S&P: Trend for Kazakhstan’s economic risk is stable

July 24. Trend

By Elena Kosolapova

S&P: Trend for Kazakhstan's economic risk is stableThe trend for Kazakhstan’s economic risk is stable, despite the negative outlook on the long-term sovereign rating, Standard & Poor’s Ratings Services said in its new report “Banking Industry Country Risk Assessment: Kazakhstan” published on July 24.

S&P classifies the banking sector of Kazakhstan in group ‘8’ under the Banking Industry Country Risk Assessment (BICRA) methodology. Other banking systems in group ‘8’ are those of Azerbaijan, Tunisia, Argentina, Hungary, and Nigeria. In addition, the agency includes Russia, which is in group ‘7’, as a peer for the Kazakh banking system.

The bank criteria use the BICRA economic risk and industry risk scores to determine a bank’s anchor, the starting point in assigning an issuer credit rating. The anchor for banks operating only in Kazakhstan is ‘bb-‘.

Major strengths factor for Kazakhstan’s banking sector are good economic growth prospects compared with developed countries, strong Kazakhstan’s fiscal and external balance positions and diversified funding base with a sizable share of retail deposits and limited reliance on external funding.

Weaknesses factors are aggressive lending, weak underwriting standards, and rising credit losses over the past three years; inability of regulators and banks to clean up very high levels of problem loans after the crisis; low risk-adjusted returns of the banking system; weak governance and transparency, and a high incidence of corruption and fraud in the banking sector.

“Economic risks in Kazakhstan remain very high in a global context. Kazakhstan’s economy depends heavily on the hydrocarbons sector,” the agency said.

Although S&P expects GDP growth to slow to 4.5-5 percent in 2014-2016, it expects banking assets to grow much faster at about 15 percent in 2014-2015, similar to the rate in 2011-2013.

In the agency’s opinion, the Kazakh economy has been in a “correction” phase since 2011, during which banks’ nonperforming and restructured loans have remained the highest among peers and have not declined, while credit losses have increased. The view of extremely high credit risk in Kazakhstan takes into account the country’s banks’ history of aggressive underwriting standards and the country’s weak payment culture and rule of law.

Industry risks are also very high in Kazakhstan, according to S&P. The agency believes the Kazakh banking regulators lack independence and can be subject to political interference. Their corrective actions to prevent the system from overheating before the recent crisis and to clean up the banking system’s very high level of problem loans afterward proved ineffective. In S&P’s view, Kazakh banks’ risk appetites remain aggressive, reflecting opportunistic growth by some small and midsize Kazakh banks as well as banks’ continued financing of volatile real estate and construction projects. The banking system’s risk-adjusted profitability is low because income generation significantly lags balance sheet expansion at rapidly growing banks, due to margin pressure, or due to poor asset quality at a few large and midsize banks. Compared with before the crisis, Kazakh banks now predominantly finance themselves with customer deposits, a large part of which is from the government and government-related companies.

The expectation of a slowdown in GDP growth is largely due to lower oil production and increased regional tensions. However, the banking sector has only modest risk exposure to the oil sector. S&P still expects growing demand for credit from small and midsize enterprises (SMEs) and consumers, which tend to be the banks’ core lending customer base. Nevertheless, the agency expects credit risk in the economy to remain extremely high.

S&P expects that the very high volume of nonperforming loans (NPLs) will decline only gradually in 2014 and 2015, partly through write-offs stimulated by newly enacted tax incentives. In addition, the agency expects that the unwinding of large imbalances, caused by the credit and real estate boom, will likely continue to constrain the banking sector’s development. Nevertheless, S&P believes most problem loans related to the 2008 crisis have already surfaced, and that credit losses, while remaining elevated in a global context, are unlikely to increase further.

“We view the trend for Kazakhstan’s industry risk as stable. Margin pressure and undiversified revenues typically do not allow banks to generate sufficient earnings to buffer a rise in credit costs, which could happen in a down cycle,” S&P said.

The agency notes that some consolidation in the banking sector is underway, with three mergers pending, and the regulator’s imposition of increased minimum capital requirements will make it harder for small banks to operate in future. If consolidation negatively affects the view of industry stability, S&P will likely revise downward the assessment of industry risk.

“As opposed to precrisis financing by Kazakh banks, we expect continued growth in corporate and retail deposits to fund lending growth, with very limited recourse to wholesale funding in international capital markets,” S&P said.