for the oversight of the bank's management andfor any decisions affecting the future structure and role of the bank. This newv Supervisory Councilcame into existence in May 1997. In June 1997, the authorities signed the contract for the firstinternational audit of the bank. The audit results have established the true financial situation of thebank, and the Supervisory Council is now assessing altemative possibilities for the future directionand main product areas of the bank including the need, if anv, for the injection of new capital fromthe existing and/or newv private shareholders. In the interim. the NBU has restricted the commercialactivities of the bank in order to limit the risks to depositors. which might be caused by businessactivities not supported bv an adequate base of capital. In particular. the bank's license has beenrestricted to limit its lending to corporate clients, and its exposure to the interbank market is beingmonitored closelv. Bv end 1998 the first elements of the restructunrng of the bank will be put inplace, specifically the registration of the Oshchadnyi Bank as a joint stock company with 100% ofthe shares owned by the state. the strengthening of the credit function. including the establishment of

37

ANNEX 4Page 10 of 11

appropriate loan approval ceilings for the branches; the restructuring of the loan portfolio; and thefinalization of a detailed plan for the creation of a Treasury function. Additionally, by mid 1999 thefollowing elements of the restructuring of the bank will be put in place: the initiation of therationalization of the branch network as described in the concept paper on the strategic developmentof the Oshchadnyi Bank; the operationalization of the Treasury function: and the finalization of anIT strategy, a Product Development, and Marketing strategy and a Human Resource Developmentpolicy.

25. Former State Banks. In relation to the three large former state banks in the economy -Prominvest Bank, Bank Ukraina, and Ukrsots Bank - the Government and the NBU have initiated aprogram of measures to strengthen their financial health and to insulate them from further pressuresto lend for politicallnon-commercial reasons. This program includes. first, a clear set ofarrangements to address the position of these banks in regard to the properties they occupy. A swapof the state-owned properties they occupy for newly issued state equity stakes in the banks hasrecently been finished for two of the three banks; for the third bank this swap will be completed byend 1998. The Government is now committed to sell off these equity stakes by end 1998. Second,the Government has defined a program and schedule for the repavment of the banks' loansguaranteed by the state through the issuance of Treasury Bills of Exchange. For Government-directed loans that are not guaranteed. appropriate reserves against possible losses are to be formed.Third, the NBU will assess the perfornance of the bad-loan wvorkout units of these three banks andtake appropriate measures to improve their performance, as required- bv end 1998. Fourth, and asone main element in its strengthening of its bank supervision efforts, the NBU has programmed thefull on-site examinations of the three banks and has already completed two of these. In all threebanks, these reform efforts will be re-enforced by the ongoing technical assistance to management,which is being provided by Western experts to at least two of the three banks under Bank/EBRDguidance. The authorities are committed to supporting such technical support arrangements andextending their coverage to a larger number of banks. Finally, the Government has agreed to reducethe stock of debt outstanding on the books of these three banks which is guaranteed by theGovernment or any of its agencies to UAH 125 million by end 1998 and UAH 100 million by mid1999.

Part Five: Deposit Insurance

26. The Government and the NBU have practically completed the further technical worknecessary to establish a viable Deposit Insurance scheme, including calculations of the fundingneeded for viability as well as improvements in the draft Law on Deposit Insurance. By the end of1998, the revised Deposit Insurance Law will be submitted to the Verkhovna Rada. TheGovernment and the NBU expect the law to be adopted no later than bv the end of 1999. Thedeposit insurance scheme to be created will only be operationalized once the availability ofsufficient funding from the Government budget has been assured.

Part Six: Other Reforms

27. In addition to these identified and specific areas of structural reform, the Government isalso committed to other reforms designed to produce a stronger and more competitive bankingsector. Some of these will be pursued as possible prior actions for the Extended Fund Facility(EFF) arrangement, which the IMF and the Government are currently discussing. Furthermore, theGovernment and the NBU have recognized that the banking system is still relatively underdevelopedand could possibly benefit from accelerated foreign bank entry. To this effect, the Government has

38

ANNEX 4Page 11 of 11

allowed foreign banks to also transact business in Hrivnya since July 1997. The Government andthe NBU will assess the impact of foreign bank presence on the overall banking system'sperformance, and consider on the basis of this assessment. the appropriateness of increasing thecurrent limit of 15% of foreign owned capital as part of total banking system statutory capital.

28. In support of the financial sector reform program described in this letter, the Governmentof Ukraine is requesting a Financial Sector Adjustment Loan from the World Bank in an amount ofUS$300 nillion.

World Bank User.A\ANNEX4.doc02/13.98 9:28 AM

39

ANNEX 5Page I of 8

UKRAINE: FINANCLIL SECTOR ADJUSTMENT LOANPOLICY MATRIX

Policy Issues and Measures already taken Actions prior to Actions prior to Board Actions prior to Second Actions prior to ThirdObjectives 1 1 Appraisal/Negotiation Presentation tranche tranche

L STABLE MACROECONOMIC ENVIRONMENT

Establish and Policy measures, including Maintain a macro- Maintain a macro- economic Maintain a macro- economic Maintain a macro-maintain an interest rate policy, are in economic framework framework consistent with framework consistent with the economic frameworkappropriate compliance with IMF consistent with the the program as determined program as determined on the consistent with themacroeconomic Stand-By and program as determined on on the basis of indicators basis of indicators agreed upon program as determined onframework supported complementary Bank the basis of indicators agreed upon by the by the Government and the the basis of indicatorsby consistent trade, adjustment programs agreed upon by the Government and the BankIIMF and progress agreed upon by themonetary and Government and the Bank/IMF and progress achieved by Government in Government and thebudgetary policies. Bank/IMF and progress achieved by Government in carrying out the program. Bank/IMF and progress

achieved by Government carrying out the program. achieved by Governmentin carrying out the in carrying out the programprogram. _

Z.g Maintain liberal Interest rates are largely Maintain interest rates Maintain interest rates Maintain interest rates Maintain interest rates0 interest rate policy free and gencrally positivc largely free and generally largcly free and gcnerally largely free and generally largely free and

I positive positive positive generally positive

11. LEGAL FRAMEWORK FOR BANKING ACTIVITY

New Law on the The new NBU Law has First reading of draft Law Approval of NBU LawNBU to ensure its been redrafted in the lightreasonable of World Bank commentsindependence and has been submitted by

the NBU to the Parliament

ANNEX SPage 2 of 8

Policy Issues and Measures already taken Actions prior to Actions prior to Board Actions prior to Second Actions prior to ThirdObjectives Appraisal/Negotiation Presentation tranche tranche

New Law on Banks Submission to Parliament of Approval of new Law onand Banking Activity new Law on Banks and Banks and Banking

Banking Activity, which will Activity.include specific and detailedarrangement for all substantiveinterventions in bankspresently authorized by NBURegulation 115. Thesearrangements will include thedefinition of procedures andauthority for theconservatorship and theliquidation of banks.

IIL INFORMATIONAL AND REGULATORY BASIS OF SOUNDER BANKING

(a) LJSAccoundgngIntroduction of IAS Separate Controller's Unit Confirm detailed timetable

.I-- accounting by NBU established. Pilot IAS for steps to IAStransaction balance sheets conversion of NBU to becompleted for Central achieved by January I stOperations and other parts 1998, including theof the NIIU accountinig for complete conversion ol85 -90% of all its the pilots by end Julytransactions 1997 (condition for

negotiation).Commercial banks to Work program for IAS NBU Board to approve Small sub-set of lASreport to NBU in a reporting by commercial the new set of report consistent reporting formsformat consistent banks approved by NBU forms and issue the approved by NBU Board andwith International Board including April detailed instructions for mandated for use by JanuaryAccounting Standards 1997 deadline for reporting by the 1998.(IAS) completion of design of commercial banks for

new IAS repbrt forms. compliance as fromJanuary Ist 1998.

ANNEX SPage 3 of 8

Policy Issues and Measures already taken Actions prior to Actions prior to Board Actions prior to Second Actions prior to ThirdObjectives Appraisal/Negotiation Presentation tranche tranche

Introduction of IAS Separate Reports and NBU to give official Conversion was mandated asaccounting in Statistics Unit established approval of new CoA by of January 1, 1998.Commercial Banks. in NBU. June 15, 1997, and banks

to begin piloting the CoAand reporting forms inorder to achieveconversion by January 1,1998 (condition fornegotiation).

A) ImprovcArrangementforLoan LossProvisioning andtheir tax treatmentIntroduce Improved (i) NBU Regulation No. 20 (i) NBU Board to approve The NBU shall require The NBU shall haveArrangements of January 1996 the new version of banks to fully provision all required banks to fully

introduced loan Regulation 20 of 1996. loans classified as "loss" provision classifiedclassification and (Approval took place in without regard to tax loans in accordanceprovisioning procedures to September 1997) deductibility. with the timetable inbe followed by commercial Regulation 323, andbanks. A major revision of confirm this throughthis has been proposed by routine on-sitethe Bank and is now being inspections.finalized by the NBU staff.

(ii) An initial draft of (ii) Parliament to approveArticle 12 of the Corporate the Corporate Tax LawTax Law dealing with loan including an improvedloss provisions has been version of Article 12.amended in the light of (Approval took place inBank comments July 1997)

ANNEX 5Page 4 of 8

Policy Issues and Measures already taken Actions prior to Actions prior to Board Actions prior to Second Actions prior to ThirdObjectives Appraisal/Negotiation Presentation tranche tranche

(c) Reorganize andStrengthen BankSupervislon in NB]URe-organize the The Board of the NBU has Appoint a new senior NBU Board to approveDepartment endorsed the detailed manager at a level consolidated strategy for

proposals for re-organizing equivalent to Vice Bank Supervision.the department as the Governor; establish theInspectorate of Bank advisory team including aSupervision senior advisor to the Vice

Governor and Govemor;and finalize theconsolidated strategydocument for BankSupervision. Initiateprograms for on-siteinspection in three largebanks, and agreearrangements with SSMCfor supervision ofsecurities business ofbanks.

Improve off-sight Working group of NBU Uniform Bank Improvements in Regulationsurveillance of banks and Ukrainian Bankers Performance Reporting 10 will be approved(Prudential Association has completed System and the associated including addition of:Standards) new prudential regulations Early Warning System * five capital regulations

in response to must be operational and * seven risk regulationsBank recommendations be available to the * three regulations of bankand suggestions. These are Governor and senior staff open FX positionsembodied in the new of NBU. * three weighted FX positionRegulation No 10 of 1996. regulationsThe new regulationprovides improvedmeasurement of capital,and improved limits oninsider and connectedlending.

ANNEX 5Page 5 of 8

Policy Issues and Measures already taken Actions prior to Actions prior to Board Actions prior to Second Actions prior to ThirdObjectives Appraisal/Negotiation Presentation tranche tranche

Improve On-Site A detailed On-Site NBU to prepare prioritized On-site inspections in banksExamination of Examination Manual has program, specifying scope of accounting for 60% of totalBanks been completed and examinations, degree of bank assets will have been

training on the manual has branch coverage, and completed and reports will bebeen provided in all 26 contents and level of detail available.oblasts. expected in examination

reports, for on-site NBU will provide semi-annualcxaiiiiidatiolis of haniks lor reporting to the Bank onncxt two years. progress with the program.

IV. STRUCTURE OF THE SECTOR

(a) Strengthen NBU has finalized criteria By September 1997, the Develop the policy for All banks not meeting thepresent (including minimum NBU will require banks referral of such banks to higher minimum capitalarrangementsfor capital) which banks need failing statutory capital BRtI. Set up the criteria to requirements applicable fromlicensing new banks to meet to bc liccnsed. requirement in July to address thc problems of such January Ist 1998 will have hadand re-licensing N1 I has written to all conclude agreemcnts with baniks and develop thc licenses removed, andexisting banks banks which seem likely to NBU describing how they policy and procedures for liquidation procedures

fail to achieve new will achieve minimum liquidation of these banks. initiated.minimum capital capital.requirements by July 1997

ANNEX 5Page 6 of 8

Policy Issues and Measures already taken Actions prior to Actions prior to Board Actions prior to Second Actions prior to ThirdObjectives Appraisal/Negotiation Presentation trauche tranche

(b) Establish NBU has established and Develop and implement a Enforcement Resolutions Govemment to approve BRD to have initiatedenforcement capacity staffed a specialized Bank policy within BSD that signed for another 21 banks liquidation manual, initiate procedures for liquidationand procedures to Resolution Department provides criteria for the in BRD and decision to program of training relevant of at least half the totaladdress problem (BRD) to deal with proper referral of banks to liquidate remaining banks personnel, and initiate number of insolvent banksbanks problem banks, BRD taken. Timetable of liquidation procedures for no in BRD caseload.

liquidation of these banks less than three insolvent banks.Develop and implement a developed.mission statement thatderines BRI) dulies in Auciudminiciit to N1311rehabilitation and Regulation 115 to bettcrliquidation specilS NBUl aulhority to

liquidate and reorganizeNBU Governor to sign banks.first two EnforcementPrograms for the banksfrom the current caseloadof BRD with contentconsistent with modelagreement alreadyprovided to Bank. Priorto that, these two banks

Un will undergo onsiteexaminations to providethe basis foradministrative actions tobe placed on the banks.

NBU will facilitatetraining of BRRD personnelin the CAMEI, risk-basedinspection process and innecessary interaction withthe enforcement process.

Complete the staffing ofthe BRD (at least 19staff).

ANNEX 5Page 7 of 8

Policy Issues and Measures already taken Actions prior to Actions prior to Board Actions prior to Second Actions prior to ThirdObjectives Appraisal/Negotiation Presentation tranche tranche

(c) Assess capacity Detailed terms of reference An audit contract to be Supervisory Board to The following sub-components The following sub-and define role of the for a three stage program signed. approve outline of strategic in the Savings Bank components in theSavings Bank of audit, including plan. restructuring program will Savings Bank

diagnostic review have Decree to establish the have been implemented: restructuring program willbeen finalized and agreed Supervisory Council of the * registration of SB as joint have been implemented:with the Savings Bank and Savings Bank and define its stock company with * initiatethe Ministry of Finance. mandate to be approved. 100% state ownership rationalization ofThe govemment has * strengthening of credit branch networkappointed an authorized 15-20 page outline of main function * operationalizeperson to manage the components of strategic * restructuring of loan treasury functioncontractual arrangements restructuring plan to be portfolio * finalize informationfor the audit. presented to Bank. * finalization of detailed technology strategy,

plan for creation of product developmentPending the results of the treasury function. and marketingaudit, the N1i3J has stralegy, and humanrestricted the license of the resourcebank to prevent further development policy.exposure to corporatelending.

(d) Establish * NBU Board ResolutionIntervention establishing

0% Mechanisms to contingency plani:ingPrevent Systenic as NBU activity with itsSpil-overfrom own Working GroupIlliqulidity Problems and an agreed timetableIn Larger Banks for finalization of

detailed contingencyarrangements

* present Bank with briefpaper summarizingpresent NBUemergency procedures

* Commitment to recruitappropriate short termextemal advice

* establishment ofWorking Group oncontingency planning

ANNEX 5Page 8 of 8

Policy Issues and Measures already taken Actions prior to Actions prior to Board Actions prior to Second Actions prior to ThirdObjectives Appraisal/Negotiation Presentation treache tranche

(e) Speclfic I'hese banks have becn Commit to full scopc on Issuc lPresidential Dccrcc or The NBU shall review the Govcrnment will lakeInterventions in rated by the BRD on a site examinations in all CoM Resolution specifying performance of Work-Out appropriate measures toFormer State Banks basis consistent with that three banks. schedule of govemment- Units and initiate a loan reduce stock of

applied to all othcr large related debt repayments. recovery program. Govemmcntbanks. Provide the Bank with the guaranteed/directed loans

schedule and methods of Submit scheme for the Repayment of Government to UAH 100 million.repaying govemment- privatization of remaining directed loans on the balancesdirected loans and notify state shares in the three of three former state banks willthe Bank as to the banks. have been implemented (CoMtimetable and method to decree), and Govemment willreduce State equity in, and take appropriate measures tocontrol of, former state reduce stock of Governmentbanks. guaranteed/directed loans to

UAH 125 million.69) Deposit A Law on Deposit Complete further technical Finalize the revised Deposit The Parliarnent will haveInsurance: Establish Insurance has been drafted work for a viable Deposit Insurance Law, and submit to adopted the Law ona sound system of but this contains major Insurance scheme, including Parliament. Deposit Insurance andDeposit Insurance deficicncies. The NBU has calculations of funding authorities will implement

contracted external advice needed for viability and the deposit insurancefrom experienced improvements in draft Law. scheme called for in the

X__ practitioner(s) about the new Law. MoF will-4 design of a viable deposit ensure sufficient

insurance scheme. Government funding isavailable before scheme isoperationalized.

ANNEX 6Page I of 2

Ukraine at a glance 8/28W7

Europe & Lower-POVERTY and SOCIAL Central middle-

Ukraine Asia income Development dlamond^

Population mid-1996 (mil/ions) 51A 479 1,125GNPpercapita 1996 (US$) 1,180 2,180 1,750 Ufe expec ncyGNP 1996 (billtons US#) 60.7 1,043 1,967

Average annual growth, 1990-96

Population (%) -0.2 0.3 1.4 GNPLabor force () -0.2 0.5 1.8 p Irosrper primaryMost recent estimate (latest year available since 1989) capita enrollment

Poverty: headcount index (% ofpcp Liadon) 32Urban populaton (% of totaipopuatlon) 70 65 56Ufe expectancy at birth &esJ) 69 68 67Infant mortality (per 1,000 Yv births) 15 26 41 Access to safe waterChild malnutrition (% of chidw under 5)Access to safe water (% of populadton) 97 *- 78Illiteracy (% of populaion age SA+) 2 .. .. UkrneGross pfimary enrollment (% of school-age population) 87 97 104

Maie 87 97 105 Lower-nu/ddle-incomne groupFemale 87 97 101

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1975 1986 1996 1996

GOP (billions USS) .. .. 47.5 46.6 Economic raUosGross domestic investment/GOP .. .. 26.7 22.7 Openness of economyExports of goods and serviceslGOP .. .. 47.1 45.5Gross domestic savingstGOP ,. .. 23.5 20.5Gross natonal savingslGDP .. .. 22.9 20.4

Current account balance/GOP . . -3.2 -2.6Interest payments/GDP . . 1.4 1.2 Savings InvestmentTotal debt/GDP .. .. 17.3 19.6Total debt servicelexports .. .. 6.9 6.3Present value of debt/GDP ..Present value of debt/exports .. .. 47.9 Indebtedness

1975-85 1986-6 1996 1996 1997-05(average annual growth) - UkraineGOP .. -9.0 -12.2 -10.0 5.4 Loemddeic guGNP per capita 9 ° -11.5 -9.6 5.4 Lower-middle-income groupExports of goods and services .. .. 2.7 19.1 7.2

STRUCTURE of the ECONOMY1975 1986 1996 1996

(% of GOP) Growth rates of output and Investment t%)Agriculture ,, .. 15.0 13.0 lIndustry .. 50.3 46.2 -1,

Manufacturing .. .. Services .. . 34.7 40.8

.30. Private consumption . .. 55.1 57.8 JO

General govemment consumption ,. .. 21.1 21.7 OImports of goods and services ,, .. 50.2 47.9

197545 1986-96 1995 1996(average annual growth) Growth ratss of exports and Imports f,)Agriculture .. .. -4.6 -10.3 20Industry .. .. -15.7 -10.2 is

Manufacturing ..Services ,, ,. -6.4 -8.5 10

Private consumption .. ,. -0.1 -5.6 .General govemment consumption .. .. -3.5 -8.2 oGross domestic investment .. .. -33.7 -23.5 ai 92 93 94 Os 9BImports of goods and services .. .. I.S 17.4Gross Domestic Product .. -9.5 -12.1 -9.9 expors Omports

Note: 1996 data are preliminary estimates. Figures in italics are for years other than those specified.The diamonds show four key indicators in the country (in bold) compared vith its income-group average. If data are missing, the diamond villbe incomplete.

48

ANNEX 6Page 2 of 2

Ukraine

PRFiCES and GOVERNMENT FINANCE1975 1885 1995 1996

Domestfc prices Intlatton (%)(5 change) e,ooo -Consumer prices , 377 0 80.0implicit GOP deflator -0.5 -1.3 415.8 64.1 4o000 _

Govenment nnC 2000(% of GOP) o 'Current revenue 37.8 37.2 91 92 93 94 ss Current budget balance -5.0 -3.1 GOP dot O cpOverall surplus/deficit -4.9 -3.2

TRADE1975 1985 1995 1996 -_

(millons USS) Export and Import levels (mill. USS)Total exports (fob) 13,647 15,118 20X0

Commodity 1 -fefrous metals 4,484 4,847Commod7ty 2 - ores, sags, ashes 560 605 15.0

00t1Manufactures .

Total impors (cif) 15,945 19.376 10,000 °Food . .. 745 811Fuel and energy - 6 946 8,107 500 tCapital goods .. .. 3,281 4,891

Export prtce index (1995=100) 100 102 90 9a n3 94 9 0

Import price index (1995.100) .. .. 100 99 oExport m baimprs

Terns of trade (1995-100) 100 103

BALANCE of PAYMENTS19T5 198S 1995 1996

(millions USS) Currant account balance to GOP ratio (%)Exports of goods and services 16,436 19,935Imports of goods and services 17,643 21.067 0 1Resource balance -1,207 -.1132 4 r

Net income -50S -579 w !Net current transfers 200 512 LICurrent account balance, l _

before official capital transfers -1,515 -1,198

Financing items (net) 476 1,295 25Changes in net reserves 1,039 -97 *20

Memo:Reserves including gold (mil USS) ,. .. 1,069 2.087Conversion rate (loca.kUSS) 1111 1.83

EXTERNAL DEBT and RESOURCE FLOWS1975 1985 1996 1996

(mnillons USS) Composition of total debt, 1996 (mill. U$)

Total debt outstanding and disbursed S,219 9,122IBRD 491 859 G AIDA 0 0 2' 859

Total debt service 1,137 1,247 2144IBRO a 8 32IDA 0 0 C

2282Composition of net resource ftows

Ofricial grants 0 0Offtcial creditors 401 426Private creditors -220 -384 4 0Foreign direct investment 266 436 E 268Portfolio equity 517 350 33eo

World Bank programCommitments 146 1,260 A - IBRD E siareral |Disbursements 401 406 B- IDA 0- Other mulibateral F - PmeatePrincipal repayments 0 0 C.IMF G - Short-termNet lows 401 406 1 1

Interest payments 8 32Net transfers 393 374

Development Economics 8)28197

Note: Estimates for economies of the former Soviet Union are subject to more than the usual range of uncertainty.

49

ANNEX 7Page 1 of 4

DONOR ASSISTANCE IN FINANCIAL SECTOR DEVELOPMENTIN UKRAINE

A number of international and bilateral donors are supporting a rich progran of financial sectorassistance in Ukraine. The design of the assistance programs has been characterized by closecooperation between the donors in order to ensure that complementary programs are being put inplace, and that the advice being offered to the GoU on these issues is broadly consistent. A briefdescription of their programs, including financing levels, can be found below.

1. USAID

USAID has put in place an extensive prograrn of assistance in bank supervision that began in mid1995. The scope of work includes developing the capacity of on-site examinations, off-sitesupervision (early warning system) and problem bank resolution, and assisting in the developmentof a sound plan for deposit insurance. This work is undertaken through several long term advisorsthat are resident in the Bank Supervision Department of the National Bank of Ukraine. USAID'sprogram in accounting reform in Ukraine includes assistance in converting 40 Ukrainian banks toIAS, including classroom training and hands on assistance in the IAS conversion.

Additional advice has been offered in the area of Economic Research and Policy, which involvesdeveloping the analytical capacity of economists and their ability to advise policy makers.Technical and policy advice in the development of the Governmental securities market has alsobeen offered, including provision of computer hardware and softnare for the registration ofGovernment securities as well as the development of an over the counter securities trading system.USAID has and will continue to work with the NBU Legal Department in the development ofbanking laws and regulations.

Other areas of assistance include the development of the electronic funds payment system, and thesupporting infrastructure and computer equipment; the development of a centralized collateralregistry for bank loans, support to the National Center for the Training of Bank Personnel; and thesupport of FSVC programs.

UsAid is committed to a long term assistance programn in Ukraine stretching to at least the next 2-3years.

2. EU-Tacis

EU-Tacis has offered extensive assistance in the financial sector. The program includes assistancewith accounting reform, and the conversion of commercial banks to international accountingstandards (IAS); support for the development of custodian services for the stock market; support indeveloping regulations on the disclosure of financial and business information; technical assistancein institution building in a number of Ukrainian banks; and financing of the first phase of technicalassistance and a credit advisor to Bank Ukraina.

Substantial assistance is being offered to to assist the NBU in improving its skills in bankliquidation, and an extensive programn of pilot bank liquidations is scheduled to begin in mid 1998.

50

ANNEX 7Page 2 of 4

Seminars on relevant financial sector issues for the NBU and commercial banks are also part ofEU's ongoing assistance.

Future projects may include assistance to the Savings Bank for conversion to IAS; and training forthe four largest banks in Ukraine. A total of 3.5-4 million ECU are commnitted each year tofinancial sector assistance in Ukraine.

3. BKHF

The British Know How Fund's assistance includes supporting small business development inUkraine by training and other small business support services; assisting the Ukraine InterbankCurrency Exchange; placing technical advisors in Ukrainian commercial banks, particularly toassist with the handling of the EBRD SME line of credit; providing advice, through a long termresident advisor, to the Head of the Securities Commission, providing a short term advisor to theState Property Fund, and; organizing training courses for the NBU. BKHF also contributes to thebank accounting reform program in Ukraine. focusing on the development of the IAS basedreporting fonnats.

4. FSVC

The Financial Services Volunteer Corps' assistance has included training and assistance to theNBU in improving bank licensing procedures: training NBU staff in the development of softwarewhich supports the Uniformn Bank Performance Report (UBPR) for off-site supervision; providingtraining to members of the deposit insurance vorking group on the fundamentals of a depositinsurance system, taking international and regional examples into account; and providingassistance in the re-drafting of Ukrainian laws; providing written commentarv on the legalmechanisms and procedures the NBU may develop in its efforts to implement decisive legislationthat will enable it to recover funds from foreign correspondent accounts of comnmnercial banks thatfile for bankruptcy in Ukraine, and; delivering practical training in fundamental inspection skillsand western approaches to on-site bank examinations to a core group of NBU bank examiners.

5. HIID

HJD's assistance includes preparing a Work Out Manual for troubled Ukrainian banks, and;organizing a cycle of seminars, in conjunction with the Association of Ukrainian Banks.

6. German Government

The German Government's assistance program includes support for the establishment of apromotion agency for foreign investments, the establishment of a Germnan-Ukrainian loan fund forSMEs; business promotion, assistance. and training in the regions through long and short ternadvisors, and short term training in the commercial and banking sectors, including the training oftrainers at professional schools. In addition. the German Government has funded assistance to theSavings Bank in the development of a strategic restructuring plan.

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ANNEX 7Page 3 of 4

7. Netherlands Goverment

The Dutch Government has funded a twinning arrangement for Bank Ukraina as well as assistanceto four private banks in helping them meet criteria for the EBRD SME credit line. There may alsobe funds available to support a twinning arrangement for the Savings Bank.

8. Japanese Government

A Japanese grant has funded a twinning arrangement between JEXIM and the Ukrainian EXIMBank.

9. Soros Foundation

The Soros Foundation has been providing assistance to the Bank Supervision Department of theNBU with drafting a law on Deposit Insurance. Additionally, the Foundation's experts haveprovided comments to the Government and the NBU on a variety of banking legislation as well asstrategic reform in the banking sector.

10. EBRD

The EBRD has been providing an SME credit line to 10-12 newly created private commercialbanks in Ukraine (wNith assistance from the Netherlands, German, Luxembourg and FrenchGovernments. and the BKHF, KfW, EU-Tacis). In addition to strategic planning, creditmanagement. and credit advisors, technical assistance for institutional development has beenprovided in the context of their project implementation unit in the NBU. A Trade FacilitationFacilitv has also been set up.

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ANNEX 7Page 4 of 4

Ei iDonor Program Funding Duration ofWorkProgram

US-AID Bank Supervision US S 4 million 4/95 to presentAccounting UlS S 1.7 million 6/97-Accounting Training US S 250.000Economic US S 0.75 11/94-presentResearch and Policy millionGovt'l Securities tuS S 1.3 millionLegal Infiastructure US S 350.000 9/95 to present

Electronic Funds Payment US S 2 million '95 to presentLicensing/FX: FSVC US 5900,000 5/95 to present

Subtotal for US-AID: US S 15,250,000

EU-TackAounting refonn: Conunercial Banks 2 nillion ECU 6/97-6198IAS implementation support 1.5 million ECU I/98-1/99 (approx)Development ofcustodians 1.5 million ECU 9/97-3/99Disclosure regulation 2 million ECU 10/97-3/99Privat Bank .065 million ECU 10196-9197Bank Utkraina .070 million ECt' 2/97-9/97Bank Liquidation Work 1.5 million ECU 9/97-present

Subtotal for Tacb ECU .6 mIllion

BKHF Small Business Support 9/95-presentJICE, 9/96-9/97

Commercial Bank Assistance, 7/95-5/96Securities Commission Assistance. SPF.Banking Courses for NBU 1/97-1l98

10/96-6/971/96-5/98

Subtotal for BKHF 2.5 mnillon pounds

FSVC Development of off-site supervision software, presentdeposit insurance training, funds recovery.practical training for bank supervisors, banklicensing

Subtotal for FSVC No financal data available

HIID Work Out Manual ulS S 50,000Seminars for troubled banks US S 30.000

Subtotal for HUD US S S0,000

Genman Governunet Agency for foreign investments, German-Ulkainian SME loan fund, businesspromotion and assistance, traiing

Subtal for Ger 11A7 mIlNom DMGov't

Netherlands Twining arTangements and TA to banksGovernment

Subtotal for Dutcb 3,640,000 NLWGev't

Japanese Goverunent Twining with Exim BankSubtotal for Japanese US S2.5 mIllIon

GOv't

Soros Foundation Expert advice, deposit insurance, bank No fbancial data available 1994-presentlegislation

EBRD SME Credit Lines ECU 1.2 millionTechnical Assistance ECUl 1.8 millionTrade Facilitation ECt' 125.000

Subtotal for EBRD ECU 3.7 milUon

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ANNEX 8

UKRAINEFINANCIAL SECTOR ADJUSTMENT LOAN

External Financing(USS millions at current prices)

EstimaWed Projedcon1997 1998 1999. 2000

Sources 2,596 3,454 3,502 3,549Disbursement 1,278 1,309 2,913 . 2,919IMF 235 354 0 0Other medium- and long term 739 912 2,513 2,419

of which IBRJD 306 824 594 584Net short-term 304 43 400 500

Direct foreign investment 434 550 589 630Debt relief 884 1,595 0 0

uses 2,596 3,454 3,502 3,549Non-interest current account deficit 1,082 895 878 528Debt service due 1,346 2,467 2,262 2,245

of which IBRD 87 135 176 239Repayments (including IMF) 794 1,813 1,526 1,390Interest payments 551 654 735 855

Increase in gross reserves 176 0 236 835Other capital flows -7 92 126 -60

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