Institutional structure of the Ukrainian banking sector is facing major weaknesses. The close supervision and auditing of banks are needed to avoid a possible financial crisis during its transition to the market economy. The existing general mistrust in the formal financial sector is also another issue that the country currently faces. This report discusses the major constraints in financial intermediation in Ukraine and recommends a number of policy actions that may help the country to strengthen the financial intermediary role of its banks. Currently the banking sector of Ukraine is highly concentrated. Due to the lack of competition, banks operate inefficiently with high costs and high profit margins that caused large spreads between deposit and loan interest rates. The findings of this report suggest that the banking sector in Ukraine is not responding to the market forces by adjust the prices in the financial markets. Despite the low liquidity in the banking sector, banks did not increase deposit rates to attract the household savings. Similar to other transitional countries, Ukraine has been given a substantial amount of credit by international assistance agencies to finance private sector investment. These loans provided liquidity to the domestic banking sector and increased the availability of long term credits for investment. It is important to note that the excessive capital inflows may affect the domestic financial prices and the functioning of the domestic markets adversely.
