Financial Sector Market Research
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Technical Assistance Consultant’s Report Project Number: TA – 4565 (UZB) Financial Sector Infrastructure Development Draft Final Report May 31, 2007 Uzbekistan: Financial Sector Development Strategy This consultant’s report does not necessarily reflect the views of ADB or the Government concerned, and ADB and the Government cannot be held liable for its contents. FINAL REPORT MAY 31, 2007 CURRENCY EQUIVALENTS (as of December 31, 2005) $1.00 = 1180 Uzbek sums ABBREVIATIONS ADB – Asian Development Bank CIS – Commonwealth of Independent States CBU – Central Bank of Uzbekistan CCCSM Centre for Coordination and Control of the Securities Market NBU – National Bank of Uzbekistan SISB – State Insurance Supervisory Board TRSE – Tashkent Republican Stock Exchange USAID – United States Agency for International Development VAT – Value Added Tax WOCCU – World Council of Credit Unions NOTE In this report, "$" refers to US dollars. CONTENTS Page Financial Sector Development Strategy............................................................................ 1 A. Financial Sector Structure and Development ............................................ 2 The Banking System ................................................................................. 3 Insurance................................................................................................... 5 Pensions.................................................................................................... 6 Leasing ...................................................................................................... 6 Capital Markets.......................................................................................... 7 Credit Unions............................................................................................. 8 Microfinance Organizations ....................................................................... 9 B. Regulation and Supervision....................................................................... 9 The Banking System ............................................................................... 10 Insurance................................................................................................. 10 Leasing .................................................................................................... 11 Capital Markets........................................................................................ 11 Microfinance and Credit Unions .............................................................. 12 C. Policy Issues............................................................................................ 12 Demand for Credit ................................................................................... 12 Financial Sector Issues for Private Sector Development ........................ 14 Banking.................................................................................................... 14 Insurance................................................................................................. 15 Pensions.................................................................................................. 16 Leasing .................................................................................................... 16 Capital Markets........................................................................................ 16 Microfinance and Credit Unions .............................................................. 17 D. Key Elements of a Financial Sector Strategy .......................................... 18 Reduce Direct Government Interventions ............................................... 18 Establish a Foundation of Sound Regulation and Supervision................ 18 Banking Sector Reform ........................................................................... 18 Non-Bank Reform.................................................................................... 19 Appendix 1. Banks in Uzbekistan.................................................................................... 20 Appendix 2. Large Banks ................................................................................................ 21 Appendix 3. Funding Sources and Interest Rates........................................................... 22 Appendix 4. Credit Unions .............................................................................................. 23 Appendix 5. NGO- Sponsored Microfinance Organizations............................................ 24 FINAL REPORT MAY 31, 2007 Preface This report has been prepared by A. Michael Andrews (International Banking Sector and Microfinance Specialist) for the Asian Development Bank (ADB). It draws on the work completed by all the consultants engaged under ADB’s technical assistance project TA 4565-UZB, Financial Sector Infrastructure Development, including Alfred C. Dostie (Team Leader and International Banking System Specialist), Mario Lamberte (International Financial Market Specialist), John Wetherhold (International Insurance Sector Specialist), Fozil Dodiev (Microfinance Sector Specialist), Vladlen Kim (Banking Sector Specialist), Hondamir Mamatkulov (Banking Sector Specialist), Orifjan Namozov (Financial Market Specialist), and Zafar Vokhidov (Insurance Sector Specialist). The author gratefully acknowledges their contribution, and is especially indebted to Fozil Dodiev, Ravshan Rashidov, and Irina Tchen of the Centre for Social and Economic Research. Mr. Jurgen Conrad, Senior Financial Economist in the Governance, Finance and Trade Division, Central and West Asia Department of the Asian Development Bank, supervised the implementation of the technical assistance, provided helpful guidance and comments throughout, and participated in some of the field research. The conclusions, and any errors and omissions, are solely the responsibility of the author. . FINAL REPORT MAY 31, 2007 FINANCIAL SECTOR DEVELOPMENT STRATEGY • A strategy for financial sector development in Uzbekistan needs to be integrated with measures to support private sector development more broadly. With over 80 percent of the shares of all joint-stock companies owned directly or indirectly by Government, over the short- and medium-term the bulk of demand for private sector credit will come from 2.8 million individual entrepreneurs, 253,300 micro enterprises and 15,300 small enterprises. • Mobilization of savings has been constrained by many of the same issues that have restricted private sector development. In the same way that diverse decrees and privatization measures have not been part of an overall strategy or vision for private sector development,1 Government policy with respect to the financial sector contains a number of conflicting elements. • Significant progress has been made with establishing a legal framework for many aspects of a modern financial system. However the full effectiveness of policy measures is frequently lost because of inconsistent or incomplete implementation, and frequent changes in policy direction. • Without consistent application and interpretation of laws and regulations, other measures to increase savings intermediation and the use of financial products will have only limited success as public confidence and the willingness of the private sector and development partners to invest in the financial sector will remain low. • While the nature and quality of supervision varies from sector to sector, there is an overarching need for further evolution towards a risk-based prudential approach. • The banking sector is by far the largest component of the financial system. Therefore, banking reforms offer the potential for the largest and most immediate benefits. Increasing banking sector intermediation would directly support private sector development, which in turn would reinforce further financial sector development. • Direct government interventions through specialized institutions, subsidized financing programs, and tax incentives have tended to perpetuate the role of the banking sector as a conduit for planned financing rather than performing true intermediation between savers and borrowers. • The policy lending function of the state-owned banks still dominates the structure and performance of the banking system. As a first step, policy lending should be separated from commercial banking, freeing the commercial banks to focus exclusively on savings intermediation on market terms and conditions. • A concurrent package of policy measures should focus on removing the obstacles to growth in private sector intermediation posed by the many non-banking functions currently performed by commercial banks. 1 For a comprehensive analysis of private sector development see: Asian Development Bank, 2005. Private Sector Assessment for Uzbekistan. Manila. 2 • The focus on banking reform should be complemented by continuing efforts to establish conditions conducive to the development of non-bank providers of financial services. • For the insurance sector measures are required to address deficiencies in the legal framework, including civil code provisions on contracting, and the lack of capacity both in companies and the supervisory authority. • Capital market development requires an appropriately independent supervisory authority supported by capacity building within this authority and the industry (stock exchanges and professional market participants). Development of institutional investors such as insurance companies and pension funds will over time foster capital market development. • Progress with privatization is required to increase the size of the private sector and thus the supply of corporate securities—equities (shares) and debt (bonds). Enhancements in corporate accounting, disclosure, and governance are required to reduce the risk associated with and increase the attractiveness of investing in Uzbek companies. • For credit unions and leasing companies, which already have a generally appropriate legal and regulatory framework in place, the key will be continued progress with Government’s efforts to reduce the regulatory burden on business more generally, which will benefit both the providers of financial services and their customers. • The legal framework for specialized microfinance organizations currently being introduced could provide a sound basis for development if the implementing regulations and supervisory regime are suitably supportive. A. Financial Sector Structure and Development 1. The gradual pace of financial sector reform in Uzbekistan has resulted in a significantly different course of development than in many other countries in the Commonwealth of Independent States (CIS). During the 1990s, reforms in Uzbekistan focused on establishing the core legal and regulatory framework for banking and building supervisory capacity in the Central Bank of Uzbekistan (CBU) rather than liberalization and privatization. This helped to avoid the boom and bust in the banking sector experienced in other CIS countries. However, another consequence of the gradual approach to financial sector reform is that the Uzbek financial sector continues to have very high levels of government ownership. 2. The basic elements of a market-based financial sector are now in place in Uzbekistan, but private sector intermediation has yet to assume an important role. Institutions owned directly or indirectly by government account for the majority of the financial system. Banks dominate the financial system. Banks wholly or majority owned by the state account for two-thirds of financial sector assets. Leasing and insurance, which are the only other segments with sizeable assets, are also dominated by state- owned companies (Table 1). Other financial services providers remain small in both number and size. Shares (equity) of 117 companies were listed on the Tashkent Republican Stock Exchange (TRSE) at end-December 2005. Most listed companies are privatized state-owned enterprises. Secondary market trading is thin. Corporate debt (bonds) has also been issued, but volumes are small and maturity periods are usually less than one year. There were about 50 corporate bond issues between 1999 and 3 2005. Bonds outstanding amounted to approximately 36 billion sums ($32 million) at end-2005. Table 1. Uzbekistan financial sector, end-2005. Number Assets Assets (sum billion) (percent of GDP) Commercial banks 28 5,657 37.2 Wholly or majority state-owneda 5 3,764 24.7 Joint stock with minority state ownershipb 7 1,436 9.4 Private joint-stock 12 268 1.8 Banks with foreign capital 4 189 1.2 Credit unions 22 7 0.0 Microfinance organizations 14 6 0.0 Insurance companies 25 214c 1.4 Of which, Uzbekinvest (state-owned) 1 148c 1.0 Leasing companies 12 77d 0.5 Of which, Uzquishloqmash (state-owned) 1 70d 0.5 Collective investment funds 18 4 0.0 Private pension plans 1 n.a. n.a. a. NBU, Asaka, Khalk Bank, Microcredit Bank, Aloqabank. b. Pahkta, Uzpromstroy, Ipoteka, Gallabank, Ipak Yuli, Savodar, Turon. c. Estimate. d. Estimate for end-2004. Memo: GDP 15,210 billion sums at end-2005. Sources: Central Bank of Uzbekistan, Credit Unions Association of Uzbekistan, Microfinance Association of Uzbekistan, Centre for Social and Economic Research, bank financial statements. The Banking Sector 3. The banking sector in Uzbekistan is highly concentrated and segmented. It has evolved away from the Soviet system of specialized banks. The joint-stock banks with minority state ownership that emerged through initial rounds of privatization and the remaining state-owned banks have a legacy of serving particular sectors or functions (Appendices I and 2). However, all Uzbek banks have universal licenses and thus officially serve all economic sectors. 4. The investment activities of the banking system have not kept pace with growth in the economy. Assets and loans have declined sharply as a percent of GDP (Figure 1). This indicates that the strong economic growth recently experienced in Uzbekistan is occurring in spite of rather than because of the contribution of the financial sector. This prompts a crucial question: Why is the Uzbek banking system not growing and not providing more financial intermediation to foster even faster economic development? 5. A major reason for the current under-development of the financial sector is the effect of policy measures that conflict with the objectives of encouraging use of the financial sector, coupled with frequent changes in and inconsistent application of various regulatory requirements. The Uzbek banking system performs very significant tax collection functions and also serves as a fiscal agent of government. The role as fiscal agent is in some ways a carry-over from the Soviet banking system, with Uzbek banks being responsible for not only the allocation of resources under various Government programs, but also being required to directly intervene in the financial management of enterprises to ensure funds are used as intended. The resulting tendency to view the banking system as agent of Government rather than an intermediary is compounded by 4 lingering distrust of banks originating in the loss of monetary value of deposits through high inflation in the 1990s and from restrictions on cash transactions. 6. Most of the government Figure 1. Size of the banking system. controlled banks are rather $US billions anomalous for banking institutions 6.0 as their total loans exceed total Assets 5.0 deposits, reflecting that they 4.0 mobilize far fewer savings than Loans their size would suggest. State- 3.0 owned National Bank of Uzbekistan 2.0 Deposits (NBU) accounts for almost 60 1.0 percent of total bank loans, but only 0.0 about one-third of total bank 2001 2002 2003 2004 2005 deposits. Two other banks are Percent of GDP wholly owned by government and 70 two joint stock banks are majority Assets 60 state-owned. The government- 50 owned banks collectively account 40 Loans for two-thirds of banking sector 30 assets, but function more as 20 Deposits conduits for various government 10 financing programs than as true 0 2001 2002 2003 2004 2005 intermediaries. Seven banks with Source: Central Bank of Uzbekistan. government minority shareholdings collectively account for a further 26 percent of banking system assets. 7. The 12 banks with wholly private domestic ownership and four banks with foreign shareholders have only a small share of the market. However, unlike the state-owned banks, the private and foreign banks have deposits that exceed their volume of loans, indicating that these institutions function more like conventional banks, mobilizing savings to finance their investments. Thus, the private and foreign banks collectively have only about 4 percent of total loan volume, but almost 14 percent of total bank deposits. 8. Uzbekistan remains in the lower range of CIS countries by most measures of financial deepening. Numerous policy initiatives to support the development of the financial system, including implementation of an efficient electronic payment system to promote use of the banks for the majority of transactions, and introduction of deposit insurance in an effort to build confidence in the banking system, have had only a minimal effect on financial sector development. As a result, most banks continue to serve more as direct implementing agencies for government policies than as true intermediaries. This is evidenced by the low levels of deposit mobilization in Uzbekistan (Figure 2). 9. Efforts to directly control the supply of financial services are another distinct feature of the banking sector in Uzbekistan. There is a wide range of lending programs at preferential interest rates (Appendix 3), and the establishment in 2006 of Microcredit Bank continues the legacy of establishing specialized banks focusing on government priority sectors. Although successful in some respects, the provision of subsidized lending programs to meet policy objectives has significant downsides, primarily in reducing incentives for provision of products and services on commercial terms, discouraging deposit mobilization and in embedding otherwise avoidable risks in the 5 banking system. 10. A further downside is the creation of opportunities for rent- Figure 2. Bank deposits in selected CIS countries. seeking. Those not among the (percent of GDP) eligible borrowers attempt to obtain 25 subsidized credit, and those Russia 20 obtaining it may opt to use it for Kazakhstan other than the intended purpose. 15 Uzbekistan This leads to further restrictions 10 and policing efforts on the part of 5 Azerbaijan government and the banks, with Kyrgyz Republic 0 effectiveness always open to 2000 2001 2002 2003 2004 2005 question because of people’s Sources: Centre for Social and Economic Research, National Bank of Azerbaijan. endless inventiveness. Regardless of the effectiveness of efforts to ensure only qualified borrowers receive the funds, and that they are used for their intended purposes, the policing efforts devoted to subsidized lending programs are a substantial cost to both the banks and borrowers. 2 Insurance 11. There were 23 non-life and two life insurance companies in Uzbekistan at end- 2005. With total market size equivalent to $38 million in gross premiums in 2005, the market penetration ratio is one of the lowest in the world: The premium to GDP ratio was less than 0.3 percent. Knowledge of insurance products and their use remains at a low level. The market consists almost exclusively of general (property and casualty) insurance. Virtually no life insurance is sold by domestic companies. However, a successful marketing agency, Safe-Invest, sells life insurance products of foreign companies directly to Uzbek residents. More attractive interest rates provided by banks on individual term deposits coupled with uncertainty over claims paying ability make life insurance products offered by domestic carriers unattractive for individual customers. Another constraint to insurance sector development (and contractual savings in general) is a lack of long-term investment instruments. 12. Industry concentration is very high with the five largest insurance companies accounting for over eighty percent of premiums. State companies no longer enjoy special treatment or separate tax holidays. As a result, the share of premiums earned by the three biggest state-owned companies has fallen from over 90 percent in 2001 to about 40 percent in 2005. However, state-owned Uzbekinvest is still by far the largest insurance company. Together with other state-owned companies, Uzbekinvest dominates the compulsory insurance market. Most other insurance companies are small, with 15 having less than the equivalent of $500,000 capital. 13. The industry earns very large underwriting profits (the difference between premiums earned and claims paid) with the loss ratio (claims paid to premiums earned) never exceeding 25 percent, and in the remarkably low range of 10-15 percent over the last three years. In large part this is attributable to ambiguity of wording in contracts, lack of knowledge among the insured, limited ability to pursue legal disputes, and lengthy claims procedures established by insurers. 2 This section and the following section draws on the work of the insurance sector specialists under the TA. 6 14. This highly unbalanced relationship between the insured and the companies is favorable for industry profitability, but undermines any potential for development of a functional and efficient insurance market. The experience with compulsory third party liability auto insurance illustrates the problems. Only 500 claims were filed in 2002 with respect to 10,000 recorded road accidents. The insured tend to avoid making accident reports and make settlements themselves. When claims are filed, contracts are frequently dishonored for technical reasons, leading the public to view premiums for compulsory coverages as more of a tax than a purchase of insurance. 15. Tax incentives have been used extensively to promote the insurance industry. Companies enjoyed a three-year profit tax holiday for the period that ended May 2005 provided the tax savings were directed to specific purposes including training, expansion of agent networks, purchases of equipment and increasing capital. A new three-year tax holiday for the service industry, including the insurance sector, was introduced effective 1 April 2006. Such incentives often result only in companies “gaming” the system, in effect undertaking the same activities they would have in the absence of tax incentives, while enjoying the tax holiday. Enforcement efforts add to the administrative burden borne by both the tax authorities and the companies, and can ultimately defeat the intended purpose of the incentives. A sound regulatory and supervisory system is likely to be more effective in the long run in fostering development of the industry. Pensions 16. There are two pillars to the Uzbek pension system, the pay-as-you-go social security fund, and a mandatory private pension fund managed indirectly by the social security administration through state-owned Khalk Bank. Individual private retirement savings plans have not been introduced in Uzbekistan, but there is an element of “pillar three” retirement savings in the mandatory private pension fund, as entrepreneurs can make voluntary contributions. The state social security fund, which despite the name is not a fund but rather financed on a current (or pay-as-you-go) basis from general government revenues, encompasses a range of programs including disability payments, and the state old-age pension. 17. The Accumulation Pension Fund was introduced in 2004, with contributions beginning in 2005. One percent of all wages is directed to the Fund, with 4.1 million individuals contributing in 2005. In addition, 18,000 individual entrepreneurs made voluntary contributions. The Fund balance is projected to be 82 billion sums by end- 2008. Government paid the start-up costs for the Fund, and has provided a tax holiday to Khalk Bank as an indirect subsidy for the Fund’s operating expenses. Each individual member of the plan is entitled to receive interest on contributions equal to at least the rate of inflation. Government debt and bank deposits are currently the only investments of the Fund. As the Fund grows there is likely to be a shortage of suitable investment instruments in which Khalk Bank will be able to invest contributions, raising questions of how the investment returns mandated by the plan can be met. 3 Leasing 18. The leasing industry in Uzbekistan is still at an early stage of development, but has been growing rapidly. At end-2005 there were 31 active lessors, comprising 12 specialized leasing companies and 19 commercial banks, up from only 13 lessors in 3 This section draws on the work of the financial markets consultants under the TA. 7 2002. The 4,078 lease agreements executed in 2005 had a total value equivalent to $96 million, comprising 3.2 percent of total fixed investments in Uzbekistan. 19. Leasing provides a viable substitute for loans to finance equipment. However as with lending, the volume of leases outstanding overstates the level of financial intermediation. NBU accounts for 95 percent of the banking sector’s lease portfolio, and Uzquishloqmash Leasing (UQML), which is also state-owned and largely funded by government programs, is by far the largest specialized leasing company. Aside from NBU and UQML, the specialized leasing companies and commercial banks typically have lease portfolios equivalent to a few million dollars or less. 4 Capital Markets 20. There is limited capital market activity in Uzbekistan notwithstanding the establishment of key elements of the supporting infrastructure including a stock exchange with an automated trading system, a central securities depository, and a real time gross settlement system. Government remains a major player both in the issuance and ownership of securities. 21. Excluding time and savings deposits of banks, fixed income instruments outstanding at end-2005 amounted to the equivalent of $72 million, about 60 percent of which was government debt, with the balance comprised of short term corporate securities (Table 2). Treasury bills and bonds are sold by auction. Banks are the main participants in the government debt markets with 20 banks and one non-bank financial institution acting as primary dealers. Corporate securities generally have an original maturity of less than one year and are collateralized or bank guaranteed, with banks purchasing about 80 percent of the issues. Virtually all of the secondary trading in corporate securities takes place in over-the-counter market (OTC) transactions, with less than two percent of the value traded on the TRSE. About three percent of trading in 2005 took place in the Inter-Bank Trading System, which will increase significantly in future since the system was only introduced by the Banking Association in the last quarter of 2005. Table 2. Fixed Income Instruments Outstanding, end-2005. Assets (sum billion) Assets(percent of GDP) Treasury bills (under one year) 15.8 0.1 Treasury notes/bonds (over one year) 33.7 0.2 Corporate securities (under one year) 36.1 0.2 Sources: Central Bank of Uzbekistan and Centre for Coordination and Control of the Securities Market. 22. Share issues and trading have been growing steadily, although given the very small base, the equity market is still dwarfed by the banking system. There were 2,114 joint stock companies registered at end-2005, up about 8 percent from the previous year. The vast majority of joint stock company shares are owned directly or indirectly by the state (Table 3), reflecting that the major role of capital markets to date has been to participate in partial privatizations of state-owned entities. Reflecting this, the TRSE, established in 1994, still has branches in all twelve regions of the country and 84 broker offices. Four shares are listed on the highest trading board of TRSE (A List) and 113 on 4 This section draws on the work of the financial markets expert under the TA. 8 its third board (C List). Most primary issues are made through the OTC market, with secondary trading spilt more evenly between the OTC market and the TRSE. 23. Institutional investors do not yet play a role in Uzbekistan. The Pension Accumulation Fund so far has invested almost exclusively in bank deposits, and the life insurance sector is virtually inactive. There are no unit trusts (mutual funds) in the conventional sense, although there are 18 privatization investment funds remaining from the more than 80 established in 1996-2000 to involve individuals in the securities market through participation in privatization of state property. Theses funds are very small, with net asset value of about sum 4 billion at end-2005. The funds are also very liquid, in part because they are prohibited from declaring dividends and there are few options for the required reinvestment of their profits. Table 3. Number of Stock Companies and Book Value of Equities end-2004 end-2005 Total joint stock companies 1,957 2,114 Open joint stock companies n.a. 1,754 Closed joint stock companies n.a. 360 Equities, total book value registered equities* (sum billion) 2,171 2,787 Of which, owned by the state 2,090 2,325 owned by the private sector 127 462 * Issues of equities are registered at the State Securities Register and Central Depository. Sources: “Chastnaya sobstvennost’”, N10, 2-7 March, 2006; “Biznes Vestnik Vostoka”, 19 January, 2006. Credit Unions 24. In contrast to the experience in many other countries, the legal foundation for credit unions in Uzbekistan was established before major efforts were devoted to credit union development. The credit union law was enacted in 2002, with the first credit union licensed in September of that year. From the outset, the focus on development support for credit unions was on training of credit union staff and members, the establishment of systems and some limited grant support for equipment. 25. At end-September 2006, there were 32 credit unions with almost 48,000 members and 8,900 loans outstanding (Appendix 4). The large excess of number of members over number of loans is an indication that credit unions are successfully attracting savings. At end-September 2006 credit unions served about half as many small and micro borrowers as the banking system did at end-2004, although with a smaller average loan size. 26. Although still among the lower ranks of the CIS countries in terms of outreach (Table 4), Uzbekistan credit unions appear at this point to be among the most successful in achieving sustainability. In many other countries external finance has been provided to try to “kick-start” credit unions, but this has frequently served to undermine the principle of cooperative ownership. In Uzbekistan, the exclusive reliance on member funds5 has given depositors a reason to take a keen interest in credit union performance as they wish to safeguard their personal investment by ensuring the election of well-qualified directors and retention of competent staff. The USAID funded support for Uzbekistan credit unions is no longer being provided directly by the World Council of Credit Unions 5 Although ADB’s Small and Microfinance Development Project includes a component to provide subordinated debt to credit unions, this has, perhaps fortunately, not been advanced. 9 (WOCCU), as the Credit Union Association of Uzbekistan has evolved into a second-tier organization, or apex, to provide support and services to individual credit unions. Table 4. Credit Unions in Selected CIS Countries, end-2005. Penetration Assets Number Members (members, percent of population) ($US millions) Georgia 56 5,710 0.06 1.3 Kazakhstan 136 n.a. n.a. 256.4 Kyrgyz Republic 320 28,972 0.56 15.8 Moldova 504 96,299 2.84 18.6 Russia 213 277,776 0.19 141.1 Ukraine 746 1,297,000 2.76 409.3 Uzbekistana 32 47,876 0.18 10.4 a. end-September 2006. Sources: World Council of Credit Unions, Credit Union Association of Uzbekistan, National Bank of the Kyrgyz Republic, Kazakhstan Agency for Financial Supervision, International Monetary Fund. Microfinance Organizations 27. The first specialized microfinance organizations were established in Uzbekistan in 1998 with United Nations Development Program assistance. Subsequent support from other external funding agencies led to additional NGO-sponsored microfinance organizations, peaking at 14 in 2005, with nine of these still operational at end-October 2006. Some microfinance organizations closed down for a variety of reasons, including an uncertain legal environment and generally challenging business conditions, operations not sustainable without ongoing sponsorship, and employee fraud and loan losses. 28. Collectively, the microfinance organizations have a much smaller average loan size (about $160 equivalent) than either banks or credit unions, and total loans of just over $3 million equivalent at end–September 2006 (Appendix 5). The small loan size is in part due to funding constraints, and in part due to targeting very small and start-up businesses. Banks and credit unions cater to more established micro and small enterprises. Until November 2006, microfinance organizations operated under a legal framework that limited funding to donor grants and their own resources. Some existing microfinance organizations have achieved sustainability, with income sufficient to finance ongoing activities, while others are still dependent on donor support. The outreach is greater than for either banks or credit unions with microfinance organizations serving over 20,000 active borrowers. B. Regulation and Supervision 29. While the nature and quality of regulation and supervision varies from sector to sector, there is an overarching need for further evolution towards a risk-based prudential approach. The legacy of blurred lines between the supervisory authority and the industry, a focus on regulatory compliance and a history of direct oversight and intervention in management decisions remains evident in the activities of the CBU, State Insurance Supervision Board (SISB) and the Centre for Coordination and Control of Securities Markets (CCCSM). Effective risk-based supervision will also require enhancing the risk-management capacity of financial institutions. 10 The Banking System 30. The legal regime for bank supervision is based on the law on Banks and Banking, 1996, with a number of subsequent amendments, and over 200 instructions, regulations, resolutions of the President and Cabinet of Ministries and normative documents of the CBU. In common with the banking laws of many CIS countries, the Uzbek law has virtually no reference to risk management standards or risk-focused supervision, which has become a cornerstone of international best practices. Some areas of risk management are addressed by prudential norms, but the basic legal framework is more oriented to regulatory compliance than towards risk management. 31. Frequent amendments to laws and issuance of new resolutions makes regulatory compliance a continually moving target for Uzbek banks. In part, this is due to the policy formation and legal drafting process, which does not necessarily include consultation with the banking industry. Prudential requirements for Uzbek banks are based on international standards, and in many instances are more stringent than the minimums required by international best practices. While the prudential norms are sound, and bank reporting in most cases indicates comfortable margins above the required minimums, the evidence suggests that the banking system has much less resilience than the numbers indicate. For instance, the prevailing standard for loan classification and provisioning makes it likely that earnings and capital are overstated. 32. The CBU devotes about 70 staff to supervision, divided into departments for on- site (Inspection) and off-site supervision (the Licensing Department undertakes ongoing off-site supervision in addition to its responsibilities for licensing). The CBU has received extensive technical assistance to support the development of prudential standards and supervision methodology. Bank reporting requirements are extensive, with the CBU using an automated system to process daily balance sheet and transaction reports for every branch of every bank. The detail of daily reporting by banks and analysis by the CBU is evidence of the extensive focus on regulatory compliance, as a risk-based approach to supervision relies on verification of the adequacy and implementation of banks’ own policies and procedures rather than extensive review of individual transactions. Insurance 33. The legal framework for insurance has significant deficiencies with respect to prudential standards and the independence, resources and powers of the supervisory agency. The Law on Insurance Activity, 2002, which replaced the Insurance Law of 1993, establishes the broad legal framework for general insurance, with rule-making and enforcement powers delegated to the Cabinet of Ministries. Technical assistance had been provided by the ADB for drafting the insurance law,6 but the version of the law ultimately enacted does not include a number of key elements from earlier drafts, especially with respect to establishment of a regime for prudential regulation and supervision. 34. The new law divided the insurance market into life and non-life segments but there are no further legislative acts regulating life insurance. Definitions of classes of insurance were taken from European regulations with the aim of bringing the insurance legislation in line with European standards in the longer run. In addition to the Law on Insurance Activity, Chapter 52 of the Civil Code deals with insurance contracts. This 6 TA 3488-UZB Development of the Insurance Industry. 11 chapter has proven problematic for the insured public since it has provided a legal basis for insurance companies to dishonor claims on technical grounds. 35. The Insurance Law provides that the supervision function is to be assigned to a government body determined by the Cabinet of Ministers. Gosstrakhnadzor, which is the State Insurance Supervisory Board (SISB) established under the Ministry of Finance, was responsible for supervision pursuant to the 1993 insurance law and continues to exercise this function. The authorized staff complement is 15 organized into two departments: Licensing and Inspections; and Methodology. Currently seven positions, including that of the agency head, are vacant. Its functions are very wide and include the representation of all parties involved in insurance activity including the companies and policyholders, the development of insurance related legislation, and policyholder protection. Some of these activities, such as representing industry interests, go much beyond the conventional role of the regulator and potentially conflict with other activities such as policyholder protection. 36. The head of the SISB is appointed by the Cabinet of Ministers and is subject to removal at any time, thus not having the fixed term appointment advocated by international standards to provide operational independence. Due to limited staff and budget, the SISB frequently draws on staff from the Ministry of Finance to fulfill its functions. The only remedial action currently available to the SISB is the ability to suspend a company’s license for up to ten days. Further supervisory action can only be pursued through the courts. These arrangements fall well short of international best practices requiring an independent supervisory agency with adequate resources to pursue a clear mandate to ensure prudential soundness of the industry and policyholder protection. Leasing 37. A legal foundation is provided by the 1999 Law on Leasing. This law was amended in 2002, together with amendments to the Civil Code to address uncertainties and conflicts between the two laws. The Tax Code was similarly amended to harmonize with the criteria and classifications situated in the Law on Leasing. The Code of Economic Litigation Procedures, amended in 2003, provides for the repossession of leased assets. This framework, which appropriately does not include prudential oversight of specialized leasing companies, provides an overall favorable environment for the development of the leasing market, evidenced by the entry of three new specialized leasing companies and nine banks into the leasing market since the reforms of 2002- 2003. Capital Markets 38. The 1993 Law on Securities and the Stock Exchange and the 1994 Law on The Mechanism of the Securities Market provide a basic legal framework for capital markets in Uzbekistan. The CCCSM is the regulatory authority for the securities markets. It is a state body attached to the State Property Committee, which is by far the largest shareholder and seller of stocks. This arrangements harbors the potential for conflicts between capital markets development objectives and the regulatory objective of investor protection on one hand, and privatization objectives of maximizing the returns to government on the other hand. There are no self-regulatory organizations in the generally accepted sense, although there is a national organization of investment institutions which functions as an industry association. Accounting and disclosure 12 standards do not conform with international practices, making it difficult for potential investors to asses the risks of corporate bonds or equities. Microfinance and Credit Unions 39. The legal regime for microfinance is still very much a work in progress. The law on microfinancing introduced in September 2006 is very general, with the detail to be contained in regulations yet to be implemented. It is noteworthy that the law mandates the CBU to establish a licensing mechanism without providing detail on this mechanism. The revocation of the interim legal framework for microfinance organizations before the new licensing regime was developed and established, and absence of transitional provisions means that the current small base of microfinance activity is continuing to shrink. The microfinance organizations existing prior to the introduction of the new law are now in a state of legal limbo. The interim legal arrangement provided by Resolution 309 of the Cabinet of Ministries was repealed by Resolution 225 on 31 October 2006, but the procedures for licensing under the new law are not yet in place. The net result may be that all pre-existing microfinance organizations effectively wind-down, with some subsequently re-establishing under the new legal regime. 40. The credit union law and prudential standards introduced in 2002 are generally appropriate, reflecting accepted international standards and best practices. Prudential reports are required on a monthly basis, and the CBU undertakes a program of off-site analysis, with annual on-site examinations of all credit unions. The Credit Union Association has proved a useful vehicle for dialogue between credit unions and the CBU on regulatory issues. 41. Many of the legal concerns for microfinance organizations and credit unions originate with the legal framework more broadly applicable to commercial activities. Like their micro and small business clients, credit unions and microfinance organizations are subject to regulations establishing daily cash limits for businesses, with the requirement that all cash receipts be deposited daily in a bank account. The inability to hold cash to meet requirements for loans disbursements or, in the case of credit unions, cash withdrawals, is an administrative impediment to their development. Similarly, the requirement to disburse loans exclusively by bank transfer is an obstacle to the very small loans issued by microfinance organizations given high transactions costs. C. Policy Issues 42. The current approach to financial sector development in Uzbekistan provides mixed messages to the users and providers of financial services. These have resulted in limited deepening of the financial sector despite the recent strong overall economic growth. Greater financial intermediation is required to further accelerate growth, and perhaps more importantly, position the economy through greater diversification to deal with down-cycles in commodity prices, to which Uzbekistan remains vulnerable given its economic structure. Demand for Credit 43. Estimates of demand for credit vary, but it clearly far outstrips supply. Since government directly or indirectly owns more than 80 percent of the equity of all joint- stock companies, the bulk of the private sector demand for credit comes from the 2.8 13 million individual entrepreneurs in Uzbekistan,7 253,300 micro enterprises and 15,300 small enterprises. While a significant number of these individual entrepreneurs and businesses are wholly self-financed, if even 25 percent require credit8 there are almost 770,000 potential small and micro-business borrowers. 44. There is additional demand in the agricultural sector, notwithstanding government’s targeted financing programs, illustrated by the fact that about 10 percent of credit union loans are advanced for agricultural purposes. About 80 percent of the agricultural sector’s contribution to GDP is accounted for by small-scale entrepreneurship, suggesting that a significant portion of the 160,000 collective and dekhan farms (a family small-scale business involved in production and sale of agricultural products) are potential small and micro-finance borrowers. 45. Considering individual, small and micro-enterprises and small-scale agriculture, the total number of potential private sector borrowers is conservatively in the range of 800,000, concentrated in the micro and SME segments. With fewer than 50,000 micro and SME borrowers currently served (Table 5), there is clearly an enormous unmet demand for small and micro-credit. If the average loan size were $1,000,9 unmet demand exceeds $800 million, or about one quarter of the total loan portfolio of the banking system. Table 5. Serving the small end of the market, end-September 2006 Number of borrowers Sums (million) US$ (million)b Banks’ micro-credit portfolio 16,200 a 46,600 37.3 Credit unions 8,901 13,059 10.4 Microfinance organizations 20,482 4,107 3.3 Total 45,583 63,766 51.0 a end-2004. b 1$US = 1250 sums Sources: Central Bank of Uzbekistan, Credit Unions Association, Microfinance Association. 46. Survey results indicate that access to credit is a much larger obstacle to business than high borrowing rates.10 This is confirmed by the rapid growth in credit union lending 7 Survey data for 2004 estimates a much higher number, 4.7 million. The Asian Development Bank (ADB) Private Sector Assessment, relying on data from the State Committee on Statistics, cites 2.8 million at end 2003. Clearly, the demand for credit could be much higher than the conservative estimate provided above. Centre for Economic Research, 2005, “Microfinance Development in Uzbekistan” (Tashkent). 8 Surveys provide varying results, but generally indicate that between one-third and two-thirds of businesses and entrepreneurs in Uzbekistan desire external financing. See Mario B. Lamberte and Mariano Cordero “Rural Finance in Uzbekistan” in Mario B. Lamberte, Robert C. Vogel, Tom Moyes and Nimal A. Fernando, eds. 2006, Beyond Microfinance: Building Inclusive Rural Financial Markets in Central Asia, (Manila: Asian Development Bank), and Centre for Economic Research, 2005. 9 Larger than microfinance organization loans, but still less than the average for credit union loans and banks’ small and microfinance loans. 10 The survey was undertaken by the Center for Social and Economic Research. Difficulties in getting a loan and lack of working capital were cited as main issues by over half of survey respondents, while the cost of credit was cited by only six percent. Almost 30 percent of respondents would have been prepared to pay interest rates of 3 or 4 percent per month, with over 20 percent prepared to pay monthly rates of 5 percent or more. Source: Centre for Social and Economic Research, 2005. 14 despite interest rates far in excess of those charged under various policy lending programs, and the fact that banks, particularly the small private banks with less access to government funding, charge significantly higher rates for lending their own resources than lending under government programs (Appendix 3). Financial Sector Issues for Private Sector Development 47. Some financial-sector specific issues need to be addressed on a priority basis as part of the government’s ongoing efforts to reduce the bureaucratic burden on businesses. Key policy changes that would help the financial sector better support private sector development include: (i) Removal of the system of daily cash limits for businesses; Formatted: Bullets and Numbering (ii) replacement of the requirement for all business-to-business transactions to be conducted electronically with a limit on the maximum size of cash transactions; (iii) placing the onus for tax payment on the tax payer, and cease the practice of requiring banks to provide customer information to third parties such as the revenue authority; and (iv) timely processing of foreign exchange purchases. 48. In addition to these reform measures, the government will need to continue with efforts to reduce the bureaucratic burden on businesses. The 2001 introduction of a “one window” system for new businesses to obtain registration, certifications and permits was a step in the right direction. However it still takes on average 19 days to register a business and a further 17 days to obtain necessary permits and approvals.11 There is clear scope to further streamline these processes. Banking 49. The non-bank functions performed by commercial banks and channeling of funds to so called priority sectors and borrowers through preferential financing programs has limited the growth of savings intermediation. The small private banks and credit unions, which are less involved in these directed activities, are growing rapidly, in contrast to the banking system as a whole. This suggests that separation of policy functions from intermediation would spur development of the financial sector and contribute to stronger growth. 50. Government policy lending needs to be separated from commercial banking so that the commercial banks, whether government owned or private, have a clear focus on savings mobilization and investment on commercial terms. This could be accomplished in two ways. One is to re-designate an existing bank as a development bank, transferring its commercial business to another bank, and transferring policy lending from other state banks to the development bank. The other option is to create a new development bank to assume state-banks’ policy functions. Under either option, the process could be phased, starting first with one bank. Starting with NBU offers the opportunity to remove the majority of policy lending from the commercial banking system, but it would also be possible to begin with one of the smaller banks, treating it as a pilot project. Given the dominant role of NBU, ultimately NBU has to be transformed to ensure that the reforms have a significant impact on the banking system. 11 International Finance Corporation, 2005, Business Environment in Uzbekistan as Seen by Small and Medium-Sized Enterprises (Washington: IFC). 15 51. Bringing more savings into the formal banking sector requires policy measures to encourage rather than mandate the use of the banking system. The requirement to use the banking system for financial transactions has been primarily motivated by concerns over revenue collection and the administration of financing programs. The resulting intervention by commercial banks in entities’ financial management, debiting of banks’ customer accounts without the knowledge and consent of the account holders, and sharing of bank client information with various authorities all provide incentives for business and individuals to avoid the formal banking sector. 52. Funding provided under Government programs and the potential availability of large deposits from government-related entities is a disincentive for banks to intermediate household and small enterprise deposits. It is less costly for banks to target large deposits from government organizations and state-owned enterprises rather than developing capacity for large-scale mobilization of small deposits. State-owned banks faced with capacity constraints are likely to focus on delivery of Government policy loans and externally funded programs, and devote fewer resources to commercial lending. 53. There is a need over the medium term to review the existing legal framework for banking to identify and remove inconsistencies, and to introduce the elements of best practices that have developed since the original introduction of the banking law in 1996. While the oversight of banks comes closer to international best practices than the current approaches to insurance and capital markets, there is still room for improvement. Reduction in the frequency of legal changes and improvement in the consultation and drafting process would facilitate regulatory compliance. Introduction of a greater emphasis on risk management and risk-focused supervision would enhance the environment for private sector intermediation. Greater transparency and disclosure would help foster market discipline as a necessary complement to prudential oversight. Insurance 54. A sound system of regulation and supervision is required to establish a base for development of the insurance industry. The existing law needs significant amendment to address deficiencies in prudential standards for insurance companies, and to establish a supervisory authority with the independence and resources required to meet international best practices codified in the International Association of Insurance Supervisors Core Principles. Amending the legal framework can take place over a year or two, but building supervisory capacity will be a medium- to long-term project. It is important that this work be initiated at an early date so that supervisory capacity is in place before the insurance industry begins to grow rapidly. 55. Chapter 52 of the Civil Code requires amendment as part of a larger effort to address the significant imbalance in the current relationship between the insured and insurance companies. Reducing the scope for denial of claims over narrow contractual issues would be an important first step in changing the public perception of compulsory coverages from a tax to an actual purchase of insurance. Concomitant measures should include the building of capacity within the insurance industry, including the training of brokers, agents and claims adjusters. Specific issues to be addressed with compulsory coverages include: Formatted: Indent: Left: 0.5", (i) Complete reform of third party liability automobile policies; Space After: 0 pt, Numbered + (ii) development of a workers compensation scheme managed by the private Level: 1 + Numbering Style: i, ii, iii, sector; and … + Start at: 1 + Alignment: Left + Aligned at: 0" + Tab after: 0" + (iii) establishment of an earthquake facility. Indent at: 0.5" 16 56. A regulatory framework for life insurance needs to be introduced as part of the review of the legal framework. The currently unregulated purchase by Uzbek residents of products from foreign companies indicates at least some emerging demand for life insurance. An appropriate legal basis can help to ensure that life insurance companies are ultimately able to play a significant role in mobilizing domestic resources and making them available for productive investment through purchase of debt and equity securities. Emergence of such institutional investors is a key element of developing domestic capital markets. 57. Establishing an independent supervisory authority and building capacity will take time, but this work needs to be initiated now to avoid a “boom and bust” cycle. Privatization of the state-owned insurance companies without an effective supervisory regime in place presents a greater risk of failures, which would further undermine the limited confidence of the public in insurance companies’ claims paying ability. There has been little interest expressed by foreign insurers in investing in Uzbek insurance companies. This may change with improvements in the legal and policy framework. However, in the near to medium term Uzbek companies will be faced with the difficult challenge of building expertise in risk management without the benefit of significant knowledge transfer from foreign companies operating in Uzbekistan. Pension Funds 58. Introduction of the Pension Accumulation Fund was a positive step that should be followed by additional measures. First, the arrangements for oversight and investment policies of the Fund need to be reviewed to ensure that they are appropriate for a second pillar pension fund. It will be important that the Fund not become a “dumping ground” for otherwise unattractive shares of state-owned enterprises, or a tool for implementing industrial or regional development policies at the expense of prudent investment decisions. A second step is to expand the range of the “third pillar” options by introducing a policy framework conducive to private retirement savings in addition to the current provision for voluntary contributions by entrepreneurs to the Accumulation Fund. Over time, this could lead to the emergence of institutional investors managing considerable amounts of long term savings, which would foster capital market development. Leasing 59. The existing framework for leasing is broadly appropriate, with the outstanding issues relating more to problems with general commercial activities than with the legal or tax provisions for leasing. There is considerable ambiguity over what qualifies as imported “technological equipment” and is thus exempt from customs duties and VAT. There is also a lacuna in the leasing law as it does not provide for secondary leasing, thus not permitted a lessor to re-lease equipment in the event the original lessee defaults. Capital Markets 60. Development of the capital markets has been limited by the pace of privatization. Government still controls over 80 percent of all joint-stock company equity, indicating that the private capital markets currently serve only a very small portion of the economy. Thus, while the measures noted below are important, without additional privatizations to increase the size of the private sector and the supply of equities and corporate debt, 17 capital market growth will continue to be slow. Key capital market development measures are: (i) Establish an appropriately independent supervisory authority meeting the Formatted: Bullets and Numbering standards established by the International Organization of Securities Commissions; (ii) build capacity in the authority and the industry, including stock exchanges, brokers, and other professional market participants; (iii) enhance the application of governance, accounting, and disclosure standards to reduce the risk of investing in Uzbek companies; and (iv) continue with the development of the pension and insurance sectors so that over time institutional investors will emerge. 61. Enhancing the quality of capital market supervision will provide a sound framework for the market development over the longer term, helping to establish and maintain investor confidence. There is also a need to educate the general public about securities markets in order to attract private savings. In addition to these policy measures, there are also specific technical requirements to enhance the trading systems for government debt and the systems of the TRSE to reduce operational, clearing and settlement risk. Microfinance and Credit Unions 62. The uncertainty over the transitional provisions for NGO-sponsored microfinance organizations to obtain a license under the new law and regulations means that lending will be sharply curtailed, at least for an interim period. However, with greater legal and policy certainty there is potential to expand microfinance activities to levels more commensurate with those elsewhere in the region. Government will need to match its expressed commitment to microfinance with: (i) Clear and comprehensive regulations and licensing procedures to Formatted: Indent: Left: 0.5", complement the 2006 Law on Microfinance; Space After: 0 pt, Numbered + Level: 1 + Numbering Style: i, ii, iii, (ii) clarification of the transition provisions for microfinance organizations … + Start at: 1 + Alignment: Left + previously operating under resolution 309; and Aligned at: 0" + Tab after: 0" + (iii) a supervisory regime consisting only of licensing, reporting and consumer Indent at: 0.5" protection such as “truth in lending” disclosure, reflecting that microfinance organizations, by virtue of not accepting deposits, do not require prudential regulation. 63. The short history of credit unions in Uzbekistan has been very positive, which is in part attributable to the establishment of a broadly appropriate framework for regulation and supervision at a very early stage of sector development. While there are some issues under discussion between the Credit Union Association and the CBU, the principal policy requirement for further development is to continue to permit credit unions to operate without direct government intervention. Unlike banks which have been directed to provide financing to selected sectors and qualifying businesses at subsidized rates and rely extensively on Government or other external finance, credit unions have been free to lend on the basis of their own credit assessments and charge market- determined rates of interest. The requirement to mobilize their own member resources for lending has helped to ensure close member oversight of the credit union, and initial success has helped to attract additional deposits. 18 D. Key Elements of a Financial Sector Strategy 64. A strategy for financial sector development has to be integrated with an overall approach to private sector development. There is a symbiotic relationship between the financial sector and the real sector, with policies to support growth in one also benefiting the other. Reduce Direct Government Interventions 65. The focus of financial sector policy and private sector development more generally needs to be on establishing conditions conducive for business. Coherent policies, a legal framework that changes only after consultation with affected stakeholders, and consistent interpretation and application of laws and regulations will benefit both the financial sector and the private sector more broadly. Within the financial sector specifically, there is limited scope for state-owned institutions and government funding to meet the demand for credit, and coercing or co-opting banks to target specific sectors or products has had limited success and imposes otherwise avoidable risks on the banking system. Recognizing this, the Government should look to increased private intermediation rather than new or expanded specialized programs and state-owned institutions to meet the real sector’s financing needs. In addition, further progress with privatization will reduce direct Government participation in the real sector. Establish a Foundation of Sound Regulation and Supervision 66. One benefit of the gradual pace of financial sector reform in Uzbekistan has been success in implementing some elements of international best practices in regulation and supervision prior to the establishment of large privately owned banks. However, there is significant scope and need to enhance the legal framework and practice of supervision. While banking supervision is more advanced than insurance or capital markets oversight, the much larger size and systemic importance of the banking sector means that the need for continued enhancement of banking supervision is just as imperative. There is a need for a comprehensive review of the legislation for banking, insurance and the capital markets, significant upgrades in the independence and capabilities of the non-bank supervisory authorities, and an overall enhancement of the focus on risk- management and risk-based supervision rather than compliance oriented supervision.12 Banking Sector Reform 67. Since the banking sector is by far the largest component of the financial system, bank reforms offer the potential for the most immediate and largest benefit for the real sector. Two key structural reform measures are needed: (i) Eliminate the intrusive non-bank functions performed by the banking Formatted: Bullets and Numbering sector, including acting as agents for tax collection and the execution of government policies, and direct intervention into the financial management of enterprises; and 12 The older compliance-based approach relies on highly prescriptive regulations, with the activities of the supervisory authority focusing on ensuring compliance through regular review of individual transactions and activities. In contrast, a risk-focused approach places the onus on the board of directors and management of a financial institution to establish policies and procedures that enable the financial institution to comply with standards of sound business practice. The more modern risk-focused approach to supervision relies extensively on verifying the existence and adequacy of an institution’s own policies and procedures rather than individual transaction review. 19 (ii) separate policy lending from commercial banking. 68. The first measure would remove one of the major incentives for individuals and businesses to avoid using the formal banking sector. The second would enable commercial banks to focus on lending on market terms and conditions unfettered by the need to deliver policy loans. Establishment of a specialized development bank funded by government could provide a vehicle to continue to deliver policy loans if the authorities wish to continue this practice, while also transparently accounting for the fiscal cost of government programs. 69. The separation of policy lending from commercial lending would be a step towards the previously announced divestiture of significant shares of Asaka Bank and NBU. A further measure to reinforce the separation of policy lending from commercial lending would be the divestiture of the government’s remaining share in banks previously partially privatized. Non-Bank Financial Sector Reform 70. While the non-bank financial sector is small relative to the banking sector and in absolute terms, it would be a mistake to neglect it for at least two main reasons: First, growth and development of well-functioning non-bank financial institutions, including not only capital markets and institutional investors, but also microfinance institutions and credit unions, generates significant economic and social benefits. Second, the development of a balanced financial system makes the corporate and financial sectors more resilient to shocks by reducing systemic vulnerabilities in a bank-dominated financial system. 71. For insurance and capital markets, the establishment of a solid framework for regulation and supervision should be the first priority. Sequencing of reforms—focusing first on the legal framework and practice of supervision—will help to avoid costly institutional failures. Privatization of state-owned insurance companies can be addressed over the medium term. Significant growth in capital markets activities cannot be expected until there has been expansion of the private sector through further privatization and organic growth of existing private enterprises. 72. For credit unions and leasing, the key is to permit these sectors to continue to develop without being subject to direct policy interventions. The approach to licensing and oversight of microfinance organizations now being introduced should result in a regime emphasizing only registration and reporting, reflecting that institution not taking deposits do not require prudential regulation. APPENDIX 1. BANKS IN UZBEKISTAN Bank State-ownership Deposits Assets Headquarters Legal structure Staff Branches Minibanks (end-2005 data) (includes indirect) (sum billions) National Bank of Uzbekistan Tashkent State joint-stock 100 percent 6201 93 56 743 2,886 Asaka Bank Tashkent State joint-stock 100 percent 2365 27 71 231 599 UzPromstry Bank Tashkent Joint-stock 33 percent 3981 46 72 309 522 Pakhta Bank Tashkent Joint-stock 28 percent 8108 183 618 186 357 Ipoteka Bank Tashkent Joint-stock 43 percent 4338 39 130 212 272 Khalk (Peoples) Bank Tashkent State joint-stock 100 percent 10845 199 183 89 191 ABN AMRO Bank Uzbekistan Tashkent Foreign subsidiary 18 percent 52 1 0 88 104 Ipak Yuli Bank Tashkent Joint-stock 24 percent 459 4 14 50 72 Gallabank Tashkent Joint-stock 48 percent 1615 32 72 23 72 Hamkorbank Andijon Joint-stock 838 22 42 35 61 UzKDB (formerly UzDaewoo) Tashkent Foreign subsidiary 5.5 percent 81 0 2 43 58 Microcredit Bank Tashkent Joint-stock 90 percent 2911 75 161 25 55 Kapital Bank Tashkent Joint-stock 476 2 19 32 53 Savdogar Bank Tashkent Joint-stock 0.5 percent 1408 35 50 30 49 Turon Bank Tashkent Joint-stock 10 percent 996 18 40 35 47 Credit Standard Bank Tashkent Joint-stock 88 1 0 35 46 Aloqabank Tashkent Joint-stock 52 percent 722 12 17 28 34 Exchange Trust Bank Tashkent Joint-stock 301 2 5 27 30 ALP Jamol Bank Tashkent Region Joint-stock 298 3 7 17 22 RavNAQ Bank Tashkent Joint-stock 127 0 2 13 21 Parvina Bank Samarkand Closed joint-stock 279 4 27 12 20 Uzbekistan-Turkish Bank Tashkent Foreign subsidiary 92 0 0 10 17 Bank Saderat Iran Tashkent Foreign branch 28 0 0 1 11 Universal Bank Kokand Joint-stock 148 2 6 2 5 Uktambank Qarshi Joint-stock 81 0 7 1 4 Davr Bank Tashkent Closed joint-stock 56 0 0 2 3 Turkison Bank Tashkent Joint-stock 105 0 2 1 2 Samarkand Bank Samarkand Joint-stock 19 0 1 0 1 Sources: Central Bank of Uzbekistan and commercial banks. APPENDIX 2. LARGE BANKS The six largest banks, of which three are wholly or majority owned by government and three have significant government minority holdings, account for about three-quarters of bank deposits and over 90 percent of loans. National Bank of Uzbekistan, 100 percent owned by the Ministry of Finance, finances large investment projects in priority sectors and administers the majority of credit lines provided by International Financial Institutions (IFIs). It has a network of 100 branches and 56 mini- banks (sub-branches usually staffed by up to three employees providing deposit and payments services, and accepting loan applications which are adjudicated at a branch) covering all regions of the country. It accounts for almost two-thirds of banking sector loans, 90 percent of which are government guaranteed under various financing programs. Asaka Bank, 98 percent held by the Ministry of Finance and indirectly 100 percent owned by government, is the second largest bank accounting for just over 10 percent of banking sector assets. Like all the state-owned banks it has a universal banking licence and thus serves all sectors of the economy, however, its core business continues to be serving the automotive sector, including providing low interest rate loans to finance UzDaewoo car purchases. It has 27 branches and 71 mini-banks. UzPromstroy Bank, with a 33 percent government shareholding, mobilizes a larger share of deposits than the large wholly government-owned banks, accounting for about 13 percent of total bank deposits, but only about 9 percent of assets. UzPromstroy Bank historically has focused on large industrial and construction enterprises with a network of 46 branches and 72 mini-banks. Pakhta Bank historically served the cotton sector and related agricultural enterprises. Although only 28 percent government-owned, it continues to play a central role in channelling agricultural credit, evidenced by the fact that it’s deposits comprise only about half of it’s funding base and are less than total loans extended. Pakhta Bank has also spearheaded government efforts to extend banking services in rural areas, with over 600 mini-banks, accounting for more than a third of all mini-banks in the country, although it has only about 6 percent of total banking assets. Ipoteka Bank, with a 43 percent state-shareholding was formed in 2005 through the merger of two other banks to provide mortgage financing at preferential rates. It has about a five percent market share, and in contrast to the other large government-controlled banks has a loan to deposit ratio of only 62 percent, likely because mortgage lending has not yet developed into a major activity. Khalk (Peoples’) Bank, 50 percent owned by the Ministry of Finance and 50 percent by the CBU, provides basic banking services including deposits and transfers, utilities payments, foreign exchange transactions and payment of state-pensions and through a network of 199 branches, 183 mini-banks and 2350 retail service points. Despite the breadth of coverage, its focus on small deposits and transactions services is evident in its relatively small market share—3.4 percent of total assets. 22 APPENDIX 3. FUNDING SOURCES AND INTEREST RATES Suppliers Interest Rates Commercial Banks Commercial lending 18 – 24 percent, or more Policy lending Fund for the support of employment 16 to 45 percent of CBU refinance rate* depending on the purpose Fund for preferential lending 50 percent of CBU refinance rate Fund for the purchase of agricultural products 3 percent per annum Fund for the promotion of dekhkan and farming entities 16 to 40 percent of CBU refinance rate, depending on the purpose Centralized financing for construction 2 percent Mortgage lending fund 5 percent Purchase of terminal for acceptance of plastic card 50 percent of CBU refinance rate payments by retailers and service providers Asaka Bank Loans for purchase of Uzdaewoo cars 4 to 7 percent per annum, depending on the term Microcredit Bank Business start-up 5 percent Micro-leasing 50 percent of CBU refinance rate Expansion and working capital Not higher than CBU refinance rate Credit unions 24 to 60 percent per annum Microfinance organizations 24 to 72 percent per annum *CBU refinance rate at end-2005, 16 percent. Sources: Decrees, resolutions, regulations, Central Bank of Uzbekistan, banks, credit unions, microfinance organizations. 23 APPENDIX 4. CREDIT UNIONS (end-September 2006) Assets Loans Deposits Capital № Credit Union Region Sum Sum Sum Sum Members Number Number (000s) (000s) (000s) (000s) 1 Sherdor Samarkand 1,292,538 211 1,067,377 580 1,035,338 222,907 5,736 2 Umid Buhara 817,461 397 645,367 598 610,792 185,374 3,488 3 Marvel Namangan 45,411 26 38,076 4 6,180 38,230 132 4 Lastochka Navoiy 1,540,532 635 1,075,974 723 693,717 758,816 2,414 5 Ishonch Djizzak 742,726 369 680,775 323 571,704 120,255 3,022 6 Tayanch Namangan 354,226 375 349,769 237 307,801 34,448 1,795 7 Hazina Samarkand 339,920 131 284,156 144 266,039 62,678 3,820 8 Madadkor Andijan 967,711 482 896,029 668 757,568 178,747 3,586 9 Baraka Tashkent city 485,901 518 493,314 96 417,348 45,594 1,093 10 Buhoro tadbirkori Buhara 486,140 210 410,876 330 385,440 92,724 1,888 11 Kapital Union Tashkent city 290,155 137 272,172 17 30,895 53,437 301 12 Oltin vodiy Fergana 923,765 848 856,977 677 758,846 141,733 2,922 13 Omad Sirdarya 118,786 118 104,357 37 90,765 25,590 1,618 14 Asr Andijan 840,468 815 785,725 448 559,243 192,110 5,096 15 Finans plus Tashkent city 171,708 61 152,519 60 137,685 30,954 284 16 Avitsenna Buhara 230,795 149 198,082 130 167,658 57,766 1,592 17 Nurafshon Fergana 439,637 395 387,689 164 321,776 102,590 1,742 18 Aziya Trast Tashkent city 1,196,269 260 1,078,476 277 983,105 193,267 588 19 Imkon Tashkent city 1,475,382 1,544 1,374,101 159 1,045,191 256,639 2,087 20 Universitet Tashkent city 139,235 88 113,280 50 98,562 33,648 554 21 Inom Djizzak 187,538 140 172,421 55 143,292 38,216 398 22 Kesh Kashkadarya 55,532 51 46,772 15 35,685 16,945 216 23 Farovon Surhandarya 121,402 55 98,235 22 92,419 25,198 379 24 Kredo Buhara 83,051 75 80,085 57 62,820 18,177 238 25 Jahon Andijan 754,482 368 707,693 305 613,987 110,051 741 26 Poytaht Invest Tashkent city 229,380 68 173,150 40 110,226 96,849 140 27 Mehribon Namangan 34,381 38 29,175 0 0 32,744 1,207 28 Mador Fergana 322,710 250 307,384 131 262,830 51,926 456 29 Tashabbus Fergana 59,247 39 53,125 27 39,800 18,057 116 30 Tezkor-kredit Tashkent city 163,685 34 100,031 38 137,631 24,029 98 31 Agrosanoatfinans Andijan 14,713 8 14,350 1 700 13,995 62 32 Tashrif Fergana 21,181 6 11,800 3 8,700 11,851 67 Total 14,946,068 8,901 13,059,313 6,416 10,753,743 3,285,547 47,876 Sources: Central Bank of Uzbekistan, Credit Unions Association of Uzbekistan. 24 APPENDIX 5. NGO- SPONSORED MICROFINANCE ORGANIZATIONS (includes only Microfinance Association member, end-September, 2006) Loans Average Service Assets Loan Name Region(s) Staff Active Outstanding Locations (sum) Size Borrowers (sum 000) (sum 000) Samarkand Centre for city and Social- 4 sub-offices Samarkand Economic rural areas 38 178,727,618 122 15,298 125 region Development of "SABR" Samarkand region Karakalpak Branch of the Business Women's Republic of Nukus city 40 n.a. 5,182 486,676 93 Assosiation of Karakalpak Uzbekistan "Tadbirkor Ayol" Republic of Nukus city, Karakalpak, Muynak city, JDA Surhandarya Termiz city, 12 73,358,158 380 61,358 217 International and village Samarakand Karnab regions Kungrad, Kanlikul, Shumanay, Republic of NGO "Daulet" Hodjeliy, 45 794,215,443 6,388 640,464 100, Karakalpak Kegeliy, Chimbay Districts FVRM- Fergana Valley Andijon 53 1,618,147,144 3,703 1,422,595 520 Uzbekistan Tashkent Tashkent, city Fergana, Fergana city PAD Surhandarya, Termez city 30 n.a. 759 471,020 620 Microfinance Samarkand, Samarkand Kashradarya city regions Karshi city FINCA Tashkent Tashkent city 43 1,051,959,670 3,948 1,010,360 255 International city Total 261 3,716,408,033 20,482 4,107,774 1,933 Source: Microfinance Association of Uzbekistan.