Kazakh Govt Moves To Rebuild Country’s Banking Sector

Dec 23. Dow Jones. ALMATY

By Kadyr Toktogulov

Kazakh Govt Moves To Rebuild Country's Banking SectorThe Kazakh government has a strategy to rebuild the country’s banking sector after its near-collapse over the past year-regulating financial companies heavily during periods of growth but easing restrictions when the economy slows and credit dries up.

The proportion of nonperforming loans in Kazakh banks’ portfolios shot up over the past two years, to above 30% this year from over 3% in 2007, amid the global economic slowdown and as cheap foreign funding disappeared.

In February, the government was forced to inject capital into BTA Bank (BTAS.KZ) and Alliance Bank (ASBN.KZ), Kazakhstan’s second-largest and sixth-largest banks by assets respectively, to prevent them from failure, as their bad loans and inability to repay foreign debt of over $10 billion and $4 billion respectively weighed on the whole banking sector. Former senior executives of both banks are now either under arrest or wanted for what law-enforcement agencies and the financial regulator said were fraudulent transactions.

In addition to BTA and Alliance, BTA subsidiary Temirbank (TEBN.KZ), Kazakhstan’s 10th-largest bank by assets, defaulted last month on its foreign obligations, which included Eurobond issues of $500 million and $300 million maturing in 2014 and 2011, respectively.

All in all, the government has provided around $19 billion to prop up the economy through the banks, including about $5 billion in equity participation and direct deposits. Kazakhstan, the energy-rich Central Asian giant with a population of 16 million, has 38 registered banks, with the top five controlling over 65% of banking sector assets. London-listed Kazkommertsbank (KKGB.KZ) is the country’s largest bank by assets.

To prevent the sector from repeating its recent mistakes, the government now aims to encourage banks to rely less on foreign investment and focus instead on domestic business, such as corporate and retail deposits.

The first step toward rebuilding the financial sector will be legislation to back the theory. The legislation is almost certain to pass, as the government controls parliament.

Under the latest plan, the regulator wants banks to make higher provisions on their loan books, in percentage terms, as loans rise, and it would toughen penalties for fraud and mismanagement by senior executives, board members and shareholders. The regulator has also said it will probably cap banks’ overseas borrowing to avoid overexposure to the foreign capital markets.

The basic principle behind the new regulation is combining oversight of the banking sector as a whole with regulation of individual institutions, Yelena Bakhmutova, chair of the financial supervision agency, told Dow Jones Newswires. “The concept envisages that the financial sector’s development won’t differ too much from the GDP growth of the country. I believe this is justified as it will lower risks of potential systemic crisis,” she said.

Kazakh banks have welcomed the new countercyclical approach to regulation, saying it would help them avoid the market’s previous bubbles and excesses.

“What I agree with in the concept is the counter-cyclical regulation, which will be tightened in booming times and eased during economic slowdowns and a drop in lending,” Halyk Bank (HSBK.KZ) Chief Executive Officer Umut Shayakhmetova told Dow Jones Newswires.

Alexander Picker, CEO of UniCredit’s (UCG.MI) Kazakh unit, ATF Bank (ATFB.KZ), Kazakhstan’s fifth-largest bank by assets, said the new regulatory environment in the sector should improve risk management, a lack of which led to the banks’ current troubles.

“I hope there will be a more conservative approach to loans,” Picker said. “There were times in Kazakhstan when banks ran after customers and speculative deals, which is never a good idea.”

Banks Worried About Competitiveness  

But banks are also concerned that the tougher regulation may make the Kazakh financial sector less competitive than those of neighboring countries, including Russia and China, and in the West.

They say a balance between regulation and growth is important if Kazakh banks, which were the first of the former Soviet bloc to fall prey to the crisis, are also to lead the way out.

“We asked the government to make a comparative analysis between Kazakh, Russian and Western financial sectors so that Kazakh banks do not end up in a stricter and less-competitive environment after the new regulation kicks in,” Shayakhmetova said.

“Russian banks will have more opportunities to expand into foreign markets, including Kazakhstan, if they aren’t burdened by tougher regulation and aren’t limited in foreign borrowings and investments.”

Both the regulator and the central bank say Kazakh banks won’t be at a disadvantage in the local market compared with their foreign peers as they will be subject to the same regulation.

“We’ve witnessed that Kazakh banks’ main competitive advantages are the knowledge of the local market’s specifics, an ability to quickly and flexibly adjust business practices,” Daniyar Akishev, a deputy governor at Kazakhstan’s central bank, told Dow Jones Newswires. “That has worked better in Kazakhstan than just large resources of [foreign-owned banks’] parent companies.”

Government Keen To Restart Bank Lending But Banks Reluctant  

The authorities also say they would like to see banks increase their lending to boost economic growth. But banks remain cautious, as their main concerns are their portfolio quality and the state of the Kazakh economy.

Kazakh gross domestic product contracted by 2.2% on the year in the first three quarters of 2009. The economy grew 4% on the year in the same period last year. The government expects the economy to grow by just 0.1% this year, after a 3.2% rise last year.

Central bank Governor Grigoriy Marchenko said at a press briefing last month that the central bank was trying to discourage commercial banks from keeping their cash in central bank deposits by cutting interest rates. He said the banking sector’s cumulative free liquidity was over $8 billion.

“We would like to see a growth of credit to the real sector of the economy,” Marchenko said. “We all understand that the expansion of credit is important for the economy to start growing.”

The government has supported lending in the past year by injecting money into the sector through its refinancing and capital injection programs.

“The question of whether lending growth will resume in Kazakhstan will be entirely dependent on how significant the pressure to shrink balance sheets will remain in the future,” UBS said. “At the moment, there is no sign that this is easing.”

A New Approach To Investing In Kazakhstan  

Meanwhile, BTA and Alliance’s defaults on foreign debt have made it even more difficult for Kazakh banks to borrow in international markets, though Halyk’s Shayakhmetova says foreign investors were to blame for their own losses.

Shayakhmetova said following their experience with BTA and Alliance, foreign investors would be forced to look at Kazakh banks individually and assess their risks, capital, liquidity and portfolio quality individually.

“Everybody has learned a lesson from the crisis,” Shayakhmetova told Dow Jones Newswires. “And most importantly, foreign investors have learned a huge lesson about Kazakhstan’s financial sector.”

“Investors also realized that the state will not be liable for their money in case a bank they have lent to has failed. The ‘Too Big Too Fail’ policy doesn’t cover foreign liabilities and foreign investors,” she said.

Despite the uncertainties, banks are cautiously optimistic about the prospects for their business next year.

“We’re optimistic about the next year as long as there are no external shocks,” Shayakhmetova said. “Even if we have 20% of provisions this year and stay at this level next year, then we won’t see extra charges on our portfolio and we’ll start seeing good profits.”

London-listed Halyk, Kazakhstan’s third-largest bank by assets, prides itself in being least hit by the global financial crisis because of its more tightly managed foreign debt. The bank also boasts of its more conservative lending practices.

Halyk’s moderately optimistic expectation is echoed by its rival ATF.

“I do think we have reached the bottom already,” ATF’s Picker told Dow Jones Newswires when asked about the direction of nonperforming loans across the sector. “Though I’d be cautious.”

“The recovery in the banking sector should start showing once the debt restructuring by BTA and Alliance is out of the way,” Milena Ivanova-Venturini, a banking analyst at Renaissance Capital, told Dow Jones Newswires.

BTA said earlier this month that it had set the terms of a deal to restructure its $10 billion debt, and the regulator has given the bank a March 23 deadline to get the creditors’ votes to complete the restructuring. Alliance gained its creditors’ final approval for its debt restructuring plan last week.

“What you will see post debt-restructuring is a very unleveraged sector with a lot less foreign borrowing, which would likely come below 15% of GDP [down from 44% of GDP at the peak],” Ivanova-Venturini said.

Kazakhstan’s banks will “look cleaner and stronger. The hope is that this will come with better risk management practices in the short to medium term,” she added.