Annual balance sheeet

Despite the fact that the previous year had been favorable for country, both with regards to politics and economics, none of the banks has been able to rest on its laurels. With the stable development of the banking system, in the background one could feel a high level of emotional tension, the major sources of which were increased competition, taking on higher levels of risk, and tightening of state regulatory controls. Actually everything happening on the market over this last period has been a continuation of trends that had already begun to emerge. However, this persistent process has been full of notable events, some of them quite dramatic.

Yelena Dudka

The Year’s Top Five Hits
Uncle, Give Me a Ruble
The Growth in External Loan Volumes
The undisputable leader of the hit parade of banking trends is the growth in the external debt of banks. In 2004, Kazakhstani banks borrowed approximately US$6 bln from abroad. In 2005, according to Bolat Zhamishev, head of the Financial Supervisory Agency (FSA), “The growth rate of this index has gone down. So, in the first three quarters of 2004 banks’ foreign obligations increased by 72.8%, but over the same period in 2005 the amount increased by only 41.7%.” The total volume of foreign loans to the banks for 2005 has not been officially announced as of yet, but if we assume that the growth rate of this index remained at about 40%, then the total amount should be at about US$8.5 bln. Basically, as per the opinion of Mr. Zhamishev, the level will remain “quite high”. At the same time, banks’ foreign debt, as of the end of September, totaled 43.2% of the total volume of obligations, which according to the FSA head is quite acceptable and not overly high.
The banks themselves are very proud of their foreign loans, which their press releases write as “proof of the high trust held on the part of international financial institutions, and allows them to extend the possibilities for provision of credits for the development of the economy”. Nonetheless, even taking into account all the plusses of cheap foreign money, not everybody considers them as an absolute benefit for the country. For example, the National Bank of Kazakhstan (NBK) is not satisfied with the fact that the inflow of a large quantity of foreign currency in combination with oil money is making the tenge much stronger. And, the Finance and Budget Committee under the Mazhelis even suggested in May 2005 that limits should be set on the external debts of the republic, even on loans to commercial enterprises. According to them, the foreign loans of commercial banks and the uncontrolled ones of private companies, significantly effect inflation growth and threaten the economic safety of the country. This suggestion was not supported by most members of the Mazhilis or the administration, as it would have led to increasing the cost of credit, accompanied by a volume decrease, and created the potential for corruption during the setting of such quotas. The banking lobby also would have fought the measure.
Respected international experts have also warned Kazakhstan about risks related to rapid growth in foreign loans. Jean Lemier, head of EBRD, stated at the Fifth Annual Kazakhstan Congress of Financiers in November, “Your banks have been able to attract large volumes of capital at low rates on the international capital markets. The high ratings assigned by international agencies have had a contributory effect. However, such large volumes of foreign capital carry a significant risk that needs to be effectively managed.” International ratings agencies agreed with Mr. Lemier. Magar Kuyumdjan, a credit analyst at S&P, believes, “The high increase in domestic credit together with the large number of foreign loans of Kazakhstani banks, may cause serious problems related to the quality of assets in case of significant economic downturn.” The potential fallout of economic decline seems to be a key point in this whole scenario. Due to economic cycles, such an events will happen sooner or later. When and how it happens is dependent upon how successful the policies on foreign loans for each bank will be. The more conservative a bank’s policy is, the less it will suffer in case of economic downturn or crisis. However, in case the economic boom continues for another several years, most likely the more aggressive financial institutions will take dominant positions on the market (please see Table No. 2).
The main reason for the hyperactivity of some banks with regards to the foreign capital markets seems to be a desire to outdo competitors with regards to asset volume and to grab a larger share of the market by any means. This race has already put Bank TuranAlem (BTA) onto a pedestal. As per results released in November, BTA has become the largest bank in Kazakhstan (please see Table No. 1). Another active participant in the loan movement, Alliance Bank, has been intermittently been rotating in and out of the fifth position along with Bank CenterCredit. As of the close of November, Alliance was in sixth place, but the possibility that it will be in fifth place by year’s end cannot be excluded. As well, Alliance’s ambitions are not limited to just ranking as fifth, and the bank has expressed a desire to take the leading position in the banking sector by 2010. Interesting is the fact that on www.banker.kz, a professional forum, there is an active discussion occurring on the policies of Alliance. Namely, by some opinions, Alliance’s assets are being pumped up in preparation for selling the bank in the future.
One of the top three banks, Halyk Savings Bank (HSBK), has been maintaining the most reserved position. Grigori Marchenko, chairman of the HSBK board of directors, stated at a press conference on 1st November, “We do not have a special necessity for foreign loans, such as through the issuance of Eurobonds, which we do once a year, and have no plans to do this more often,” further adding, “The bank can attract domestic funds more cheaply.” Timur Isatayev, head of ATF Bank, which is maintaining the fourth position in the country, agrees with Mr. Marchenko, and stated at the beginning of the year, “The Kazakhstani market is currently offering the conditions for issuing bonds at better terms than on Western markets.
Since many discussions are occurring about the high risks related to the high growth of foreign loans, which in particular implies default risks, a reasonable question arises as to why foreign banks continue this practice. The point is that over the previous few years the profitability of corporate bonds has been decreasing in the West, which is why investors have been looking for new markets and instruments with higher yields and acceptable levels of risk. Regarding Kazakhstan, the country is considered a good credit risk. Both the government and large Kazakhstani companies have retired their obligations on time and in full. High ratings have been assigned to both by international ratings agencies, S&P and Moody’s. The prognosis accorded by these agencies is stable and positive, which reflects experts’ opinion on the further political and economic development of the country, as well as the future development prospects of certain companies.
One might suppose “that the existing credit risks of Kazakhstani banks, such as insufficient transparency regarding ownership structure, strong pressure on levels of capitalization, limited portfolio diversification, as well as the large concentration of outstanding domestic credit and foreign loans”*, which are being sustained by high, compared to Western standards, rates of return.

Your Milk Has Spilt
Expansion into the CIS
By the end of 2005, consolidated bank assets increased by more than 40%, exceeding KZT3.5 trln (approximately US$27 bln). This amount is equal to 58% of GDP (in 2004 it was 39.3% of GDP). By the end of the third quarter of 2005, the total volume of credit issued domestically was more than KZT2.5 trln (approximately US$18 bln), out of which long-term credits, being of a term longer than one year, comprised 70% of the total.
The exceeding liquidity of the banking sector, a necessity for risk diversification, and the provision of banking services outside the country, several years ago led to the idea of exporting capital. Although, one cannot see there has not been the possibility for domestic placement of that capital. Another point is that domestic banks still do not have enough capital of their own to finance huge projects, such as those in the oil and gas sphere. Local banks do not issue syndicated credits like foreign banks, as they do not trust each other and do not wish to cooperate. In 2004-05, the expansion of Kazakhstani banks, primarily into other CIS countries, has acquired a systematic basis. By 1st September, 24 subsidiary banks, including branches and representative offices, were working abroad.
Experts regard this issue in various ways. At the end of October, Mr. Zhamishev stated at a press conference that the FSA is intending to work out measures to stimulate the expansion of commercial banks into external markets. “It would be unreasonable to prevent banks from realizing their competitive advantages by limiting their expansion into external markets,” he said. The FSA head stressed that such expansions are mostly implemented through subsidiary and affiliate banks, and not through the direct provision of credit to foreign commercial enterprises. According to Mr. Zhamishev, this “strategy permits risk to be lowered, as the capital of subsidiary banks is consolidated during the financial reporting of the parent bank in accordance with prudential norms.
Banks would probably be happy to directly provide loans to commercial enterprises in other countries, but the farsighted FSA has set up a rule, according to which if a non-Kazakhstani company has no rating or a rating lower than BB-, then a bank must make a risk assessment at 150% of the calculated risk level. One should not expect that in the immediate future the FSA would soften their requirements on this issue, as risk evaluation in such operations is quite difficult. Mr. Zhamishev believes, “At present, our neighboring countries cannot boast of such high levels of supervision. At the same time, Kazakhstani banks, in comparison with international financial institutions, lack statistical data on default rates and the software to permit systematic tracing of risks in neighboring markets.” At the Congress of Financiers, he added that as per the results of an audit checking whether banks are meeting requirements concerning systems of risk management and internal control, the performance level is 64% on average.
Mr. Lemier was very reserved when estimating the expansion possibilities of Kazakhstani banks outside the country during his speech at the Congress of Financiers. He noted, “Many of your banks have begun investing into Russia. This is normal. But at the same time this is a new type of risk, which must be managed.” In their reports, analysts at S&P have not concealed their watchfulness concerning the fact that local banks have begun intensively extending their presence on the markets of other CIS countries, which characterizes a higher level of risk. Akhmet Sharkh, a partner in Ernst & Young, an audit company, fully supports the S&P analysts’ opinion. According to him, Kazakhstani banks have completely valid reasons for starting expansion into other markets. However, they “must stop and think about all the prevalent risks that might arise during the process”. The acceptance of hasty decisions based on a simple desire to expand and develop business beyond the national economy is quite dangerous, and the consequences should not be ignored. Mr. Sharkh recommended to banks that are planning to purchase assets abroad “to carry out complex research of risks, such as through the attraction of independent experts competent in financial, legal and technological matters, as well as on tax issues, human resource management, and security in banking transactions.”
Local banks regard international experts as old patients regard new, expensive doctors. They listen to the advice given of course, but they do not become scared anymore, nor do they rush to utilize everything the “doctor has prescribed”. Even revolutions in Ukraine and Kyrgyzstan have not stopped Kazakhstani investors on their way into the new markets. There had been rumors that Kazakhstani businessmen specifically buy out banks in those CIS countries having political unrest, in order to pay the cheapest possible price. During the last Congress of Financiers, Anvar Saidenov, the chairman of the board of BTA, an umbrella bank itself, said that the state should create conditions for the banking industry so as to make the sector competitive on external markets. He noted, “We are ready for competition, and we are waiting for support from the government.”

Do Not Open the Door to Anybody
Problems of Capitalization
In the previous year, banks’ capital grew faster than their assets. Over the first three quarters of 2004, the assets of banks increased by 69.4%, and in the same period in 2005 by 38%. While over the same period, capital growth was 49.2% in 2004 and 38.4% in 2005. As of 1st October 2004, the combined capital of the banks reached KZT482 bln (approximately US$3.5 bln). One of the most influential factors for this was the FSA measure taken to increase the capitalization of banks, as Mr. Zhamishev noted.
According to the report of the Financier’s Association prepared for the Congress, “At present, the level of capitalization of the banking sector in general corresponds to norms of capital sufficiency.” The further increase of this index, necessary for asset growth, is quite difficult. The primary trouble is finding sources for increasing the level of capital. Profits, despite their growth, are not sufficient. The possibilities for attracting subordinated loans are practically used up. Since such loans can comprise no more than 50% of capital of the first level (editor’s note: roughly defined, this refers, to retained earnings in combination with a bank’s charter, or base, capital, in conformity with the Basil Accord, which regulates international banking), and most of the banks have already reached this limit. The largest banks are placed on international exchanges; however, the procedures for such placement are too time consuming.
At the beginning of December, S&P circulated their new analytical report on the risk of concentration in the banks of the regions of Eastern Europe, the Middle East and Africa. The report states that in comparison with banks in such countries as Russia, Kuwait, Bulgaria, the Czech Republic and Turkey, “Kazakhstani banks have the lowest indices of capitalization”. Even by constantly increasing the capital level, they are still only at the minimum level as required by the state.
“The root of the problem is the lack of desire to increase capital through the attraction of new shareholders, which is to say an action resulting in even a slight loss of control,” believes Mr. Zhamishev. According to Andre Kuusvek, regional director of EBRD, the republic lacks transparency among shareholder groups, in both commercial banks and companies. During a speech at an international conference called “Corporate Management and the Investment Climate in Kazakhstan” at the end of October in Almaty, he stated, “If we were to take a list of companies and banks in Kazakhstan, one would wonder who actually owns the shares. Quite often, one can see whole networks that lead to one to three persons who control the