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* Tycoon opposed 2016 nationalization of his bank
* Court ruling is blow to government
* Finance ministry says it will appeal ruling
* Central bank: nationalization can't be reversed
* President warns Ukraine risks default
* Dollar bonds fall after decision (Adds security council meeting, cenbank quote, Zelenskiy reaction)
KIEV, April 18 (Reuters) - Ukrainian tycoon Ihor Kolomoisky won a major victory on Thursday in his battle with the government over the nationalization of the country's largest bank after a court ruled the change of ownership was illegal.
The ruling is a major setback for the government, which wrested PrivatBank from Kolomoisky, a co-founder of the bank, in December 2016.
PrivatBank was nationalized as part of a clean-up of the banking system backed by the International Monetary Fund, which supports Ukraine with a $3.9 billion loan program.
Ukraine's dollar-denominated bonds fell more than 1 percent after the ruling by a Kiev court as President Petro Poroshenko said in a televised address that overturning nationalization threatened "default and a new economic crisis."
He has previously said that any backsliding on PrivatBank would spark a "deep crisis in relations with the IMF."
The central bank said it was impossible to reverse the nationalization and it would appeal against the ruling.
Speaking at a specially-convened meeting of Poroshenko's security council, Central Bank Governor Yakiv Smoliy warned reversing the nationalization risked a return to economic instability, higher inflation and currency volatility.
After taking over the bank the government had said it wanted to recover money it says was siphoned out while Kolomoisky owned it. It has shored up the lender with billions of dollars since it was nationalized.
Kolomoisky denies any wrongdoing and says the bank was forcibly nationalized without proper justification.
"That means I won. I won the lawsuit," Kolomoisky said after Reuters told him the news of the court's decision, which was announced while Reuters was conducting a phone interview with him. "Well, excellent," he added.
Kiev's Western backers in a coordinated statement said they were "closely monitoring" the situation and that it was important for the authorities to continue efforts to recover losses from former owners and related parties of failed banks.
The fate of PrivatBank has loomed over Ukraine's ongoing presidential election campaign.
Kolomoisky has publicly supported the candidacy of Volodymyr Zelenskiy, the frontrunner to beat Poroshenko, the incumbent, at an election run-off this Sunday. Zelenskiy has repeatedly denied that he would seek to hand PrivatBank back to Kolomoisky if elected.
Thursday's ruling could boost Kolomoisky's chances of winning compensation or retrieving the bank.
The finance ministry also said it would appeal the ruling. Kolomoisky suggested that instead the central bank should admit defeat and "submit a confession about how they did everything unlawfully."
"I don't call it a nationalization, I call it an expropriation because people receive compensation after a nationalization. They don't receive anything after an expropriation. And we didn't receive anything. So I want a legal assessment," he added.
BLOW TO IMAGE
The authorities have spent nearly $6 billion since the nationalization to plug a hole in PrivatBank's balance sheet, caused by what the government says were fraudulent lending practices and money laundering.
Kolomoisky disputes that assessment of the bank's health when it was nationalized. The case led to hundreds of lawsuits and the authorities see it as a test of their fight against corruption.
"We are doing everything possible to prevent panic," said Smoliy. "Such decisions could destroy all the stability that has been achieved in previous years."
Earlier, Deputy Central Bank Governor Kateryna Rozhkova told a briefing she saw no grounds for PrivatBank's former owners to be compensated.
"Our international partners do not accept this decision and do not understand the arguments of the court," she said, adding that she expected the current central bank's leadership to stay in place after the election.
Lawsuits challenging the nationalization of PrivatBank "deal irreversible damage to Ukraine's international image," the central bank said in a separate written statement.
Zelenskiy, a 41-year-old comedian with no prior political experience, has had to fend off accusations from Poroshenko that he is a puppet of Kolomoisky, whose TV channel airs Zelenskiy's shows. Zelenskiy insists his relationship with Kolomoisky is strictly professional.
"All this just underscores that the biggest risk of the Zelenskiy presidency is the relationship with former oligarch Kolomoisky and the unresolved issue of PrivatBank," said Timothy Ash of BlueBay Asset Management after Thursday's court ruling.
"Indeed, whether or not he gets the bank back, he is still being pursued for the losses which the state had to cover in the bank resulting from the nationalization."
Zelenskiy on Thursday said that as president he would do everything to ensure PrivatBank remained stable and repeated he would not try to hand PrivatBank back to Kolomoisky.
Asked on a TV show whether he would try to give $2 billion in compensation to Kolomoisky, Zelenskiy said: "I do not have 2 billion to give to someone." (Reporting by Polina Ivanova, Natalia Zinets and Pavel Polityuk; writing by Matthias Williams; Editing by Susan Fenton/Andrew Osborn)