The Republic of Kazakhstan
Financial System Stability Assessment
Author:
International Monetary Fund. Middle East and Central Asia Dept.
Search for other papers by International Monetary Fund. Middle East and Central Asia Dept. in
Current site
Google Scholar
Close

This Financial System Stability Assessment highlights that the global financial crisis exposed serious bank vulnerabilities in Kazakhstan. The authorities successfully contained the ensuing systemic crisis, however, left unaddressed important weaknesses that continue to linger. The government has nationalized three of the largest banks and restructured their external obligations, thus preventing a collapse of the banking system. The banks’ solvency situation is adequate but somewhat fragile as a result of legacy problems. A faster transition to risk-based oversight is needed. The relative vulnerability of banks to shocks warrants increased emphasis on risk. This can be achieved through the adoption of more advanced risk-assessment tools and a more extensive use of stress test results for risk analysis. The financial safety net and resolution framework were upgraded during the crisis but need further adjustments. The government amended the resolution framework in 2009 to incorporate several desirable features such as restructuring, purchase and assumption, and bridge bank. However, during the crisis it bypassed the use of sequential crisis management tools and nationalized banks and restructured their external liabilities. The resolution framework suffers from the absence of special authority and requires the approval of depositors and creditors. Adjustments to the Emergency Liquidity Assistance framework are needed to limit its availability to solvent institutions.

Abstract

This Financial System Stability Assessment highlights that the global financial crisis exposed serious bank vulnerabilities in Kazakhstan. The authorities successfully contained the ensuing systemic crisis, however, left unaddressed important weaknesses that continue to linger. The government has nationalized three of the largest banks and restructured their external obligations, thus preventing a collapse of the banking system. The banks’ solvency situation is adequate but somewhat fragile as a result of legacy problems. A faster transition to risk-based oversight is needed. The relative vulnerability of banks to shocks warrants increased emphasis on risk. This can be achieved through the adoption of more advanced risk-assessment tools and a more extensive use of stress test results for risk analysis. The financial safety net and resolution framework were upgraded during the crisis but need further adjustments. The government amended the resolution framework in 2009 to incorporate several desirable features such as restructuring, purchase and assumption, and bridge bank. However, during the crisis it bypassed the use of sequential crisis management tools and nationalized banks and restructured their external liabilities. The resolution framework suffers from the absence of special authority and requires the approval of depositors and creditors. Adjustments to the Emergency Liquidity Assistance framework are needed to limit its availability to solvent institutions.

Macro-Financial Setting and Financial Sector Overview

A. Unbalanced Economic Growth and Financial Vulnerabilities

1. Prior to the global financial crisis, Kazakhstan experienced high and unbalanced growth, and accumulated significant financial vulnerabilities (Figure 1). The non-tradable sector, particularly construction recorded unsustainably high growth rates fueled by a credit boom financed through wholesale borrowing, mainly from Europe (Figure 2). Between 2005 and 2007, Kazakhstan’s banks borrowed from abroad the equivalent of 44 percent of GDP and loaned a substantial part of those funds to non-tradable sectors. As financial conditions tightened with the onset of the global financial crisis, banks lost access to foreign financing and were forced to deleverage aggressively, triggering a decline in stock and real estate prices and a strong deceleration in non-oil economic activity, particularly in the construction sector. A 20 percent devaluation in 2009 further complicated matters, as widespread unhedged foreign currency borrowing led to further contractions in demand and problems with loan servicing.

Figure 1.
Figure 1.

Kazakhstan: Distribution of Loans and NPLs

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Figure 2.
Figure 2.

Kazakhstan: The Aftermath of the Crisis

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

2. The crisis prompted the intervention of several banks and the restructuring of their external liabilities, but bad assets were not addressed. The 2009 devaluation worsened the banks’ external debt servicing problems, prompting the government acquisition of majority stakes in three large banks (Alliance, Temirbank, and BTA) and minority stakes in another two (KKB and Halyk Bank). Despite the restructuring of some of these banks’ external liabilities in subsequent years, banks continued to face difficulties as the deceleration in growth, the collapse of real estate prices, and the devaluation led to a significant build up of non-performing loans (NPLs).

3. Banks’ balance sheet repair will be key to support effective financial intermediation and balanced economic growth. The marked deleveraging after the crisis did not represent a drag on economic growth because it coincided with a needed downsizing of the construction sector. Further, the subsequent pickup in growth amidst subdued private credit was possible because it was driven mainly by commodity exports—an activity that funds itself abroad—and by directed lending and government subsidies to other economic sectors. However, to achieve sustainable growth over the medium term, it will be essential to restore the normal flow of credit in the economy, for which banks’ balance sheet repair is of the essence.

B. Financial System Structure

4. Banks dominate the financial system in Kazakhstan. The banking sector consists of 38 commercial banks, which account for 77 percent of total financial system assets and 44 percent of GDP. Public sector assets represent 60 percent of total banking assets at end-February 2014.1 There are 17 banks operating in Kazakhstan, including 14 foreign subsidiaries. Kazakh banks have a presence in neighboring countries and in Europe.2

Figure 3.
Figure 3.

Kazakhstan: Structure of the Financial System

(Percent of Financial Assets)

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Source: NBKNote: Figures in parentheses indicate the number of institutions in each sector.

5. Although the five largest banks accounted for more than half of banking assets in 2013, concentration has been declining as medium-sized banks have expanded their lending. Several large universal banks and some foreign subsidiaries compete for large corporate clients. The smaller banks typically operate in niche markets, and a few banks specialize in SME and retail lending. The consumer lending market is fairly concentrated with the top three banks accounting for one half of the market share and the top seven for 76 percent.3 Some foreign subsidiaries focus on servicing companies that also operate in the home country of the parent bank, while others have actively expanded their market share in Kazakhstan to benefit from lower funding costs. Two global banks have exited the country in the past year.4

6. The public funded pension system, formerly comprised of ten private pension funds, accounts for 18 percent of the financial system. At the beginning of 2013, the government began a gradual process of nationalization of the ten private pension funds (owned by banks) with all assets to be consolidated in the Unified Accumulation Pension Fund (UAPF) by April 2014. The government is the single shareholder of the UAPF and NBK has the fiduciary management mandate. The nationalization was justified on the need to improve returns on the assets and minimize the risk that the minimum return guaranteed by the government generates a drain on fiscal resources.

7. The insurance sector and the rest of non-banking institutions are small. The assets of the insurance sector (34 companies) are 3 percent of total financial sector assets and those of mortgage companies and other non-banking organizations represent less than 1 percent each. The securities exchange (KASE) is quite small, with very limited activity in equities and corporate debt.5 The largest markets are those for foreign currency transactions among banks and government repurchase transactions made in the automated repo market.

Financial Sector Risks and Resilience: Recovery From the Crisis is Not Yet Complete

A. Banking Sector

The current situation

8. The crisis has had a lasting impact on the structure and solvency of the banking system. The reduction in wholesale funding triggered by the crisis prompted banks to revise their lending strategies in order to avoid duration and currency mismatches. As a result, the system has been streamlined and rendered less vulnerable to external developments, including the February 2014 devaluation. However, deep-seated vulnerabilities remain, as high NPLs continue to saddle banks, and little progress has been made until now in resolving the nationalized banks.

9. Weak underwriting standards, low asset quality, and low profitability are the main challenges for banks. The system-wide NPL ratio is about 30 percent, and NPLs are concentrated in the five largest banks and reflect mainly loans to corporations and SMEs. Banks’ return on assets (ROA) is low reflecting both low earnings and loan-loss charges. The system’s aggregate capital asset ratio (CAR) has stabilized at around 17 percent and the Tier I capital ratio has remained at around 13 percent in recent years, following the external debt restructuring and state-funded recapitalization of the state owned bank BTA. However, the capital adequacy of a number of banks is under pressure and banks are exposed to foreign currency risk, as 38 percent of loans are in foreign currency, mostly to unhedged borrowers.

10. The extent of bank weaknesses is understated by financial soundness indicators (FSIs). Longstanding concerns about collateral valuation, inadequate loan classification, and under provisioning have become more pronounced with the adoption of IFRS-IAS39 and the associated introduction of subjective factors in supervisory assessments, as supervisory skills have not been upgraded—see paragraph 59. While there is no estimate of the impact of these factors on capital adequacy ratios, the FSAP views the problem as potentially significant.

11. Credit growth has picked up slightly after years of stagnation, but rapid growth in the consumer segment raises concerns. Credit continues to grow at relatively moderate rates (about 13 percent annually), as state-owned energy and mining companies borrow abroad and investment outside the commodities sectors is recovering slowly. However, growth in lending by consumer oriented small- and medium-sized banks reached nearly 50 percent in December 2013, raising concerns about loan quality. High interest margins and the short maturity of this type of loan in the face of shortening funding maturity have made consumer lending attractive to banks.6

Figure 4.
Figure 4.

Kazakhstan: Credit Real Growth

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Source: Haver Analvtics

12. NBK announced macroprudential policies (MaPPs) to limit the growth in consumer lending, but more could be done to improve their targeting. On December 2013, NBK announced the introduction of three MaPPs, to become effective on April 1, 2014: a 50 percent cap on the debt-to-income (DTI) ratio, an increase in the retail lending capital risk weight from 75 to 100 percent, and a 30 percent bank-by-bank ceiling on growth in consumer loans—see Appendix I.7 While the first two aim at containing risks associated with further consumer lending, the ceiling on lending growth is a blunt instrument that will constrain lending irrespective of the quality of borrowers and may put some banks at disadvantage relative to others—it was nonetheless used due to NBK’s inability to monitor the DTI ratio. At present, data gaps seriously limit NBK’s work on MaPPs, but NBK should begin to monitor the effectiveness of the MaPPs once the coverage of data on consumer loans improves with the operationalization of the credit registry.

Figure 5.
Figure 5.

Kazakhstan: Dollarization and Wholesale Funding

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

13. Lower reliance on market borrowings has improved the profile of banks’ funding. Wholesale funding (bond and cross-border interbank borrowings) declined from its pre-crisis peak of 50 percent to 20 percent of the banking system’s total liabilities by end 2013. Owing to continued deposit growth of both retail and corporate clients and modest lending growth, the loan-to-deposit ratios for domestic and foreign currency have improved in recent years. However, the high dependence of large banks on a few corporate deposits poses concentration risks.

14. Foreign currency risk continues to be high. While lower dependence on foreign currency (FX) denominated wholesale funding has led to lower FX-related liquidity risk, dollarization keeps the economy vulnerable to exchange rate volatility and exchange rate-induced credit risk. The share of FX-denominated loans has declined by nearly 20 percentage points since 2009, while the share of FX deposits has risen and both shares now stand at a relatively high 40 percent. The impact of the recent devaluation on banks’ balance sheets should be confined to a worsening of credit risk.

15. The government has recently announced an economic reactivation program based on lending to SMEs, which poses additional risks. On February 21, 2014 the government announced its intentions to use 500 billion tenge to support the economy in 2014. Half of these funds, to be provided by the Kazakhstan National Fund, will be channeled to SMEs through the banking sector. Banks will receive government funds at subsidized rates to be onlent to SMEs at below-market interest rates. Banks are expected to bear responsibility for the credit risk associated with these operations, but there are concerns about their ability to properly assess their risk.

16. Government efforts to divest intervened banks have regained momentum. SK announced recently its intention to sell its 89.9 percent stake in Temirbank (13th largest bank) and 16.6 percent of Alliance Bank (the ninth largest bank) to a local businessman, who owns two smaller banks (Kassa Nova and ForteBank). The regulatory approval for the second of these transactions was granted recently and the sale would reduce the state’s participation in Alliance Bank to 51 percent. More recently, KKB, together with another local investor, has initiated the acquisition of equity stakes in BTA (see oversight section for risks on the transaction). SK would temporarily retain a minority stake in BTA.

17. Capital standards are disjointed. While Basel II has not been fully implemented, the authorities have introduced some features of Basel III.8 NBK has announced the adoption of Basel III definitions of capital, but not the risk weights. In addition, beginning in 2013, NBK introduced new rules for loan-loss provisioning under which banks would set up two types of provisions: specific provisions based on IFRS and dynamic provisions based on a formula provided by regulators—the adoption of dynamic provisions was suspended shortly after. There is a risk that these changes are being introduced too quickly and without sufficient guidance.

Banking Vulnerabilities

18. The financial sector is faced with a number of risks (Appendix III).

  • Lower than anticipated growth in emerging markets (EM), especially in China and Russia, with the latter possibly aggravated by the Ukraine crisis. This scenario, motivated in part by U.S. tapering, could impact foreign direct investment to the region, lower medium-term growth, and cause an additional decline in housing prices, further weakening credit quality. Echange rate depreciation would heighten indirect credit risks—if the central bank were to intervene, a loss in international reserves would take place, leading to tighter liquidity.

  • A sustained decline in oil and other commodity prices in an environment of weak global demand. This could lead to a fall in oil prices and lower the value of Kazakh exports. The result would be a marked deceleration in domestic growth and a depreciation of the tenge, both of which fuel credit risk.

  • Insufficient progress to bring down NPLs. These depress bank profitability, limit banks’ ability to increase capital and extend credit, and pose a contingent liability for the public sector.

  • Concerns about another devaluation, rapid consumer lending growth, and/or the inconsistent implementation of regulatory reforms could trigger a confidence crisis. System-wide deposit withdrawals and reduced access to wholesale funding could ensue, possibly triggering a liquidity crunch and/or asset fire sales.

19. The impact of these risks was quantified using stress tests.9 The tests were carried out in a baseline (consistent with the IMF’s World Economic Outlook (WEO) forecasts) and two stress scenarios characterized by temporary reductions in growth of different magnitude, stretching over a 3-year period ending in December 2016. The failure to bring down the high current level of NPLs—essentially a projection of the status quo—and the introduction of Basel III deductions (which impacts the estimated capital ratio) were assessed in the baseline. The hurdle rates were set at the regulatory minima, in line with Kazakhstan’s gradual phasing in of the Basel III minimum capital requirements beginning in 2015. The risks posed by lower-than-anticipated growth in EMs and a decline in oil prices were analyzed in the stress scenarios. The impact of a confidence crisis was assessed through a combined funding and market liquidity stress scenario (Appendix IV). To illustrate the potential impact of overvaluation of collateral and forbearance, an adjusted baseline was also calculated.10

20. The tests show that, while the situation of the banks is currently stable, they are in a weak position to withstand shocks.

  • In the baseline, credit losses arising mainly from the February devaluation and the phase-out of capital instruments ineligible under Basel III lead to a steady decline in the banking system’s capital ratio, partially eroding the initial buffers but remaining above the regulatory threshold—the Tier 1 ratio dips below the conservation buffer but also remains above the regulatory minima. However, seven banks accounting for nearly half of the system’s assets, fail to meet regulatory minima in the projections; the capital shortfall is equivalent to 2 ½ percent of GDP.

  • In the stress scenarios two additional banks fail to meet capital requirements, bringing the total to 9 banks accounting for slightly more than half of the banking system’s assets. Under the more severe scenario, the capital deficiency reaches 5 percent of GDP.

  • Banks that fail the tests in the baseline and stress scenarios include state-owned and private large banks, as well as smaller banks. NBK’s stress tests confirm these estimates.

  • In the adjusted baseline, the situation of the banks worsens significantly, highlighting the potential significant impact of inadequate valuation of bank assets and forbearance. No stress tests were conducted on this adjusted baseline.

21. The stress tests also reveal that FX-induced credit risk is elevated and loan portfolios are highly sensitive to changes in oil and gas prices. The tests shed light on the relative importance of various financial intermediation risks:

  • The exchange rate was found to be a key driver of indirect credit risk for both the corporate and the household/SME sectors, and oil and gas prices are also important determinants of corporate credit quality. On the other hand, direct FX risk is small in light of banks’ limited open positions.

  • Sovereign and other market risks are low. In the stress scenarios, an adverse two-standard deviation move resulting in a 97 basis points increase in the 5-year sovereign yield has only very limited impact on results. A permanent 20 percent drop in all other asset prices, including real estate prices, could be also be absorbed by banks.

  • Concentration risk is significant. Concentration risk measured by the impact of a default of the largest three exposures of each bank is relatively high, as capital ratios would fall by around 7 percentage points from their current level. Eleven banks (about a third of the banking system’s total assets) would breach current regulatory minimum requirements if their three largest exposures defaulted.

22. The authorities’ regulatory path is highly ambitious and actions need to be taken to manage the impact on bank’s balance sheets. The banking system as a whole would be able to digest an immediate implementation of Basel III capital definitions. With only one exception, all the banks in the sample remain above the new minimum capital requirement in 2015 if Basel III deductions were to be phased out immediately and in full. However, increases in capital would be needed if current buffers are to be maintained or if banks were confronted with the shocks analyzed here, including those in the baseline. With an unchanged level of NPLs, a number of banks would likely need external or governmental capital injections to comply with the new regulatory solvency framework.

Figure 6.
Figure 6.

Kazakhstan: Macrofinancial Baseline and Stress Scenarios

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Source: NBK and IMF staff estimates.
Figure 7.
Figure 7.

Kazakhstan: Scenario Solvency Risk Results

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Source: IMF staff estimates.Note: Pre-impairment profit includes net interest income and net fee and commission income (panel B). The bucket “nonlinearities” also includes the effects of dynamic balance and RWA sheet evolution. While “FX rate risk” refers to (pure) market risk losses in unhedged trading positions, “indirect credit risk” covers losses from FX-induced credit default risk.The charts in panel C show the upper and lower quartile (defining the box), the median, and the highest (lowest) ratio still within half the interquartile range. The red line gives the regulatory minimum capital requirement as of end-2016.

23. Liquidity stress tests reveal that the banking system would be able to cope with substantial funding stress, although some banks do not appear sufficiently resilient. Cash flow-based liquidity stress tests (using the Basel III LCR framework) were used to assess resilience to the Basel III scenario and to scenarios motivated by the recent run on Kazakh banks (Appendix Table 3).11 Under the scenario suggested by the Basel Committee, the banking system’s stock of High Quality Liquid Assets (HQLA) is more than sufficient to absorb the liquidity outflows while cash inflows decline and asset prices deteriorate (LCR exceeds 2). However, 12 banks, accounting for a third of the banking system’s assets, would see their coverage ratio drop below the hurdle rate, pointing to pockets of vulnerability. If deposit outflows increased, secured funding fell by 30 percent, and customers drew 30 percent of their committed lines, the coverage ratio for the system would still exceed 100 percent but 17 banks (56 percent of total assets) would not be able to cover the outflows.

Figure 8.
Figure 8.

Kazakhstan: Solvency Risk: Sensitivity Analyses

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Source: IMF staff estimates.

24. Direct contagion risk through bilateral interbank exposures is limited. Banks net lending exposures account for less than 1 percent of total banks’ assets (0.3 percent of GDP) and only six banks have net bilateral exposures above ten percent of their regulatory capital. The exposures tend to be slightly stronger between foreign subsidiaries from the same country. Pure interbank contagion stress does not result in bank failures, indicating weak connectivity among banks.12 However, conducting scenario contagion analysis on stressed capital levels resulting from the severe stress scenario (sustained decline in commodity prices) would cause an additional (but small) bank to drop below minimum capital requirements. These results are consistent with the results of NBK’s contagion model.

25. Cross-border linkages have become less important. Banks external borrowing reached $11.5 billion (5 percent of GDP) in September 2013 and their assets abroad stood at $6.4 billion (2.9 percent of GDP) as of December 2013. The main source country for external borrowing is the United Kingdom (54 percent), reflecting eurobond issuances by Kazakh banks in international markets. The next largest lender is China (21 percent), which has extended a credit line to the Kazakhstan Development Bank.

Figure 9.
Figure 9.

Kazakhstan: Liquidity Risk: Scenario Analyses

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Data source: Kazakh banks, NBK. IMF staff estimates.Notes: The LCR is given in percent.

26. NBK’s stress testing framework could be improved. Given the risks currently faced by the banking system, it is recommended to assess explicitly FX-induced credit risk and market risk, including asset price risk, sovereign risk, foreign exchange rate risk, and interest rate risk, at least through sensitivity analyses. With respect to liquidity risk, NBK should use the liquidity stress testing tool provided by the FSAP team and banks should be encouraged to apply this framework for surveillance and supervisory assessments. Based on the work done during this FSAP, NBK should continue estimating the impact of regulatory reforms, while coordinating closely with the banks. NBK would also benefit from making better use of the available data at the central bank, including through more effective collaboration between the Financial Stability and Statistics Departments.

B. Insurance and Pensions

27. The insurance sector is not of systemic importance, but it is faced with severe financial risks. Solvency indicators are currently at adequate levels but they may be artificially supported by reinsurance agreements that have not been closely supervised (Table 5). Portfolios are liquid and support nonlife liabilities, but there is an asset-liability mismatch for the long-term business. However, legislative changes in 2010 introduced retroactively mandatory coverage for professional sickness, creating an unfunded liability equivalent to one third of the sector’s total capital. In addition, earthquake exposure, which could wipe out the entire capital of the nonlife insurance sector, is not adequately protected through reinsurance. On the life insurance front, the main risks are related to the unification of the pension sector.

28. The nationalization and unification of the pension system poses risks. The new consolidated system will likely produce savings as a result of synergies (Appendix II); however, hidden transition costs related to operational and valuation risk will likely emerge in the coming years. Appropriately, a regulation directing the investment of the pension funds into low yielding government bonds has been removed and asset management fees have been cut by half. However, it remains to establish an explicit mandate to maximize returns of the retirement income of the members, which is important in light of NBK’s potential conflicts of interests as the regulator of the banks and the pension funds—see paragraph 64.

Bolstering the Financial Safety Net

A. Weak Systemic Liquidity Management in Normal Times

29. Banks rely on the local interbank market and, increasingly, on FX swap market to manage their liquidity, which complicates systemic liquidity management. The local interbank market is an auction-driven market where 26 banks trade with each other—and with 25 other financial institutions—through repos. Owing to insufficient collateral and the segmented nature of the interbank market, several banks have increasingly turned to the FX swap market.13 Turnover in the latter often exceeds turnover in the interbank market. Bank’s increased use of the FX swap market for managing tenge liquidity complicates NBK’s task of managing systemic liquidity in the face of a tightly managed exchange rate.

30. Liquidity management by banks appears to be inefficient in many cases, but banks have generally responded to excessive volatility by building tenge liquidity cushions. Weak liquidity management is particularly apparent around quarterly tax reporting periods, when, despite predictable heightened seasonal demand for tenge liquidity, several banks do not build sufficient reserve buffers in to cover the anticipated liquidity squeeze. This recurring practice has spillover effects elsewhere in the financial system, whereby other banks’ capacity to properly manage and forecast system liquidity is undermined.

B. Untested Crisis Management Framework

Emergency Liquidity Assistance

31. NBK has the authority to provide emergency liquidity assistance (ELA) to financial institutions facing liquidity stress, but no solvency requirement is established in the law. NBK can engage in ELA in domestic and foreign currency. Procedures include emergency lending of two forms: last resort lending (for banks) and special purpose lending (for banks and non-banks). However, there are no provisions requiring that these facilities be extended to solvent institutions or that they be offered at a penalty interest rate.

32. The authorities stressed that there have been no cases of ELA during the past five years, including during the recent deposit run. However, a ‘special purpose lending facility’ was established and used in October 2011 in the form of a repurchase agreement denominated in foreign currency for one year and collateralized by bonds issued by SK. This appears to have been a blend of ELA and open assistance (solvency support). Additionally, SK provided liquidity support to nationalized institutions in the form of deposit placements as part of its role as holder of stakes in the nationalized banks. Going forward ELA should only be extended to solvent institutions and, if provided in foreign currency, only if sufficient foreign currency reserves are available to do so.

Amended Bank Resolution Framework

33. The framework for bank resolution was amended during the crisis to incorporate options used commonly elsewhere. Prior to 2009, the law offered limited resolution options short of liquidation to deal with troubled institutions: (i) a temporary closing through conservatorship; and (ii) the forced purchase of outstanding shares in a troubled institution. The prevailing framework did not allow the authorities to dilute the existing shares of undercapitalized or insolvent banks without resort to share purchase, as is common under international practice. This was corrected in 2009, along with the introduction of new options, which included bank restructuring, purchase and assumption (P&A), and bridge bank.

34. The P&A and bridge bank options, as foreseen in the current legislation, are not yet practical. The provisions require the approval of depositors and/or creditors, instead of giving the supervisor full authority to independently mandate these resolution methods. Although the intervention options under law imply that there is a graduated movement from temporary administration to resolution and liquidation, there are no clear triggers for each stage. No crisis simulation exercise has ever taken place.

35. Revocation of a license does not occur simultaneously with a resolution transaction, which poses risks to effective resolution. There are currently two separate procedures for revocation and resolution and a lag between when revocation and resolution may occur, which would put pressure on NBK to rush the resolution decision, as the law mandates KDIF to start paying depositors within 14 business days of the court ruling of forced liquidation. In practice, this would prevent NBK from opting for options such as a P&A, which can take longer to implement.

36. The current legal framework of banks resolution procedure is lacking limitation of judicial review. According to best international practice, judicial review of the decisions regarding application of resolution measures should not be subject to their annulment and status quo reinstatement; possible remedies for any wrongful decision related to resolution measures should be limited to compensation of damages suffered by the affected parties.

C. Crisis Preparedness Framework

Legal Framework and Corrective Action Arrangements

37. Early response and remedial measures are contemplated in the Banks and Banking Law. These measures are available in cases of rapid financial deterioration or violation of prudential norms and include changing of organizational structure, limiting acceptance of deposits, ceasing dividend payments, increasing provisions for loan losses, dismissing bank executives, and suspending high risk operations. The option to dismiss executives has been applied to the chairmen of three banks in recent years.

38. The law grants NBK the power to authorize a party to become a large participant in a bank; however, concerns about the effectiveness of this power have arisen recently. A Presidential Decree was announced in early 2014, at a time when NBK had received an application from KKB for the purchase of BTA. The decree temporarily lifts the requirement that NBK verify compliance with prudential standards of the purchasing and purchased bank or reject the sale in case of existence of limited remedial action and/or sanctions imposed to either of the two banks. This raises serious concerns about the safety and soundness of the resulting bank and, given the size of the transaction and the very large holdings of NPLs by BTA, about the stability of the system.

Deposit Insurance

39. The Kazakhstan Deposit Insurance Fund (KDIF) has a strong capital position but its governance structure is problematic. KDIF has responsibility for standard ‘pay-box’ duties and can also provide limited financial assistance to sound institutions undertaking a purchase and assumption transaction, and has examination authority over member banks. There have not been any payouts of depositors since 2007, and during the recent crisis the KDIF was not involved in resolution. KDIF’s adjusted fund equity to insured deposits ratio is a healthy 11 percent. Moreover, full coverage of deposit insurance is afforded to over 99 percent of deposit account holders, and the total amount of deposits insured is also high at 55 percent of total deposits. KDIF is governed by a Board of Directors that includes two current directors of banks, which is not considered a good practice.

Systemic Risk Monitoring and Coordinating Arrangements

40. The Council of Financial Stability and Financial Market Development (the Council) is in charge of coordinating the oversight of financial institutions. The Council was created in 2010 and is chaired by the Governor of NBK. It meets monthly, and its membership includes NBK, the Executive Office of the President, Ministry of Finance (MoF), the antitrust agency, and the association of financial institutions. The Council has a broad mandate that includes making recommendations on macro-prudential policy and overseeing progress on implementation of Basel III.

41. The council introduced a procedure for identifying SIFIs on the basis of five criteria. A threshold of 10 percent is established for each of five variables; banks that exceed the thresholds are considered systemically important. The variables are: the shares of bank assets, bank loans, personal bank deposits, deposits by commercial entities, and interbank payments. The Council has not published a list of SIFIs, but markets perceive that there are currently 2 banks that meet the SIFI criteria.

42. Information-sharing between safety net participants (NBK, former FSC, KDIF) is provided for under the Law on the Insurance of Deposits, but the law does not stipulate mechanisms for coordination among safety net players regarding individual troubled banks.

Delinquency Management and Resolution of NPLS: Solving the Legacy Problem

A. Slow Progress Resolving NPLs

43. The authorities introduced a three-pronged approach to NPL resolution in 2011, but its impact has been limited. The scheme provided for three options: (i) selling NPLs to the Problem Loans Fund (PLF), an NBK-funded asset management company (AMC); (ii) transferring NPLs to bank-specific special purpose vehicles (SPVs, decentralized AMCs); or (iii) writing NPLs off. The program was not very ambitious, as it did not allow the transfer to the PLF of NPLs collateralized with real estate (the most commonly used collateral) or those in the books of state owned banks. Unsurprisingly, the impact of the strategy has been limited, as virtually no loans were transferred to the PLF, and SPVs have not been used extensively. Further, real estate-backed NPLs have not been written off by banks.

44. Other obstacles hamper the transfer of NPLs to the PLF and discourage banks from writing them off. These include bank secrecy laws, which prevent the PLF from having access to loan documentation needed for the appraisal of the loan; property registration rules that significantly restrict collateralized debt transfers in the presence of liens of third parties; and non-neutrality of taxation in cases of loan restructuring of write offs. The latter, which includes taxation of the recovery of loan-loss provisions in cases of write offs and banks’ inability to recognize write-off related losses for tax purposes, is a critical obstacle to resolution.

45. A full assessment of the banking system’s NPLs is needed. NPLs are largely concentrated in real estate and construction, and the underlying collateral is often an unfinished construction, which is difficult to price or sell. The authorities should consider undertaking a risk-based review of the quality of the assets held by those institutions with the highest concentration of NPLs.

46. Several measures were introduced recently to jumpstart the resolution process. In 2013, NBK introduced a ceiling of 20 percent for NPLs, which declined to 15 percent in 2014. The PLF’s mandate has been broadened and further recapitalization is envisaged with funds from Kazakhstan’s National Fund. Changes to the tax rules and insolvency regime providing incentives to debt restructuring are expected shortly and reforms aimed at loosening bank secrecy rules in the context of restructuring and facilitating debt assignment are currently under preparation.

47. However, the main obstacles highlighted still remain to be addressed; While the recent measures are ambitious, many of the obstacles highlighted above still need to be tackled. In particular, the proposed changes do not appear to alleviate significantly the tax burden associated with debt restructuring or to remove deficiencies in the insolvency framework. Moreover, even after its planned recapitalization, the PLF would remain underfunded and clarity is needed on how the large write-offs required to meet the NPL ceiling would be dealt with in banks’ balance sheets.

B. A Multi-Track Approach to Resolve the NPLs Universe

48. Effective resolution of the NPL overhang calls for a multi-track approach to address a diverse NPL universe and significant improvements to the enabling framework. The multiple track approach includes: (i) debt write-offs; (ii) foreclosures, repossession of collateral, and recovery under insolvency proceedings; (iii) sales by PLF and SPVs of bundles of NPLs, either directly or through NPL/mortgage-backed securities for cases where the claims have value; and (iv) PLF and SPVs acquiring ownership in collateral for bundled marketing. For this approach to work it will be necessary to make legal and tax changes aimed at addressing the problems highlighted above, to introduce stronger incentives for out-of-court resolution, strengthening the insolvency regime, and lowering the costs of foreclosures.

49. Several adjustments to the legal environment are needed. These include loosening bank secrecy rules—to facilitate loan appraisals; less costly and more transparent foreclosure and insolvency proceedings; eliminating the tax burden of debt write-offs/forgiveness and the withholding tax in case of debt forgiveness to individuals; and the suspension of VAT on fixed asset purchases and foreclosures in the context of NPL resolution.

A stronger PLF and more effective SPVs

50. The PLF, or a new centralized AMC, should have a strong mandate and be operationally independent. Budgetary independence is critical to limit political interference. The mandate of the PLF would need to be expanded and consideration should be given to granting it special powers. Temporary employment of specialized business and operational restructuring consultants would also be needed. The revamped PLF or new centralized AMC must be required to report regularly to the parliament and the public, and be subject to strict audits.

51. Pooling of distressed assets for disposal would create economies of scale. Different approaches should be used for different types of NPLs. Irrecoverable NPLs with worthless collateral should be written off or, when appropriate, used as voting levers in ongoing or expected collective proceedings and in rehabilitation cases for debt-for equity swap purposes. Small-value NPLs with insignificant collateral could be outsourced to debt-collection entities for cost savings. Significant unsecured NPLs could be used for securitization and the business areas of corporate debtors to achieve a critical mass to boost their investor-appeal.14 Significant secured claims with attractive collateral could be considered for bundled marketing by classes of collateral, such as urban commercial and residential real estate.

52. The financial engineering activities of the centralized AMC should take into account potential investor interest and aim at creating prospective demand. To support these efforts, potential buyers would need access to relevant information and appropriate due diligence procedures and a supportive legal environment would need to be in place. International markets for distressed assets—international debt and hedge funds, private equity funds and long-term financial investors—should be approached to enable efficient sales of NPLs and NPL collateral. Funded real estate development companies interested in purchasing construction sites and semi-finished constructions should also be contacted.

53. The viability of an agency able to engineer the products described above depends crucially on access to non-domestic sources of capital. While the legal framework in place does not pose insurmountable formal legal challenges in this respect, other policy actions will need to be implemented to make Kazakhstan more attractive to international investors. In this regard, the exit from the local market of three foreign banks in recent years amidst increasing regulatory uncertainty, non-transparent financial transactions (including the sale of the nationalized banks), and weak governance are a source of concern.

54. Obstacles faced by SPVs in the realization and sale of NPLs also need to be addressed. The legal and tax obstacles described earlier also hamper SPV’s ability to realize NPL collateral. In addition, continued banking relationships with clients may discourage SPVs from engaging in vigorous and impartial resolution of existing NPLs. Therefore, structural separation and a clear mandate for independent decision-making for SPV managements is needed to help break the links between banks and corporates in the context of NPL resolution. Tight supervision of SPVs’ activities will be needed to prevent them from hiding the true volume of NPLs through mutual transactions among banks and regulatory barriers for such trades should be contemplated.

Broadening NBK’s resolution toolkit

55. It is essential to re-assess the viability of banks holding high percentages of NPLs and, if necessary, deploy resolution tools for the unwinding of their operations. The banks that were nationalized in 2009 are expected to be placed back in private hands in the coming months. Given the systemic size and/or troubled nature of some of these institutions, they should be placed under a monitoring plan involving a high degree of scrutiny and would contemplate their potential unwinding if they failed to make substantial progress in resolving in a timely manner their outsized level of NPLs. In anticipation of a future resolution in the form of a P&A or bridge bank, it will be necessary to make amendments to the relevant Banking Law provisions for these untested resolution options. In particular, it will essential to remove the requirement of depositor and shareholder approval (see section on the Financial Safety Net).

Strengthening Financial Sector Oversight: Avoiding Another Surge in Bad Loans

56. NBK is responsible for regulation and supervision of banks, insurers, pension funds, investment funds, credit bureaus, and securities markets. During 2011–13, the Committee for the control and supervision of the financial market and financial organizations (FSC)—then a subdivision of NBK—performed the supervisory and regulatory functions.15 NBK is accountable to the President, who, inter alia, appoints its chair (with the consent of the Parliament) and his/her deputies. The President also approves NBK’s structure, overall staff size, and wage system. The law does not specify the conditions under which the NBK chairman and his/her deputies may be removed from office. In January 2014, a Presidential decree abolished the FSC and its departments were subsequently absorbed by NBK.

57. The Payment Systems Department (PSD) of NBK and the FSC-NBK are the overseers of the Financial Market Infrastructure (FMI). The operators of the systemically important FMIs in the Kazakh market are the Kazakhstan Interbank Settlement Center (KISC), the Kazakhstan Stock Exchange (KASE), and the Kazakhstan Central Depository (KACD). All of them are majority-owned by NBK. PSD-NBK oversees the FMIs operated by the KISC as well as payment instruments and services, while FSC oversees the FMIs operated by the KASE and KACD.

A. Bank Regulation: Achieving Better Implementation

58. Supervision is intensive and intrusive, but oriented towards compliance. Although some forms of risk-based supervision, such as CAMELS ratings, have been introduced, supervisors focus mainly on the conformity of banks’ processes and practices with regulations. Less attention is devoted to the assessment of banks’ risks. Supervisors should rely more on risk assessment tools and a more intensive use of stress test results in the area of capital adequacy. Training and staff exchanges with foreign supervisory authorities should be considered.

59. Supervision needs to be strengthened in three key areas. The introduction of IFRS-IAS39—which leaves room for discretion in the assessment of provisions—without adequate training for supervisors has weakened their ability to scrutinize banks’ provisions. NBK should contemplate additional training of examiners on collateral valuation and secured improved access by supervisors to the Real Estate Registry. Weaknesses in the assessment of market risk (non-inclusion of commodity risk) in the trading book and interest rate risk in the banking book need to be addressed, including by providing guidance on model risk and validation; interest rate risk in the banking book should be assessed separately from market risk. Home-host relationships are inadequate in light of the active cross-border activity of the main Kazakh banks. More frequent contacts and information exchanges with foreign supervisors are needed to facilitate effectively monitoring the foreign operations of the domestic systemic players.

60. The phasing in of Basel III provisions needs to be calibrated with caution. NBK is planning to start the implementation of Basel III in 2015 and to complete it by 2019. During this period, priority to the implementation of Pillars 2 and 3 of the Basel framework. The former requires the introduction of ICAAP requirements; the design of a supervisory review process based on both, NBK’s own risk assessment system and the review of banks’ ICAAP reports. Disclosure requirements should converge as much as possible towards those set by Basel in order to foster market discipline and encourage banks to upgrade their risk management systems.

61. Parliamentary approval of amendments to the Law on Anti-Money Laundering and Combating of Terrorism Financing (AML/CFT) is expected this year. Kazakhstan’s AML/CFT framework was evaluated by the Eurasian Group (EAG) in 2010. The 2011 mutual evaluation report revealed major deficiencies, notably with respect to guidance on customer due diligence requirements, politically exposed persons, correspondent banking, identification of high-risk accounts and identification of beneficial owners. Prompt implementation of amendments to the AML legislation is a high priority for NBK. Regulations and guidelines for monitoring are being drafted and will be issued when the law is passed to become effective on January 1, 2015. The authorities are recommended to comply with the FATF revised standard. Kazakhstan is tentatively scheduled to undergo a reassessment by EAG in April 2017.

B. Insurance Sector: Stronger Prudential Requirements and Reinsurance Supervision

62. Insurance legislation has been updated and supervision brought closer to international best practices, but more emphasis on risk is needed. Largely in response to the crisis, the sector’s regulation underwent a major overhaul. Over 88 changes updated Law No 126-II on Insurance Activity and 14 changes related to insurance were made to the Civil Code. The solvency regime is basically Solvency I with some enhancements. To compensate for the lack of sensitivity inherent to Solvency I, NBK requires sensitivity testing and asset liability matching analysis on a regular basis. However, the regime does not map insurers’ risks into capital requirements. The supervisory approach has some risk-based features, but all insurers continue to be treated with the same intensity. NBK has a wide set of preventive and corrective measures that are enforced consistently.

63. Supervision of reinsurance is inadequate. The use of reinsurance by insurance companies has lead to a mechanical improvement in solvency indicators, but this may mask insufficient risk transfer. Careful analysis of the reinsurance agreements is needed to verify that they are effectively transferring risk. Also, the proper level of reinsurance protection acquired by the insurers needs to be a focus of supervision.

C. NBK Management of Pensions: Sound Investment Practices are Key

64. The pensions system has been consolidated into a single pension fund (UAPF) owned by the government and managed and supervised by NBK.16 The Charter of the UAPF delegates the fiduciary ownership role of UAPF to NBK and charges the Council for Management of the UAPF Assets (CMA) chaired by NBK with designing its investment policy. The law preserves the key parameters of the funded pension system created in 1997, including the government guarantee of the preservation of contributions in real terms.

65. The governance of UAPF is not in line with best practice. NBK chairs the board of the UAPF in its role as fiduciary owner, makes investment decisions as chair of CMA, and is the supervisor, custodian, and statutory asset manager. Separation of the control functions from the ownership is recommended. CMA should be subject to the same transparency and accountability standards required from listed companies in major markets, and should avoid investments whose risks that are not well understood—direct infrastructure financing and investments to support entities in financial distress.

D. Securities Markets: Reducing Uncertainty and Mitigating Mispricing and Reputational Risks

66. Oversight of the securities markets has improved. The powers of the entities in charge of securities regulation and supervision have expanded, and customer protections and market transparency have improved. The improvements include the adoption of IFRS and Auditing Standards for issuers and public interest entities; strengthened accountability for unlisted securities through the establishment of a single securities registry; and the requirement that licensed firms establish a system of risk management and internal controls to better identify and manage operational and other risks.

67. However, the securities sector suffers from mispricing, uncertainty, and reputational risks due to uneven implementation. Instability in the rules governing market practices and inconsistent approaches to reform create uncertainty about the validity of transactions to the detriment of market development and pricing. With only a few transactions occurring in a secondary market over a lengthy period of time, it is difficult to establish whether the price obtained in the market is true and bona fide. This may prevent properly haircutting and valuing collateral or accounting for net asset values in open-ended funds. Moreover, standard measures to address reputational risks, default risk, misconduct, and financial disruptions are lacking and should be adopted.

E. Financial Market Infrastructure: Addressing Gaps in Risk Management

68. There is legal uncertainty on the finality of payments and settlements. The law on payment and transfers does not define when a transfer or payment is final and irrevocable in the FMI. Similarly, the Securities Market Law does not provide finality of securities market transactions. Amendments to the relevant laws should be passed to eliminate uncertainty regarding finality and irrevocability of payments and settlements.

69. The lack of an intra-day liquidity support from NBK to the Inter-Bank System for Money Transfer (ISMT) exposes the system to liquidity risk. There is no reliable access to liquidity in the ISMT and liquidity risk can be high during evening settlement of foreign exchange transactions (when liquidity from the repo market is not available) or when large value payments occur at the end of the day. Similar problems exist with incoming settlement instructions from the securities market.

Figure 10.
Figure 10.

Kazakhstan: Economic Developments

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Sources: Kazakhstani authorities; and IMF staff estimates.
Figure 11.
Figure 11.

Kazakhstan: Banking Sector Developments

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Sources: Kazakhstani authorities, GFSR, and IMF staff estimates.1/Authorities did not provide systemwide CAR data during BTA’s second debt restructuring, hence the gap in the CAR graph.2/ Accounting for exchange rate valuation effects.
Figure 12.
Figure 12.

Kazakhstan: Capital Markets and Expected Default Frequencies

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Sources Bloomberg.
Figure 13.
Figure 13.

Kazakhstan: Monetary and External Sector Developments

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Sources: Kazakhstani authorities; Bloomberg, and IMF staff estimates.
Figure 14.
Figure 14.

Kazakhstan: Key Financial Soundness Indicators—Cross-Country Comparison

Citation: IMF Staff Country Reports 2014, 258; 10.5089/9781498311007.002.A001

Sources: IMF FSI database, and World Economic Outlook.
Table 2.

Kazakhstan: Selected Economic Indicators, 2010–2019

article image
Sources: Kazakhstani authorities, and Fund staff estimates and projections.

In 2009, credit growth would be -2.5 percent, if adjusted for the devaluation.

Does not include NFRK.

Gross debt, including arrears and other short-term debt.

Based on a conversion factor of 7.6 barrels of oil per ton.

Table 3.

Kazakhstan: Financial System Structure, 2005–13

article image
Source: NBK
Table 4.

Kazakhstan: Financial Soundness Indicators of the Banking System, 2008–2013

article image
article image
Source: NBK.

Excluding BTA and credit cards

Core and encouraged set of indicators. Indicates available aggregate data for all banks.

Table 5.

Kazakhstan: Financial Soundness Indicators of the Non-Banking System, 2005–2013

article image
article image
Sources: NBK.

For the medium and large enterprises (more than 50 people).

Equity is calculated as an average value at the beginning and the end of a year.

For the periods of 2003–2006 debt of households comprises debt of residents and non-residents. Since 2007 households’ debt includes only debt of residents and debt to microcredit and credit

Percent change in house price index.

Encouraged set of indicators