Encore, Encore. Banks Borrowing More, Control Getting Stricter
The potential risks linked to the outstripping growth of Kazakh banks’ foreign borrowings are increasingly causing more concern for the Financial Control Agency, as well as all those who follow the development of the financial sphere. Unsurprisingly, a round table on this topic was one of the most interesting sessions at the conference “Exploring Kazakhstan’s Potential” held by the Fitch Ratings agency in Almaty on 27 February 2007.
The Best is the Enemy of the Good
The main trend in the development of the domestic banking sector in the past few years is the unprecedented growth in the combined assets of the second-tier banks. According to the Financial Control Agency, the figure almost doubled over the past year alone to 8,872 billion tenge in early 2007. As a result, in terms of banking services penetration (defined as the ratio of assets to GDP), our country outperformed all its CIS neighbours (Russia’s figure is half of the Kazakh one), as well as developing countries such as Argentina, Brazil and Hungary. Actually, the growth rates make the banking sector a genuine locomotive of the Kazakh economy. Kazakh banks’ loan portfolio grew by 97.5% to 6,000 billion tenge last year alone. Moreover, these were mostly loans issued to the non-extractive sector.
However, there is a “but” here. In building their resource bases many local banks mainly rely on borrowings from foreign investors. For example, the share of foreign securitisation in the banks’ liabilities exceeds 50% on average and for some banks it even exceeds 65%. The junior director of the Fitch Ratings Group, Aleksey Kechko, said in his report at the conference that this hid a number of potential risks. Firstly, these are refinancing risks constituted by foreign investors shying away from the Kazakh banking sector and some banks. As a result, these banks may not be able to prolong their credit facilities — a very popular move with Kazakh second-tier banks at the moment. In this case, banks would either have to scale their businesses down or find another source of securitisation, possibly more expensive and with worse conditions. The second risk relates to liquidity and profitability. If the foreign investor decides to leave suddenly the bank may not have any liquid assets to repay the debt. Moreover, large amounts of foreign loans are currently being received. Of course, banks need some time to place the funds attracted and while paying loans off they need to accumulate liquid assets in advance to pay them off on time. All this has a negative effect on profits.
Another risk, singled out by Aleksey Kechko, is the dilemma between foreign exchange risks and credit risks. It is clear that foreign loans are received in foreign currency, and banks have two choices: either shift currency risks onto their clients or keep them in their books and hedge it themselves. About 50% of loans are now issued in foreign currency to Kazakh second-tier banks. This means that banks often prefer to shift the risk of currency fluctuations on domestic borrowers, who do not often raise revenue in foreign currency and this, again, increases the risks.
Finally, there is the fourth risk — interest risks. Interest on foreign securitisation and loans depends on the situation on the global markets. They may grow significantly and it is not absolutely obvious that banks would be able to place their funds on good terms in Kazakhstan.
Fight against Windmills or …
The flow of capital from abroad at low costs increases second-tier banks’ resource bases and, consequently, boosts banking operations. However, this also increases the sector’s exposure to the aforementioned risks. The Financial Control Agency is concerned about the high volatility of short-term bonds and banks’ practice of attracting short-term foreign loans to fund long-term projects in the country.
As a result, the agency took a number of measures in the first half of 2006 to, above all, reduce the share of short-term bonds and to increase the banking sector’s foreign exchange liquidity. In his report the chairman of the agency, Arman Dunayev, said that the agency had not tried to curb foreign loans — the aim was to reduce risks linked to these loans. In particular, it set limits for foreign currency liquidity depending on the term of loans, introduced a maximum limit for short-term liabilities to non-residents being equal to the bank’s own capital and reduced certain limits on foreign exchange positions. By doing so the regulator tried to change the structure of loans received by Kazakh banks, so that short-term liabilities to non-residents, which are paid off first in case of a default, do not dominate. Arman Dunayev said that this target had been achieved — the share of banks’ short-term liabilities to non-residents halved (from 22.3% on 1 April 2006 to 11.8% on 1 January 2007).
Generally speaking, these measures did not solve the problem of the outstripping growth of foreign loans. Over the same period foreign loans in absolute terms almost doubled. In order to avoid restrictions set by the agency banks simply increased the term of syndicated loans, for example, from 365 to 370 days. Of course, when the economy is growing, oil prices are high and the tenge is appreciating, cheap foreign loans are indeed very advantageous to Kazakh banks. However, Dunayev said, while banks’ own capital is growing in arithmetic progression, their assets and loans are growing in geometric progression. In order to bring the ratio of capitalisation to foreign loans to acceptable levels the regulator decided to adopt additional restrictions from February 2007. It set two new coefficients:
• the coefficient of the capitalisation of banks to foreign loans as a ratio of foreign loans (excluding securities) to banks’ own capital. The standard rate varies from 2 to 4 units depending on the size of own capital with a step of 50 billion tenge;
• the coefficient of the capitalisation of banks to foreign loans as a ratio of foreign loans (including securities) to banks’ own capital. The standard rate varies from 4 to 6 units depending on the size of capital with a step of 50 billion tenge.
These standard rates are expected to be introduced stage by stage between 1 April 2007 and 1 March 2008. Moreover, by 1 April 2008 the size of capital should be brought in line with these standard rates.
Solicited a Truce?
The measures that are being taken by the Financial Control Agency to reduce risks constituted by foreign loans have come under repeated criticism from banks themselves. Sometimes the dispute between the regulator and bankers turned into open confrontation. However, comments made by round table participants on the latest innovations showed a consensus or, at least, a truce was maintained there. For example, the deputy chairman of the board of directors of Bank TuranAlem, Roman Solodchenko, stressed that the measures taken had been considered by a special working group involving an association of financiers. As a result, it proposed that terms and the coefficients be changed and that a transition period be introduced. Mr Solodchenko said that this form of interaction between the regulator and bankers was unique in the CIS and that it made it possible to regard the agency as the best monitoring body in the banking sphere in the CIS. He admitted that extraordinary growth rates might indeed have a negative effect on upgrading Kazakhstan’s sovereign rating and the ratings of banks themselves. Speaking about the reasons for these growth rates, Mr Solodchenko noted that the main factor here was the fact that the local market increased in 2006, in particular, the retail market and the small and medium-sized business market. Moreover, this growth became a surprise for banks themselves which did not even forecast it. On the other hand, supply also grew in the foreign securitisation markets. All this will most likely lead to banks increasing their capitalisation and increasing borrowing and issuing loans further. Mr Solodchenko believes that this process could be slowed down only by the local market itself. Its capacity is limited and the signs of a slowdown will be observed as early as in 2008. After the market is saturated banks will cut their borrowings. The future growth of the sector, Mr Solodchenko believes, will slow down gradually and its rates will be around 20% a year.
The chairman of the board of directors of the Seimar Alliance financial corporation, Zhomart Yertayev, also spoke against the singlemindedness of the regulator’s decisions. Moreover, he compared the Kazakh banking sector to a child “who is not allowed to attend school”. Mr Yertayev said that banks clearly realised responsibility they bore for economic stability and that they were taking their own preventive measures. That is why, he said, they have the right to insist that they should be able to express their position and that a compromise should be found jointly.
Fitch experts who acted as moderators noted that according to their forecasts in order not to cut their growth Kazakh banks would most likely fulfil the agency’s demands and in this case foreign borrowings and loan portfolios would continue to grow with the same fast rates. However, bigger capitalization will enable them to have a “good cushion” against risks entailed by foreign securitization and the rapid growth of assets.
Arman Dunayev said that if the demands to increase capitalisation are met, then this scenario would satisfy the agency quite well. He also stressed that there was an acute need to, above all, increase the tier one capital. Current shareholders should make direct injections in banks’ basic capital. If this is impossible they should attract strategic investors and the agency will only hail this move, he said. As for an IPO, Mr Dunayev believes, it would only partly solve the problems of capital growth and that a solution to these problems should come from current shareholders.
Asked about the possibility of introducing further restrictions on the growth of foreign loans, Mr Dunayev also said that a more direct and efficient measure was to increase the National Bank’s minimum reserve requirements. However, he corrected himself that there should be “a differentiated approach directly linked to the terms of maturity”.
Speaking about other aspects that concern the agency, Arman Dunayev singled out the growth of some banks’ consumer loans that are not secured, a negative impact of the possible destabilisation of the property market on the banking sector, mortgage risks and the quality of the loan portfolio in general. In addition, he emphasised that the default of the Valyut-Tranzit Bank was indirectly caused by the banks themselves which issued interbank loans to it, and that is why the agency had now to solve the problem of ensuring the transparency of banking account reports and tighten auditors’ responsibility. “The next two years are to test our banking and financial system in terms of adequacy, stability and the correctness of decisions taken,” Mr Dunayev said. He gave the assurance that the agency was ready to discuss emerging problems as well as take strict preventive measures.
Judging by this “agenda”, we can conclude that the arranged truce is rather a temporary, tactical measure…
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