Kazakhstan’s Banking Sector: Status and Outlook
Nikolai Andriyanov, Analyst of Financial Institutions and Stock Markets, TuranAlem Securities*
* The opinion of the author may be different from that of TuranAlem Financial Group
The banking sector is now in a position to exert strong influence on the overall economic development of Kazakhstan. In 2004, loans to the private sector exceeded 22% of GDP. Bearing in mind that loans to raw material industries were negligible (less than 12% of the total), the importance of lending to alternative industries of the economy can hardly be overestimated. In conjunction, the economy has become exposed to certain risks that are directly associated with the impact of lending on domestic prices, and partly with the expansion of the banking system and its external position.
Reserves in the Kazakhstani banking system are now kept at a level that might seem reasonable, especially in light of the low and slowly increasing private sector lending. At early stages, the reserves did not match the pace at which credit portfolios were being boosted, an imbalance that seriously affected the overall system liquidity. However, since 2002, the reserves of second-tier banks increased from 1.72% to 2.23%, so that an adequate liquidity level was restored mainly by increasing external liabilities (see Graph 1). It should be noted that Kazakhstan is a leader in the CIS in terms of lending.
Despite the general increase in loans to the private sector compared with call deposits, Kazakhstani banks failed to create a sustainable deposit base. We believe that the increase in deposits was largely due to foreign borrowing, whereas the volatility of the indexes can be explained by rapid changes in call deposits (minus Euroloan cash flows). In addition, the expansion of funding was too slow to meet the domestic demand for loans, which is illustrated by a somewhat lower ratio of loans to D(0), i.e. call deposits, achieved in 2004 (Graph 2).
Monetisation was increasing faster than the ratio of private sector loans to call deposits, which signals a faster increase of monetary mass outside the banking system. The risk of price rise remains high. On the one hand, the swiftly growing supply of money outside the system spurs inflation in the short-term. On the other hand, the excess liquidity accumulated by banks is likely to cause the same effect in the medium-term, as released liquidity will dramatically increase the money supply. These two factors might also work at the same time.
The external position of the Kazakhstani banking system is second in the CIS in terms of net borrowing. The system’s aggregate long-term debt increased by 3.5 times since 2002, totalling US$7.27 billion in late 2004. The index of the deposit base saturation (ratio of quasi-money to M0, i.e. cash money in circulation) evidences that the risk associated with refinancing long-term liabilities is increasing, which in turn might lead to the insolvency crisis, for example, in the event of country rating deterioration (see Graph 3).
Prudential restrictions add much pressure on the increase of lending, and at the same time prevent the decrease of capitalisation of the banking system. The Agency for Regulation and Supervision of the Financial Market and Financial Organisations and the National Bank oppose the lowering of capitalisation levels because absorbing losses on loans by a structurally weak economy often results in a total crash of its financial system. At the same time, placement of instruments on the domestic market will be difficult because the demand for equity instruments in Kazakhstan remains low. The option of depository receipts is not welcomed by regulating bodies, since the new act on corporate management, which is now under consideration, envisages full disclosure of the share ownership structure. This seems to be a major concern, given the current format of depository receipt emissions in which requirements on disclosure of owners lists are very loose.
The need to increase capital was partly caused by the introduction of stricter requirements for general and special provisions, which in turn resulted in an increase in risk assets.
At present, discussions are held on whether banks should cover the risks of their affiliates with their own capital. The controversy is caused essentially by the different interpretations of the concept of "financial viability of an affiliate" and the quality of its risk management system from the point of view of the parent company and regulating authorities. The latter have no system for assessing affiliates in financial groups, which would allow assessment to be made solely depending on the management quality of the affiliates themselves. The current financial control policy tends to disregard this aspect and tie the entire risk pool to the parent company’s capital, which materially restricts its core business and leads to an imbalanced distribution of risks inside a financial group.
The fiscal limitations imposed to regulate external borrowing include an additional tax burden that is triggered if a leverage ratio exceeds 7. There is no need to comment on this policy, as it is obvious that the rigid demand for foreign capital renders any such indirect fiscal measures inefficient.
Any future toughening of prudential requirements for credit risk provisions might result in higher prices of bank products available to the population. This is essentially an emergency measure that should only be adopted in the event of material deterioration of the loan portfolio quality in order to restrict lending and increase the "free" liquidity of the banking system.
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