BANKING SECTOR: TRENDS AND INFLUENCE FACTORS
According to Azamat Muhametzhanov, Director of Strategic Planning and Marketing Department at Bank CenterCredit, each bank has its own diversification strategy corresponding to its development strategy and risk management system. As a result, it is difficult to speak about the diversification of the banking sector in general. -Situation on the financial markets remains tense. What do you think is the reason for the worsening quality of loan portfolios besides the overall economic slowdown? A. Muhametzhanov: - Over the last two years we have witnessed fierce competition in the Kazakh banking sector, which led to a more liberal evaluation standard for borrowers and credit products. Any liberalized regime can have more negative consequences in stressful conditions, as we are seeing now, when compared to a more conservative regime. Additionally, lower property prices, especially in big cities, exacerbated the quality of loan portfolios. Deputy General Director of KzRating Denis Rybalkin thinks that while refinancing was the main issue at the end of last yearbeginning of this year, now the main issue is the quality of assets of Kazakh banks.
-What can you say about the level of development of risk management systems in the Kazakh banking sector? D. Rybalkin - Despite the current negative trends in the banking sector and interconnectedness with the global capital markets, Kazakh banks are far from being in pre-bankruptcy conditions. Today the situation in the banking sector remains manageable and can adapt to the corrective actions of the Kazakh regulating authorities. I must say that introducing elements of risk management in the banking sector has brought positive results. Without these efforts or making them at a later stage, the banking sector could have been in a significantly more difficult position.
- Do you think the Kazakh banking sector will encounter problems with paying off external debt in the long term? What will be the driving force in the development in the banking sector? D. Rybalkin The first half of 2008 brought a number of new considerations that have started dominating the Kazakh banking sector significantly. The main recent financial trends were: -sharp slowdown of banking system growth; -significant worsening of asset quality; -decline in banks’ profits. The Kazakh banking system is certainly experiencing a slowdown in its growth rates. After a long period of fast growth due to international loans, the growth rate has slowed from 25.9% in the first half of 2007 to 4.2% in the first half of 2008. For example, in the first half of the year out of the top ten largest banks, four experienced negative balances, while last year only two banks had a decline in total asset volume over the same period. Kazcommerce and Alliance Bank have demonstrated negative growth in 2008.
It is evident that in the conditions of a global liquidity crisis Kazakh banks cannot attract relatively cheap foreign funds. The top five banks (apart from Narodny bank) have drawn a large amount of loans and some analysts think they may have difficulties paying back their external debt. Nevertheless even in these difficult unstable conditions on the financial markets, the largest banks have means to refinance their debts, make their payments on time and maintain adequate liquidity. The total volume of external debt remains high. Since the domestic market has limited liquidity, refinancing of
external debt is likely to remain the only possibility for large banks to cover big funding gaps and pay off their external debts. Resources drawn from the domestic market are often used to pay off external debt, which limits the pool of available resources for banking growth. It seems that without external financing (which will be available only once the situation stabilizes on the global financial markets) high growth in the banking system is unlikely. While refinancing was the main issue at the end of last yearbeginning of this year, now the main issue is the quality of assets of Kazakh banks.
Formed provisions directly affect banks’ net profits. As the quality of assets is decreasing, this factor is playing a more important role in affecting banks’ earnings as well the banking system in general. The recent earning of Kazakh banks demonstrate downward trends. Compared to a similar period last year, banks’ total net earnings in the first six months of this year declined by 41%. In our opinion, the main reason for declining profits is a deficit in liquidity and higher cost of resources.
-What actions can banks take to overcome any challenges while paying off their loans? A. Muhametzhanov: - Borrowers who have problems with paying off their loans can be divided in two groups: the first one includes those with temporary credit problems due to reduced earnings but who in the long run are able to pay off loans. Banks should have a constructive dialogue with such clients, and the majority of banks have been doing this already. The second group includes borrowers who have no prospect of paying off their debt. It is necessary to restructure loan payments for the first group, considering their possibilities. With the second group, drawing on the loan collateral often remains the only option.
Table 1. Changes in assets of Kazakh banks (mn tenge)* Bank Name 01.01.2007 01.07.2007 01.01.2008 BTA Bank 1 824 994 2 536 384 2 648 603 Kazcommercebank 2 269 194 2 775 853 2 714 259 Narodny bank of 977 040 1 261 194 1 567 245 Kazakhstan Alliance Bank 924 834 1 357 009 1 192 070 ATF Bank 1 047 197 952 615 989 598 Bank Centercredit 570 952 808 626 880 898 Temirbank 199 404 321 070 325 928 Caspian Bank 196 351 212 490 257 422 Eurasian Bank 151 637 173 896 183 797 Nurbank 205 521 190 083 204 040 Total Banking 8 874 640 11 173 755 11 684 628 system Share of top ten in 94.3% 94.8% 93.8% total assets * Data of Kazakh Agency for market regulation and supervision; calculated by KzRating. 01.07.2008 2 939 690 2 603 225 1 700 086 1 089 623 1 046 741 900 466 311 919 255 080 231 649 224 368 12 173 497 92.8%
FOREIGN INVESTORS MOTIVES ARE STRICTLY INDIVIDUAL
-What affects banks’ profitability most? A. Muhametzhanov: - First of all, it is the slower growth in banks’ loan portfolios which leads to lower interest earnings. Various countries’ banking sectors have different earnings structures, but for domestic commercial banks, interest makes up half of the earnings. The worsening quality of loan portfolios led to higher volume of formed provisions, compared to pre-crisis indicators. There has also been a marked decline in non-interest earnings.
- Loan qualities are declining today and the majority of overdue loans are in the construction industry. What actions can banks take to soften the problem of paying off loans? D. Rybalkin -First, banks can work with portfolios of bad debts and secondly, they should re-examine their lending practices. There is a problem in the construction industry and government can play the main anti-crisis role in solving it. Even the largest banks cannot pull the whole industry out of this crisis. However, banks do take upon themselves the risks of worsening loan qualities as commercial institutions and they do have to solve these problems on their own, including with the help of their earnings.
Table 2. Changes in assets’ growth* Bank Name 1 half of 2007 2 half of 2007 1 half of 2008 BTA Bank 139.0% 104.4% 111.0% Kazcommercebank 122.3% 97.8% 95.9% Narodny bank of 129.1% 124.3% 108.5% Kazakhstan Alliance Bank 146.7% 87.8% 91.4% ATF Bank 91.0% 103.9% 105.8% Bank Centercredit 141.6% 108.9% 102.2% Temirbank 161.0% 101.5% 95.7% Caspian Bank 108.2% 121.1% 99.1% Eurasian Bank 114.7% 105.7% 126.0% Nurbank 92.5% 107.3% 110.0% Total Banking system 125.9% 104.6% 104.2% * Data of Kazakh Agency for market regulation and supervision; calculated by KzRating. -What is the adequate deposit interest rate in present circumstances? What are the negative consequences for second-tier banks in case of higher deposit rates? A. Muhametzhanov: The optimal deposit rate should be, first of all, competitive, considering the importance of both retail and corporate deposits. Additionally, the deposit rate should correspond to the minimum required asset earnings and take into consideration average market rate. In sum, for banks to receive a one percent margin on retail interest transactions, the deposit rate should be 3-4% lower than the average loan rate, since banks have to pay for insurance with the Kazakh deposit insurance fund, as well as the cost of attracting funds, etc.
- Do banks need to create new strategies for working with clients and which of them look the most promising? What is the optimal diversification scenario for the banking industry at the moment? A. Muhametzhanov: The main client strategies are well developed abroad, so they can study the best international market practices and adapt them working with clients. One of the possible directions of developing client relations could be structural financing; recommendations and participation in clients’ asset management; and wider application of distance services programmes. - The fact that foreign investors are buying stock in Kazakh banks raises the questions: what motivates foreign investors? Do they put their trust in the Kazakh banking sector or are they trying to acquire financial assets at relatively cheap prices? A. Muhametzhanov: Basically all significant stock purchases in Kazakh banks took place prior to this crisis. So, it is not completely accurate to claim that foreign investors are using the current circumstances to buy financial assets at a cheap price. As an example, the recent purchase by Kookmin Bank of Bank Centercredit’s stock shows that even in current circumstances investors offer an adequate share premium. As for the motives of foreign investors, every M&A deal should be evaluated separately, as each deal has its own distinct characteristics. As for optimal diversification programmes, each bank has its own diversification strategy corresponding to its development strategy and risk management system. As a result, it is difficult to speak about the diversification of the banking sector in general. However, it is clear that one should have a balanced borrowing structure (external/ domestic), optimal investment of funds into various industries and markets (corporate, interbank, retail financing). In light of the current recession, it is also necessary to examine and improve banks’ methods of dealing with the consequences of a crisis, such as strict risk management, attention to portfolio concentration by industry, minimizing banks’ dependency on external funding, etc.
- What percent of assets of second-tier banks are of poor quality? What is the reason for the worsening quality of loan portfolios in your view? D. Rybalkin -The share of bad assets increased in the banking industry 2.6 times (up to 2% of total assets), while the share of substandard assets and conditional liabilities declined slightly compared to the second half of last year (from 47.6% to 44.4%). The main reason for worsening portfolio qualities is the credit boom which took place in Kazakhstan before the global financial crisis. Many banks lowered their lending standards due to fast turnaround of funds and the need to invest funds drawn from abroad. The banks have to pay now for their excessive liberalism. As the total volume of loans kept growing, it was difficult to evaluate the quality of banking assets accurately, since the newly issued loans negated problems of existing loans. When lending slowed, loan portfolios began to suffer in quality. According to official data, Kazakh banks’ assets are still manageable, and so KzRating has not changed the ratings of any of the rated banks so far (so far KzRating has rated 6 out of the top 10 banks, and is in the process of evaluating 3 more banks). However, many big corporate loans are not comparable in quality, since some banks may overestimate the
creditworthiness of borrowers who are affiliated with the bank.
DATA ON KAZAKH BANKS’ EARNINGS SHOWS A DECLINE IN NET PROFITS
- There is an opinion that expansion of foreign financial groups during times of lower competitiveness of national institutions will result in a situation where the former will dominate the domestic banking sector. What do you think about it? A. Muhametzhanov: The client will win regardless of the scenario. Suppose the majority of Kazakh banks belong to international financial institutions. This will lead to lower loan rates, faster client servicing and a bigger variety of credit products. It is difficult to predict whether the situation will be similar to markets in Eastern Europe and Ukraine, where over 70% of the banking sector is foreign-owned. It will depend on the future plans of the current Kazakh shareholders, whether they plan to sell stock or attract a strategic investor, depending on the economic benefits of transactions. In light of Kazakhstan’s entry to the WTO, the conditions of foreign capital entering the domestic market will be more transparent. - Just recently the Russian media reported that the Kazakh banking system is much more progressive, compared to Russia. How do assets of Kazakh banks compare to Russian banks’ assets today? D. Rybalkin The quality is comparable overall. However, one should remember that despite a number of similar traits Russian and Kazakh banking systems have been developing under different circumstances. Regarding the “progressive” character of Kazakh banking, it is true but is also quickly changing. Russian banking has been developing very fast, from the regulatory point of view, as well as new market products. At the same time Kazakh regulation has been developing as well. One of the recent changes is the requirement to increase charter capital to 5bn tenge. In our opinion, this should produce a stabilizing effect on the banking industry. In Russia higher capital requirements are planned only for 2010-2012, while its neighbouring markets will have less strict requirements.
-There are examples of interbank support in the international system. Are there any banking organizations in Kazakhstan that can help establish relations? Are interbank loans and support available? A. Muhametzhanov: There is an Association of Financiers of Kazakhstan, an organization whose main goal is to represent the interests of its members and second-tier banks. Informational support and international cooperation important. are also other meetings for commercial banks to talk to each other, exchange experience and provide support.
The Association participates in the discussion of all new banking regulation. There are also roundtables and
As for interbank loans, partnership relations funds at one bank or they exist as well. established among banks another and banks’ limits. However, the activity on but also on financial interbank loan markets considerations of placing depends not only on -The government has provided $4bn of taxpayer’s money to support banks. Banks are private organizations which should pay with their assets for their own imprudent actions. What is your opinion about supporting private institutions with public funds? What measures should banks take to improve their risk management? A. Muhametzhanov: One should remember that the government funds issued to stabilize socialeconomic development have been directed to small and medium enterprises, financing construction and investment projects. So, this programme supports the subjects of the economy, not banks alone, which have to pay for this support and repay the funds later. The state acts as the credit guarantor and the money has to be paid back according to lending agreements. The question of risk management is not related to the previous question. Banks have to improve risk management systems to ensure their long term stability. Besides, there are a number of international risk management practices already developed and which any bank would have to adopt to be in compliance with international standards. Regulators requirements play an important role in risk management. Banks have a regulation from FMA N359 “About requirements for secondtier banks’ risk management systems and their internal controls” according to which banks are developing methods to adopt Basel II.
Table 3. Changes in some indicators of asset quality and conditional liabilities* Subprime assets and conditional liabilities Bad assets and Provisions conditional liabilities 07.07 01.08 07.08 07.07 01.08 07.08 07.07 01.08 07.08 BTA Bank 47.4 65.9 59.9 0.3 0.5 1.4 3.3 4.6 5.4 Cazcommercebank 68.9 68.6 64.6 1.0 2.0 3.2 5.7 7.8 10.7 Narodny Bank of 48.3 53.1 51.6 1.1 1.4 1.8 3.9 4.6 5.3 Kazakhstan Alliance Bank 28.5 35.4 33.5 0.6 1.0 1.7 3.3 3.7 5.3 ATF Bank 9.2 12.5 10.5 1.0 0.8 2.7 2.1 2.4 3.9 Bank Centercredit 42.1 42.6 42.5 0.2 0.7 1.3 2.7 3.4 4.5 Temirbank 12.3 5.3 6.7 1.6 2.2 2.5 2.6 3.1 3.5 Caspian Bank 19.3 16.0 14.4 2.8 2.7 2.7 4.2 4.8 5.3 Eurasian Bank 21.3 19.0 9.4 0.9 1.1 1.2 2.3 2.5 2.4 Nurbank 18.4 12.8 23.0 1.7 1.8 3.1 3.8 3.9 7.2 Total Banking 42.0 47.6 44.4 0.8 1.2 2.0 3.6 4.7 6.0 System Data from Kazakh Agency for market regulation and supervision; calculated by KzRating.
- The fact that foreign investors are buying stock in Kazakh banks raises the questions: what motivates foreign investors? Do they put their trust in the Kazakh banking sector or are they trying to acquire financial assets at relatively cheap prices? D. Rybalkin In the current circumstances asset prices are rather attractive for buyers. the banking However, Kazakhstan in general is an attractive country for investors. Besides, system is
rather international; for example, in Eastern Europe a number of large international banking corporations and conglomerates play the leading role. The growing influence of international capital on domestic markets is possible in the future and it will have a positive role in lowering systemic risks. Compared to a similar period last year, banks’ total net earnings dropped 41%.