COMMENT: Kazakhstan banks - the seducers of success

By bne IntelliNews June 18, 2007

Richard Hainsworth of Global Rating -

Rising on a wave of deserved praise, Kazakhstan's banks have attracted so much foreign debt financing that the regulators are now taking fright.

Every emerging-market investment banker is hitting town and telling the Kazakh bankers how good they are, and few can withstand the charms of the rich. Especially when there is so much to praise. Yet the blandishments are eroding the conservatism of the bankers, and in time the success could slip away.

Kazakhstan's banks benefited from three real advantages:

- a stable and well-managed economy;

- a competent and assured regulator (the AFN, to use the Russian acronym) willing to implement Western regulations;

- the absence of any banking crisis that would undermine public confidence in the banking system.

The number of banks was decreased from its post-Soviet high (several hundred) to a manageable 30-odd by the AFN, which focused on substance and on risk. There was a tacit understanding about the development of the banking sectors between the regulator and the banking community. Compared to the regulatory chaos, or the form-fixated bureaucracies in surrounding countries, Kazakhstan quickly became recognised as having a well run banking system.

Three banks - Halyk, Kazkommertz and TuranAlem - were able to attract cheap foreign debt financing because of size, commercial savvy and foreign-ownership participation. They grew more strongly than all other banks in an environment that was itself growing and a substantial gap opened up between them and the next set of banks. Kazakhstan now has three tiers of banks: the top three; a second tier of about 10; and the rest.

The second tier then began actively seeking foreign funding, and thereby the ability to grow quickly. Foreign investors proved keen to buy into this success story and the second-tier banks have been growing strongly.

The trouble is that the economy cannot absorb all this new financing. While on an individual basis, the foreign financing is easy to justify; when taken together, it becomes less clear that the money lent to the entire system can be absorbed by the economy. Evidence of this is the expansion of the Kazakhstan banks into its neighbours and the ability of the Kazakh banks to pay well for their new assets.

Loosening the knot

Now the president's attention has been drawn to the dangers of over-exuberant foreign investment, and particularly to the example of the Asian crisis, where the sudden withdrawal of foreign funds impacted suddenly on what had been rapidly growing economies.

President Nursultan Nazarbayev authorised the AFN to impose strict new regulations that would constrain foreign financial investments. The banks put up a storm of protest; they pointed out that the expansion of the banks beyond the borders of Kazakhstan was in line with the general strategy of expanding Kazakh economic ties in the world. And the smaller banks, which had only relatively recently obtained foreign funding, complained that the restrictions were a plot by the first-tier banks to hamper the growth of the smaller banks.

In the end, the foreign investment constraints were watered down. Yet the affair seems to have disturbed the cosy relationship between the AFN and the banks.

The AFN believes the banks do not recognise the risks that they are running, namely:

- Taking on relatively cheap foreign funding that cannot be refinanced on the internal market places banks at the mercy of economic forces that cannot be controlled or easily understood;

- Placing assets abroad leaves the banks open to the substantially more volatile economies. There is not much evidence that the Kazakh banks have been any more successful in managing their risks in Russia, for instance, than any other investor.

The banks in turn complain that the AFN acts hastily and without adequate time for consultation, publishing new regulations and not allowing sufficient time for a considered response.

The root of the problem lies in the economy. The Kazakh banks have been a genuine success story for Western practices. Good open accounting, a focus on substance over risk and a good deal of disclosure have made the Kazakh banking system the best run economic sector and one of the most successful. But the banks have to lend to companies that fall far below these standards. In order to reduce their own risks, Kazakh banks have to invest in their borrowers to gain economic information, or the enterprises have to belong to the same financial and industrial group. Smaller enterprises - the bread and butter of national banks - are even less transparent.

In order for the Kazakh banking sector to develop internally, the level of disclosure and the quality of accounting standards has to improve. Yet this fundamental reform of the way that business is done seems unlikely, and in any case it would require a substantial period of time. If the Kazakh economy does not change, then the Kazakh banks will be forced to seek opportunities outside Kazakhstan.

Foreign investors, anxious to get exposure to the Kazakh banking success story, have been pouring into Kazakhstan. For some it is the first visit to the CIS. The trend looks to continue.

Regulations limiting foreign investment are as unlikely to succeed in Kazakhstan as they have been elsewhere in the world. Financial markets quickly find loopholes and tailor products to exploit them. But finding ways round regulations that have a macro-economic justification will put the bankers into conflict with the AFN. Yet it was a tacit cooperation between the AFN and the bankers that contributed to the success of the Kazakh banking system.

Richard Hainsworth is CEO of Global Rating, the leading bank rating agency covering the CIS financial sector

To visit Global Rating's website click here

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