A CROWDED, BUT ORDERLY HOUSE

Kazakhstan 2017 | FINANCE | REVIEW: BANKING

Imprudent business practice during boom times, volatile commodity prices, and currency turmoil have sent lasting shivers through Kazakhstan's banking sector. Yet bold remedial moves from the authorities have brought relative recovery to a listing economy.

Kazakhstan's banking system is overseen by the National Bank of Kazakhstan (NBK), accountable to the president. Its merger with the Financial Supervision Agency in 2011 cemented this role, and its significance in recent times is clear. Below that structure operate 38 commercial banks, a state-owned institution, and 16 banks where foreign ownership in excess of 30% grants them a role in the local arena. By way of contextualizing the sector, as of June 1, 2016 total sector assets accounted for 58.5% of GDP, with loans and customer deposits respectively on 37.4% and 39.2% of GDP. A concentrated market, official data reveals that as of June 1, 2016, 57.8% of total sector assets were in the hands of the leading five players. Meanwhile, of consequence for sector competitiveness, their respective shares in the total loan portfolio and total customer deposits were at 62.9% and 58.7%.

According to NBK data, the liabilities of banks reached KZT21.32 trillion in June, 2016, up 0.2% YtD. The largest component of these liabilities was customer deposits of KZT16.04 trillion, at 75.2%, and outstanding securities at 9.3% of the total, up 2.8% since the start of last year. Corporate deposits were at 56.5% of customer deposits, up 3.9% since the beginning of 2016. Individuals' deposits had risen 1.3% YtD to KZT6.98 trillion. And in terms of sector performance, the banking sector's total net income printed at KZT175 billion. Sectoral Return on Assets (ROA) was at 1.37%, down from 2.01% YoY, while return on equity (ROE) of 12.1% was shy of the previous year's 15.96% showing.

The dilemma of NPLs

Before we examine the NBK's aforementioned remedial moves, it is worth grasping the deep-rooted problems they targeted. Lending is part and parcel of a bank's growth trajectory. Yet only recently has Kazakhstan introduced stipulations that would mitigate, if not ultimately erase, the specter of NPLs. The sector's persistent NPLs are an agglomeration of those sustained before and subsequent to the global financial crisis, and by 1H2014 official data put them at 33.7% of the sector's outstanding loan portfolio. And while government policy and NBK stress testing had seen this decline by 10.6%, to 23.1%, a year later, and to 8.2% by start-June 2016, NPLs remain a sticky challenge. Qazkom, the nation's biggest lender, bought BTA Bank, nationalized post crisis, which had a staggering NPL rate of 89% at the time. Since then there have been numerous ratings downgrades in the sector on this basis. On example was S&P's July 2016 downgrade of Halyk Bank, which while apparently the most capitalized among the leading players, was downgraded from BB+ to BB in light of NPLs that had climbed to 11.2% in mid-2016 from 9.2% at end-2015. Official data shows that as of 1H2016 sectoral provisions for the combined loan portfolio of KZT1.6 trillion were in place, at 10.5% of the loan portfolio, unchanged from the start of the year. Since the government has stumped up over USD10 billion to shore up the banking sector in its darkest hour, it is determined for NPLs to be hamstringed once and for all.

The NBK has established a USD2.8 billion NPL-specific fund to help the banks deal with their demons, while a year ago fresh regulations also increased the equity-deposit ratio. And rather than rely on the sovereign wealth fund to rescue the system from of any future calamities, it has also taken IMF recommendations to heart by acknowledging NPL ratios as an alarm bell of distress. Yet according to the Economist Intelligence Unit, it seems that sector-wide NPLs will not decline much below 10% soon, as, ironically perhaps, improved transparency in financial reporting may yet reveal previously undeclared loans within the special-purpose vehicles of businesses.

Lending & Deposits

Regional turmoil and commodity shocks have seen Kazakhstan's real GDP growth slip from 4.3% in 2014 to 1% in 2015, and to 0.4% YoY in January-September 2016. This has exacted a price on consumer and business sentiment. Deflated performance has naturally taken its toll on credit growth, as citizens and businesses alike, uncertain of the future, avoid potentially crippling indebtedness. As of June 1, 2016 the combined assets of Kazakhstan's banks stood at KZT23.9 trillion, up 0.6% YtD. The key asset category was the loan portfolio, at 59.7% of total assets, though down 1.6% since the start of the year. Individual loans as of June 1, 2016 were at KZT3.71 trillion on 24.2% of the loan portfolio, having slipped 4.3% from January. And meanwhile, retail loans of KZT2.48 trillion, which made up 16.2% of the loan portfolio, had declined by 5.5% since the start of 2016.

The Long Game with Corporates

Corporate loans were at KZT6.8 trillion, on 44.5% of the loan portfolio but down 6.8% year to June. Eldar Sarsenov, the Chairman of Nurbank, explained the reality that requires qualified lending flexibility to corporate clients, which account for the bulk of the bank's loans. “Most (corporates) have business units that are struggling... we usually try to invigorate the management or provide some extra funds to kick start what their business needs to continue producing, or providing services.” What this amounts to is “a second, third, and fourth chance to jumpstart their business again.”

Currency Shock

The currency, too, has taken a battering in recent years, with tough love from the NBK ensuing. Once the conclusion was reached that low oil prices were the new norm, in August 2015 Kazakhstan floated the tenge, which within a day had devalued by 30%, raising the banks' burden of foreign debt service. This in turn dented asset quality and profitability, leaving many to wonder if the sector could, or should sustain so many players, some still battling their NPLs. To counter this FX blow, the NBK increased the maximum permissible tenge deposit rate to 14% from 10%, while also curbing FX-denominated lending through a lower maximum FX deposit rate of 2%. Furthermore, granting the sector some breathing space, the NBK has postponed the deadline for adoption of the Basel III regulatory framework from 2019 to 2021. As of June 1, 2016, the share of household deposits in FX had declined to 70.6% from 79.1% at the start of the year

Consolidation a Solution?

According to Askar Smagulov, the CEO of Altyn Bank, a consulting company examining the local banking universe, “the total number of people in Kazakhstan who qualify as affluent or middle-class by western standards is 100,000.” Indeed, when resources become scare it is a question of time before the big game turn cannibal. Meanwhile, Eldar Sarsenov, the Chairman of Nurbank, told TBY that minimum bank equity levels by 2021 will have risen tenfold from today's levels, to KZT100 billion, which will spur consolidation, “with only Qazkom, Halyk Bank, Bank Centre Credit, Sberbank Kazakhstan, and ATF Bank meeting these requirements.” In fact, in late January 2016 merger talks between the nation's two largest banks Halyk Bank and its majority shareholder, Qazkom, were confirmed, leading to an immediate 11.4% loss for the shares of the former and converse 6% rise in those of the latter at the stock market. To put this into context, as at December 1, 2016 Qazkom ranked first in the sector by assets on KZT 5.21 trillion (USD15.7 billion), thus over 20% of the total, while Halyk Bank followed on assets of KZT4.64 trillion (USD14.02 billion) in excess of 18% of total sector assets.

Enter IFC...

In 1993 Kazakhstan joined the International Finance Corporation (IFC), a component of the World Bank, in efforts to galvanize its private sector for diversified economic growth. Initial IFC advisory services graduated to actual investment in 1997, since when it has invested around USD1.4 billion of long-term finance, in support of 57 sector-diverse private sector projects ranging from energy and manufacturing to the financial sector itself. This has made Kazakhstan the IFC's principal client in Central Asia.

...And Hello SME

The government is working to assist Kazakhstan's SMEs, which it perceives as holding the potential for future economic growth. A dilemma faced, therefore, is the fact that necessary provisioning for bad loans, while vital for the banking sector per se, are a bitter disappointment for thousands of smaller firms by limiting credit availability. Back in 2014, the government had amended tax legislation to extend income tax relief for the write-offs of bad loans. Yet the banks had also seen a pronounced liquidity crisis as the currency devalued, which in turn limited their ability to lend to the key SME sector. State support for the banking sector has seen much of the national stimulus and infrastructural programs passed through it to support balance sheets. Askar Smagulov, the CEO Altyn Bank, explained that his institution engages in SME lending related to these programs that is more palatable to small businesses. “Normal lending rates are around 15-16%, while the government programs allow us to lend at lower rates of around 12%.” Damu is Kazakhstan's Entrepreneurship Development Fund, established in 1997 by Decree No. 665 on the establishment of the small business development fund. It has, since 2015, played financial agent for SMEs, extending loan guarantees to the banks towards fulfillment of the national Business Road Map 2020. Loans to SMEs had reached KZT4.58 trillion as at 1H2016, comprising 29.9% of the total loan portfolio, having risen by 8% since the start of the year.
Kazakhstan's banking system will likely have fewer players once 2021 rolls around and it simply becomes too difficult to meet stipulated minimum requirements. Because the NBK has balanced on one hand the need to support business with the need for a robust sector on the other, the resultant adequate checks and balances make financial crises brought on by economic turbulence unlikely.