10 May 2019

Banking fragility rooted in justice failures

Evidence from Ukraine

Maria Repko

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This paper investigates the links between the rule of law and sustainable economic growth, focusing on a specific aspect – namely how corruption and lack of the rule of law affect the functioning of the banking sector. It draws on the experience of Ukraine amid the crises in the banking sector (which is most of the financial sector). The burst of a bubble in the banking sector after the 2008–09 crisis was never followed by a robust recovery, and the 2014–15 crisis[1] deepened the problem. It highlighted serious dysfunctions in the justice system, with issues of corruption and political interference. Much of the banking system’s fragility and poor credit utilisation could be explained by a lack of the rule of law on different levels. When the losses materialised, flaws in the rule of law impeded a response and resulted in a massive burden falling on the state and on the economy at large. At the same time, reforms to the rule of law and the financial sector are going along separate tracks – being implemented by different teams that contact each other randomly at best. If these efforts are combined, a strong synergistic effect might be achieved.

This paper recommends a cross-sectoral policy angle for EU–Ukraine cooperation towards financial and justice sector reforms. It suggests six steps that might be taken at the crossroads:

  1. launch a special forensic bureau for financial crime;
  2. create a database for insolvency and financial fraud cases to support court expertise;
  3. streamline insolvency law and regulations;
  4. empower the independent regulator;
  5. improve the know your client and anti-money laundering procedures of EU banks internally; and
  6. support reform of the state-owned banks.

[1] During 2014–15, after a civil uprising, part of the country was annexed by neighbouring Russia (the Crimean Peninsula) and armed conflict began in the industrial eastern regions, fuelled by Russian command, arms and manpower. Coupled with the fiscal and banking crisis, this led to an economic downturn. The country lost ~16% of GDP and the local currency (hryvnia, UAH) depreciated by ~68%.

This paper has been prepared as part of the ENGAGE II Fellowship Programme, with support by the Open Society Initiative for Europe (OSIFE). The Fellowship Programme involves academic, civil society and think tank actors from Central and Eastern Europe, the Western Balkans and Eastern Partnership countries. It engages selected fellows in EU-level policy debates on the rule of law in domains such as rights and security, foreign and economic affairs. The programme entails training, study visits, public events and the publication of policy papers. See the penultimate page for more details about the ENGAGE II Fellowship. The programme is coordinated by the CEPS Justice and Home Affairs Unit and includes several CEPS senior research fellows. This publication has been written under the supervision of Cinzia Alcidi, Head of the Economic Policy Unit.

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