IV. Financial Sector Developments53
100. Over the last three years, financial deepening has continued, with the ratio of broad money to GDP rising from 15.4 percent in 2000 to 20.4 percent in 2002. Although the role of financial services in the economy is growing, their share in GDP remains at only about 4 percent in 2002. Against the background of strong economic growth, high income from oil, and prudent monetary and fiscal policies, the banking system’s capacity to intermediate efficiently Kazakhstan’s financial resources is becoming more critical for sustainable growth. The capital market, comprising both stocks and securities, has been expanding rapidly. The private pension system is advanced compared to that of other CIS countries and has contributed to capital market development. Pension fund assets have been rising steadily to $1.7 billion at end-2002. The insurance market is very small, but emerging.
101. The key issues facing regulators are to generalize the significant progress made in banking supervision to the rest of the financial sector and to ensure that adequate risk management techniques are implemented, especially as capital account liberalization proceeds.
102. The rest of this chapter describes the latest developments in the banking sector, insurance, pension funds, capital markets and unified financial sector supervision.
B. Banking System
103. The banking sector, which dominates the financial system, has witnessed impressive structural changes since 2000. The size of the commercial banking sector in relation to GDP in Kazakhstan is among the highest in the CIS countries (Figure IV-1), but is far below comparable ratios in Central Europe or the Baltic countries.
Figure IV-1.Commercial Banks’ Total Assets in 2002
1/ The bar for Russia’s banking assets in U.S. dollars is not to scale.
104. Although the growth rates of the commercial banks assets and liabilities has slowed down, their share in GDP has been steadily rising since 1999 (Figures IV-2 and IV-3). This reflects a number of factors, including successful macroeconomic stabilization and growth since 1999, as well as significant legal and institutional reforms to raise public confidence in the sector.
Figure IV-2.Banking Sector Size, 1999–2002 Figure IV-3.Banking Sector Growth, 2000–2002
105. The banking system in Kazakhstan is highly concentrated (Figure IV-4). Kazkommertsbank, Bank TuranAlem and Halyk Bank have a combined market share of around 60 percent. The strong concentration of the banking system has occurred as a result of a number of closures and mergers caused by rising capital requirements and strengthened supervision since the 1998 Russian crisis. The NBK has taken an active role in leading the process of consolidation of the sector, which had 55 banks in 1999 but only 36 banks in 2002. The biggest banks are well ahead of smaller ones in implementing prudential requirements and adhering to International Accounting Standards. Segmentation of the banking sector also reflected the provisions of deposit insurance (introduced in late 1999), which prevented banks that did not comply with supervisory regulations from participation in the scheme.
Figure IV-4.Market Concentration; Share of Five Largest Banks, percent of total
106. The strengthened budget position has resulted in a “crowding in” of private investment in recent years. Banks had to compete for private sector lending opportunities as public sector credit demand turned negative. As of end 2002, credit to government constituted only 5 percent of the domestic credit of the banking system, the rest being channeled to the private sector.
|Total credit/GDP||Structure by currency||Structure by maturity||Structure by sector|
107. Commercial Banks’ lending to the economy has increased sharply as a share of GDP over the last three years (Table IV-1). More than 90 percent of loans were extended to the non-bank legal entities. The share of lending to households is rising slowly, but remains rather small due to the lack of quality collateral and high relative costs associated with the enforcement of creditor rights. Around 70 percent of credit is denominated in foreign currency (mostly in U.S. dollars). Following the Russian crisis one half of all loans had short-term maturities. A substantial shift to longer term maturities was observed in 2002. The share of credit to small and medium enterprises (SME), however, declined (Table IV-2). The structure of the loan portfolio by branches of the economy has been stable since 2000 with the banks’ exposure to industry and trade at above 60 percent (Figure IV-5).
|Domestic currency loans|
|Foreign currency loans|
|Loans to SME|
|Domestic currency loans||18||16.9||16.4|
|Foreign currency loans||14.3||15.0||14.3|
|Loans to SME as share of total loans||26.9||24.9||21.8|Figure IV-5.Structure of Loans by Sectors of Economy
108. Deposits constituted 70 percent of banks’ total liabilities over the last two years. The deposit-to-GDP ratio doubled to 16 percent of GDP between 1999 and 2002 (Table IV-3). The growth of the share of households in total deposits is a sign of increasing confidence in the banking sector. Around 60 percent of total deposits were held in foreign currency as of end-2002, with households keeping 70 percent of their deposits in foreign exchange. Since mid-2002, the share of households deposits in total foreign currency deposits has exceeded that of firms. The growing trust in the banking system has not yet been accompanied by a strong shift in preference for the domestic currency. This may be partially explained by the fact that the gradual nominal depreciation of the tenge since 2000 has resulted in valuation gains for holders of foreign exchange.
|Total deposits/GDP||Structure by currency||Structure by sectors|
|Tenge||Foreign exchange||Non-bank legal entities||Households|
109. The large banks have borrowed funds from the international capital markets. Five banks hold ratings from international rating agencies that enabled them to borrow at competitive international rates. Five issues of Eurobonds and several syndicated borrowings totaling $1.4 billion were registered in 2001–2002. Banks have reliably serviced these debts.
110. Transition economies are characterized by a considerable lag between lowering inflation and a decrease in nominal interest rates. Kazakhstan is not an exception (Figure IV-6). Persistence of high deposit rates for banks can be explained by the history of low confidence of households in banking system after the loss of savings twice since independence. High lending rates by banks can be explained in part by the risks associated with the uncertain enforcement of creditor rights. Weak competition among banks may also play a role. Moreover, competition from non-bank financial institutions still remains weak, as these institutions have only started to offer alternative sources of financing to enterprises.
Figure IV-6.Commercial Bank Lending and Deposit Rates, 1999–2002
111. Nominal lending and deposit interest rates have decreased by more than 4.5 percentage points since 2000. Interest rate spreads also narrowed by around 3.5 percentage points, but bank profitability has remained high. Deposit interest rates are to some degree administratively constrained by the rules under the mandatory insurance scheme, which exclude from insurance coverage deposits bearing higher than average interest rates.
112. The Deposit Insurance Fund has been in place since November 1999. The NBK initially capitalized the fund with Tl billion. At end-2002, the fund’s assets reached T4 billion, invested in government securities and deposits with the NBK. Of a total of 36 banks, 22 were included in the mandatory insurance scheme, with different contribution rates, depending on the degree of compliance with the NBK prudential regulations. Insurance coverage differs depending on the type, amount, and currency of households deposits. As a result, only about half of household deposits are covered by the scheme. Since its existence, the Deposit Insurance Fund has covered deposits of one small failed bank.
C. Pension Funds
113. Pension funds assets, as a ratio to GDP, have grown from 4.3 percent in 2000 to 7.2 percent in 2002. As mentioned in Chapter V, one of the main challenges continues to be the investment strategy for the rapidly growing funds. Accumulated funds provide a supply of long-term savings, currently unavailable in the banking system. These long-term funds are attractive targets for use in different development projects, including public sector ones. Investment policies are different for the state and private pension funds. The state pension fund invested 64 percent of assets in government and NBK securities, 20 percent in the commercial banks instruments and 16 percent in international financial institutions (IFI) securities as of end-2002. The investment portfolio of the private pension funds was more diverse, with 43 percent in government and NBK securities, 5 percent in banks instruments, 39 percent in domestic corporate securities, and 13 percent in high quality securities abroad.
D. Capital Markets
114. Over the last three years, considerable progress has been made in putting in place the institutional infrastructure for the proper functioning of the securities market. As mentioned above, the growth of pension fund assets has spurred the development of capital markets. In turn, the efficient functioning of the pension system will depend on the depth of the capital market, notably of profitable investment opportunities. Work is ongoing to bring the activities of brokers, custodians, asset managers, and actuaries in line with the requirements of the unified financial sector supervision. A corporate governance code was approved in 2002. Also, regulations have been passed to improve market practices and the quality of company listings.
115. The corporate bond market has grown to over $700 million since its launch in late 1999. It has contributed to increases in maturities, reducing interest rates, and better asset-liability management opportunities for financial system participants. The overwhelming majority of bond issues are indexed to the U.S. dollar. The creation of the mortgage securities market in 2002 was an important breakthrough, which is expected to contribute to the development of small and medium sized enterprises and the real estate industry.
116. Despite its name, the Kazakhstan Stock Exchange (KASE) remains primarily an organized place for trade in government securities (81.4 percent of total turnover in 2002), foreign exchange (12.1 percent), and corporate securities (3.1 percent). In 2002, the total KASE turnover amounted to $24.6 billion, an increase of 140 percent compared with 2001.
117. The insurance industry is still at a nascent stage in Kazakhstan. Over the last few years, there was a considerable consolidation of the sector, conditioned by increased capital requirements and strengthened supervision by the NBK. The size of the insurance market has remained low, with insurance premia amounting to only 0.6 percent of GDP in 2002 (Table IV-4). There is a growing demand for insurance services from the oil and gas, mining, and transportation sectors. Meeting these requirements is severely limited, however, by the low capitalization of the industry, which results in 68 percent of reinsurance premiums accruing to nonresidents. The development of other types of insurance, such as life and individual property, is limited by the absence of demand by households.
F. Banking Sector Supervision
118. The banking system soundness indicators are broadly satisfactory (Table IV-5). Capital adequacy ratios are well in excess of minimum Basel standards, and liquidity and profitability are high. The short-term liquidity coefficient, introduced in August 2002, registered 0.87 at the end of 2002, compared with the minimum of 0.4. The number of banks not in compliance with different prudential regulations decreased from seventeen at end- 2000 to one at end- 2002.
|Classified loans to total loans||44.7||23.2||31.0||28.7|
|Loan loss provisions to total loans||9.5||4.5||4.7||5.9|
|Loan loss provisions to classified loans||21.3||19.5||15.1||20.8|
|Loan to deposit ratios|
|In foreign currency||102.9||98.0||130.2||131.2|
|Tier I capital adequacy||15.0||14.0||11.0||9.0|
|Tier I and II capital adequacy||28.0||26.0||19.0||17.0|
|Return on assets||2.8||1.5||0.9||1.8|
|Return on equity||13.8||7.9||6.1||12.8|
119. The growth of Banks’ loan portfolios has slowed from around 80 percent in 2000–01 to 37 percent in 2002. The share of classified loans appears high at 30 percent in 2000–01 (Figure IV-7). Classified loans include, however, loans to new borrowers and also loans without collateral, even though these may be fully serviced on a timely basis. The announced plan to create a credit bureau with information available to all banks would facilitate lending to the new borrowers and especially to SMEs. The share of unsatisfactory, doubtful, and bad loans increased from 7 percent in 2000 to 9.4 percent in 2002.
Figure IV-7.Structure of classified loans, 1999–2002
120. Provisioning is reported to be more than adequate, and past history indicates that the ratio of recovery of bad loans is very high. Besides provisioning for classified loans, banks have the right to make provisions of up to 2 percent against standard loans. New rules for risk classification were adopted in late 2002, which set out the criteria for quality assessment of the Banks’ assets and liabilities.
121. Enhancement of the internal control and risk management systems is of high priority for banks and also for the NBK in its supervisory capacity. Assessment of the internal control and risk management in banks has been required by the NBK as part of the 2002 external audit exercise. These measures are expected to contribute to more balanced credit and investment policies by banks.
G. Unified Financial Sector Supervision
122. Over the last three years licensing and supervision of all financial market participants, including banks, securities markets, pension funds and insurance, was brought under the NBK responsibility. There has been a tendency of commercial banks taking stakes in other banks, private pension funds, insurance, leasing, brokerage and asset management companies. As a result, influential financial-industrial groupings dominate the sector. Thus the supervisor’s access to financial groups’ ownership information has become crucial for the assessment of capitalization and general health of the financial system. Legislation was passed in 2002, enabling the NBK to obtain information on the ownership of banks. Also, a financial groups division was created in the NBK supervision department. Uniform standards, conforming to International Accounting Standards (IAS), were introduced for accounting, auditing and reporting. The challenge for supervisors is to fully implement and enforce the new regulations in order to ensure sound and transparent banking practices. An independent supervisory agency is to be spun-off from the NBK in 2004.
123. There are clear signs of growing trust in banks in Kazakhstan. Financial soundness indicators have improved, with adequate capitalization, liquidity and profitability in place. The challenges for banks will comprise:
• Further building confidence to mobilize savings;
• improving profitability through stronger credit quality and containing operating expenses;
• meeting the credit needs of borrowers, especially of small and medium-sized businesses.
Financial sector development, with banks playing the central role, is advancing quickly from a low base. Enforcement and adequate implementation of unified supervision will be critical for the health of the financial system over the medium and long term. Looking ahead, the challenge for the system will be to extend effective supervision to the non-bank financial sector, within the context of powerful financial-industrial conglomerates.
Prepared by Veronica Bacalu.