By Natalia Zinets and Pavel Polityuk
KIEV (Reuters) - Ukraine took over its largest bank on Monday in a move backed by Kiev's international donors to protect the country's financial system and accompanied by an appeal from President Petro Poroshenko for calm and assurances to depositors.
In one of the biggest shake-ups of the war-torn country's banking system since Ukraine plunged into economic and political turmoil more than two years ago, the central bank said PrivatBank had not fulfilled its recapitalization program.
Risky lending practices had left a capital shortfall of around $5.65 billion on PrivatBank's balance sheet as of Dec. 1, while 97 percent of its corporate loans had gone to companies linked to its shareholders, it said in a statement.
PrivatBank is the jewel in the crown of the business empire of Ihor Kolomoisky, a powerful tycoon who was locked in a protracted tussle with Poroshenko last year.
Rescuing it -- which the finance minister said would require a minimum of $4.5 billion from the budget -- could help unlock more aid from the International Monetary Fund next year but could also threaten more instability. Opposition parties have repeatedly called for snap elections to unseat the pro-Western leadership that took power after the 2014 Maidan protests.
They have harnessed the anger of depositors of banks previously shut down in a sweeping clean-up of the financial system, demanding the central bank chief's resignation.
Poroshenko urged the bank's more than 20 million clients to "stay calm" and said that he had submitted a draft amendment to parliament aimed at giving additional protection to depositors.
The leader of the opposition Radical Party Oleh Lyashko blamed PrivatBank's problems on the central bank, saying "Ukrainians have to pay from their pockets for these mistakes."
Another opposition lawmaker called it the "greatest robbery of Ukraine's state budget of the millennium".
"We are sure that moving the bank into state ownership is the only possible way to save the money of the bank's clients and to save the financial system," the central bank said.
Under Western-backed banking reforms, Ukraine is meant to shut lenders that cannot meet capitalization targets, but PrivatBank is considered too big to fail.
The announcement comes just days before parliament has to vote on next year's budget, which must stick to a shortfall of 3 percent of economic output, as agreed with Ukraine's international backers.
"The adoption of the budget will be the indicator. If the budget is approved this week without problems it means the situation is under control of the president and government," political analyst Volodymyr Fesenko said.
PrivatBank's chairman denied that such a high proportion of loans had gone to companies connected to its owners and told a press conference that Kolomoisky's top priority was to meet the bank's obligations to depositors.
Ukraine's dollar-denominated bonds jumped by more than 1 cent, while the hryvnia weakened to its lowest level since mid-September before recovering.
"It seemed quite clear ... that the government had to do something, so this probably comes as a relief, especially if we see positive comments from the IMF," said Simon Quijano-Evans, Emerging Markets Strategist, Legal & General Investment Management.
"Markets will be focused on how much capital is required from the state and how much can be obtained from the original owners in order to reduce the fiscal burden."
The central bank said Ukraine was ready to support PrivatBank with liquidity, adding that it did not see the nationalization as significantly impacting the currency market or inflation levels. The deputy governor said the banking system was behaving normally.
The state will issue new bonds worth 43 billion hryvnia ($1.6 billion) as part of the recapitalization, which will also count the holders of PrivatBank's eurobonds in a bail-in.
PrivatBank's Jan. 23 2018 dollar-denominated eurobond <XS054374453=TE> is currently bid at 30 cents in the dollar and offered at 47.5 cents, according to Tradeweb data. The bond closed at 65 cents in the dollar on Friday.
Its Feb. 9 2021 dollar-denominated eurobond <XS131434596=TE>, which is subordinated debt, is bid at 2 cents in the dollar and offered at 9.4 cents, according to Tradeweb data. It closed at 57 cents in the dollar on Friday.
PrivatBank's former shareholders had agreed to restructure loans paid to insiders by July 1 next year, the central bank said, while the finance minister said the bank would be sold once it was back on its feet.
"Unfortunately, the problems faced by the Bank, which have been accumulated over many years, have recently deteriorated," the central bank said. "These problems were mainly caused by an imprudent lending policy pursued by the Bank, which led to capital losses."
Recapitalizing PrivatBank and other large lenders and reducing their lending to shareholders was one of the tasks mandated by a $17.5 billion International Monetary Fund aid-for-reforms program.
The IMF praised Monday's move as an important step to safeguard Ukraine's financial stability, adding that it would continue to support the country.
Kolomoisky's control of strategic industries, including energy and media holdings, has put him at the center of ongoing power battles among the political elite since street protests ousted Moscow-backed Viktor Yanukovich and the pro-Russian rebellion erupted in the east.
"A systemic bank of this magnitude could not be allowed to fail," said Francis Malige, the EBRD's managing director for Eastern Europe and the Caucasus, in a statement.
The EBRD said it was the "right way forward" for Ukraine and later told Reuters that it could take a stake in PrivatBank if the recapitalization and clean-up go well.
(Additional reporting by Alexei Kalmykov in Kiev, Karin Strohecker, Claire Milhench and Marc Jones in London; writing by Matthias Williams; editing by Alexander Smith and Susan Fenton)