Kazakh Banks: Growth Risks
Dmitriy Angarov (junior director), Aleksey Kechko (junior director), James Watson (senior director), the Fitch Ratings international agency’s banking analysis group
Despite its relatively small size1, the banking sector of Kazakhstan is now showing quite high growth rates. Between 2001 and the first half of 2006, its assets grew by an average of 62%, making it one of the world’s fastest-growing banking sectors. This growth was mainly thanks to rapid economic development (high nominal GDP growth rates), a low starting basis and a low level of banking services penetration. Aggressive growth strategies adopted by the banks themselves also played a role. As a result, the banking penetration level, defined as a ratio of combined assets to GDP, reached 61% as of the end of 2005 (63% in the end of the first half of 2006). This is the highest level in the CIS. For example, it stood at 47% in Russia in the same period, and combined bank assets didn’t exceed 51% of GDP in Ukraine as at the end of 2005.
1. The combined assets of the Kazakh banks stood at about $45bn as of the first half of 2006, which is comparable to an average bank in a developed country.
Nevertheless, when the level of banking services penetration in Kazakhstan is compared with the other countries which have a rating of BBB (Graph 1), Fitch believes that this sector’s potential has not yet been fully exhausted. The further growth of the system, the agency predicts, will rather be in three main aspects: firstly, retail banking services, namely growth in banking services offered to individuals and small and medium-sized enterprises; secondly, expansion to neighbouring countries, the most attractive of which is Russia; and thirdly, in addition to banking services, the emergence of financial supermarkets covering other financial services, above all, insurance, leasing and pension funds management.
According to forecasts made by the Kazakh banks and collected and summarised by Fitch, between 2006 and 2009 assets and loans are expected to grow by over 200% and loans issued to individuals by almost 400%. This will lead to the banking penetration level growing from 61% in 2005 to 95% in 2009 (Graph 2). However, the growth rate will somewhat slow to an average of 25-30% a year in 2008-2009. However, the achievement of these targets, Fitch Ratings believe, is a complicated task: the high current and future levels of expansion, for example in segments characterised with higher risks (construction and small and medium-sized businesses) or in segments where the banks lack experience (retailing and the Russian market), cause higher credit risks.
It should be noted that a number of quite significant risks are posed to the banks by the fact that the growth in the sector is funded significantly by loans received from international markets. That credit ratings were raised helped Kazakh financial organisations access world capital markets and (taking into account the scarce opportunities to attract funds in the country) the banks didn’t fail to make use of this chance. As a result, this led to a significant growth in the banks’ foreign borrowings, including in the form of eurobonds, syndicated loans and direct loans from international financial organisations. For example, the average annual level of growth in foreign funding reached 78% in 2003-2005. For comparison, growth in corporate funding and growth in the retailing segment stood at 63% and 32% respectively in the given period.
According to estimates made by Fitch, the Kazakh banks’ foreign borrowings reached 36% and 37% of their total liabilities as of the end of 2005 and the first half of 2006 respectively. However, this indicator for the country’s six largest banks varied from 25% to 48% (Graph 3). This shows the different level of exposure to the risks linked to excessive growth in foreign borrowings. It should be noted that an increase in long-term foreign funding diversified and cut the cost of the banks’ liabilities. This also helped significantly increase the issuance of long-term loans and expand a range of banking services in such spheres as the pilot funding of capital spending, investment in the construction sector, mortgages and the issuance of long-term loans in security of property. However, in addition to obvious macroeconomic risks, the fast accumulation of foreign debt exposed the banks to significant structural risks such as:
· Refinancing risks, particularly in terms of large loans and when investors’ mood changes negatively towards the Kazakh banks, including political risks;
· Until now the banks transferred forex risks to borrowers instead of managing their forex positions through off-balance-sheet instruments and hedging. The agency believes that significant part of loans in foreign currency potentially increases the credit risk, particularly in the segment where borrowers have no direct access to foreign currency earnings or wages.
It should also be noted that in the first half of 2006 the regulator2 quickly adopted certain measures to curb foreign borrowings. This was due to concerns over extremely high rates of growth in the private sector’s debt (78% of GDP against the public debt standing at 5% of GDP in late 2005) and its impact on inflation and additional risks faced by the banks. However, Fitch believes that these measures will not curb the banks’ desire for foreign funding, taking into account the limited possibilities in the domestic market and the Kazakh economy’s high demand for investment.
2. Agency for the Regulation and Supervision of the Financial Market and Financial Organisations
At the same time, Fitch Ratings analysts believe that the quality of the regulation of the banking sector in Kazakhstan is quite high for a developing market. This reflects the good level of the development of the regulator, the significant level of the sector’s consolidation, high standards of financial accountancy and conservative, prudent standards. The agency also notes that the Kazakh banking system is very concentrated. For example, the assets of the three largest banks (Kazkommertsbank, Bank TuranAlem and Halyk Bank) account for about 60% of the total assets (Graph 4). However, average banks, which have more aggressive growth strategies, increase their client bases and market shares faster than the leaders. Given the differences in growth strategies and the possibility of foreign players entering the market (whose presence is barely noticeable now), Fitch expects the further correction of market positions among the top 10 banks. However, the agency does not predict major take-overs in the top segment of the market.
The most serious risk for the Kazakh banks is a credit risk. Its main component (in terms of size and costs exposed to the risk) is the issuance of loans to clients. Loans issued to construction and trade companies dominate the banks’ corporate credit portfolios. Fitch believes that the construction sector is exposed to higher risks than other sectors of the economy. In addition, relatively risky spheres for loans are small and medium-sized enterprises and foreign clients.
The agency notes that the growth in personal incomes in recent years led to a growth in spending on consumer durables and property and an improvement in borrowers’ credit standings. Combined with the banks’ development strategies this led to a significant growth in loans issued to individuals – both in absolute terms and as share of GDP – since 2002 (Graph 5). However, this market has further growth potential thanks to the moderate level of loans issued to individuals – 9.2% of GDP in 2005 and about 10.7% of GDP in the first half of 2006. In general, it is lower than in more developed markets in central Europe. As of late 2005, this figure stood at 15.3% of GDP in Poland, 16.1% in Hungary and 13.6% in the Czech Republic. In addition, many segments of the market such as loans for buying cars, credit cards and overdrafts are still underdeveloped in Kazakhstan. According to forecasts made by the banks themselves, the growth rate of loans issued to individuals will be 49% between 2006 and 2009, and they may reach 3.267 billion tenge in late 2009 against 669 billion tenge in 2005.
Loans for small and medium-sized businesses are also growing, although not as quickly as loans for individuals because of a number of structural shortcomings, for example the absence of efficient scoring models to assess small and very small companies, time-consuming processes of considering and approving loans (which increase the banks’ administrative costs) and non-transparency in these companies and a lack of liquid security. In order to ensure a high growth in loans for small and medium-sized businesses it is necessary to take a set of measures to solve these problems and reduce loan risks, which always emerge when this segment’s share grows in the banks’ credit portfolios.
In general, Fitch believes that the quality of assets and setting funds aside in terms of loss-making loans is at an acceptable level at the moment. However, with a full economic cycle nearing its end, these indicators may worsen. In addition, there is the possibility that the banks, which aim at riskier segments of crediting and which do not invest enough funds in managing risks, may face significant losses in the near future. As was mentioned earlier, another potential risk is that a significant share of loans in the banks’ portfolios is in foreign currencies. They may increase the emergence of problem loans in case of a long and/or sudden depreciation of the national currency against the dollar.
However, the agency points to the continuing high levels of the banks’ profitability. The quality of their revenues is acceptable. There is a notable improvement in the efficiency of costs, which significantly compensate for a reduced margin notable in the corporate sphere. But the banks with bigger shares in the retail banking market or specific players (for example, Halyk Bank and Bank Caspian) have higher net profits than the players who have just entered this segment of the market (Graph 6). Fitch believes that when there is no significant growth in loss-making loans the profitability of the sector will remain at a good level. It will be supported by the development of the more profitable retail business and expansion in the banks’ activities.
The agency considers the current capitalisation level acceptable, which is to a certain extent linked to the strict regulations. Markets for first-level and second-level capital instruments ensure certain flexibility, but the rapid growth of operations demands regular injections. Nevertheless, timely and sufficient injections of capital in the form of ordinary shares from the main shareholders of the banks may be insufficient for supporting forecast growth rates, especially taking into account the continuing concentrated structure of shareholder capital and possible exhaustion of the main shareholders’ free resources. Some banks can be registered as banking holdings which allows for lower levels of capital adequacy. However, Fitch reckons that this will only improve the situation with the capitalisation level for a short period.
Given this factor’s ability to attract additional capital some Kazakh banks intend to place IPOs. For example, Kazkommertsbank had already placed its shares in November 2006, whereas Halyk Bank and ATF Bank have announced plans to place IPOs in 2007. Bank TuranAlem and Alliance Bank have also said that the most possible strategy to attract capital for them will be IPOs. Bank Caspian (in which the Baring Vostok Capital Partners direct investment fund intends to buy 51%) and Bank CenterCredit will most likely choose to attract strategic partners. As a result, with a further growth of assets maintaining acceptable indicators of capitalisation will become an important factor to assess the individual ratings of Kazakh banks.
Justification of Ratings
Fitch believes that if need be the country’s six largest banks will most likely receive support from the state. As a result, their default ratings of issuers are determined by a support factor. The Kazakh banks’ ratings are generally higher than the ratings of other private banks in the CIS (Graph 7).
At the same time, assessing the financial steadiness of the Kazakh banks separately, i.e. their individual ratings too, Fitch considered the following factors:
· the very high rates of loan issues, including in new and potentially riskier spheres;
· the high level of concentration of borrowers;
· significant refinancing risks and structural risks linked to dependence on foreign funding;
· some concerns over corporate management; and
· the continuing high risks specific to the environment in which the banks operate.
However, the individual ratings reflect the following moments:
· the generally good quality of regulations in the banking sector;
· the sufficient level of consolidation of the sector, which not only helps regulation, but also gives significant advantages to the banks in terms of the client base and the scale of activities;
· the quality structure of the banks’ business with the low level of operations with linked sides and non-core activities;
· quite high levels of profitability which have been supported by low losses from loans;
· the acceptable level of adequacy at the moment which is supported by long-term funding and quality liquid assets;
· the low level of speculative trade operations; and,
· in many cases, the current acceptable level of capitalisation.
The full version of The Kazakh Banking System and Regulations: Growth Risks report was published on www.fitchresearch.com on 16 November 2006. You can find detailed information on the agency’s activities and the meanings of ratings given, as well as analytical reports on issuers rated on www.fitchresearch.com or www.fitchratings.ru
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