COMMENT: Uzbek banking sector starts to develop

By bne IntelliNews April 21, 2008

Olga Ulyanova, Elena Redko and Anton Gelin of Moody's -

The banking system still has a limited role in Uzbekistan's weak but growing economy, where the regulatory environment is immature though admittedly improving. Uzbekistan's banking system continues to be challenged by an economic environment that remains one of the weakest in the CIS. However, in recent years, on the back of relative economic and political stability, the Uzbek economy has recorded notable growth, albeit from a low base.

At the end of 2007, the banking sector of the Uzbekistan accounted for only 37% of the country's GDP in terms of assets and 19% in terms of total loans, as compared with 34% and 19%, respectively, a year before that.

The Uzbek banking sector is highly concentrated and dominated by large state-owned financial institutions - National Bank of Uzbekistan (NBU), Asaka Bank and Narodny Bank). These account for 56% of total assets and 60% of the total capital of the banking system.

The state dominance in the banking sector is likely to decline going forward with the implementation of the government's decision to privatise large stakes in NBU and Asaka Bank. Other commercial and private banks play a less important role in the sector, serving mid-size clientele operating in certain industrial sectors, as well as small and private businesses. This is unlikely to change dramatically in the near future.

Uzbekistan is also characterised by numerous banks that have high concentrations of both single-name borrowers and certain industries; for example, Asaka Bank is recognised as a specialist for the car manufacturing industry and Pakhtabank for the cotton-producing industry. The level of concentration raises concerns about the vulnerability of the loan portfolios to defaults of certain large borrowers or to cyclical movements in certain industries.

The market for banks' shares is not sizeable, but it's growing fast. Currently, the shares of several banks - Ipoteka Bank, Alokabank, Ipak Yuli, Kapitalbank, Gallabank, Khamkorbank, Pakhtabank, Trast Bank and Turon Bank - are actively traded on the Tashkent stock exchange. In 2007, the turnover in banking shares increased notably as many banks issued additional shares in order to increase their capital. In addition, there is a legislative requirement that at least 25% of any new share issue should be placed through a stock exchange.

Operating environment

Uzbekistan is among the poorest countries in the CIS. Nonetheless, a period of relative economic and political stability in recent years has allowed its national economy to demonstrate impressive growth - although from a low base.

At present, the Uzbek economy remains predominantly focused on agriculture and mining. In recent years, Uzbekistan has started economic restructuring, whereby significant investments have been channelled into the gas extraction, mining and auto manufacturing industries, as well as to a number of infrastructure projects. Uzbekistan is now one of the world's top-five countries in the production and export of cotton (20% of the country's total exports) and one of the top-10 in gold mining (25% of exports). As of end-2007, state reserves exceeded $3bn.

At the same time, the economic situation in Uzbekistan remains difficult, with inflation and unemployment rates being high and the average wage just slightly exceeding $100 per month. Although some elements of a market economy have been emerging, state-controlled businesses still dominate, whereas small private entities and entrepreneurship are underdeveloped, and often subject to excessive regulation and pressure from governmental authorities. Much remains to be done to upgrade Uzbekistan's legal framework to the level of more developed countries, especially as regards the transparency of the rules and conditions of doing business.

Banking on support

In Moody's opinion, the authorities may, under certain conditions, decide to provide systemic support to certain banks in distress, or to the whole banking system.

Although the penetration and the financial intermediation function of the Uzbek banking system are currently low, there is an understanding among both the business community and the governmental authorities that this role should be strengthened. In 2007, the government introduced the so-called "Programme for reforming the banking system of the Republic of Uzbekistan." In essence, this strategy anticipates growth in the banks' business volumes and capital levels, as well as increasing the float and liquidity of the banks' shares on stock markets. Moody's expects this will boost the banks' financial intermediation role in the national economy.

The regulatory environment of the Uzbek banking system has been developing in recent years and has yielded some positive results. However, the banking regulatory framework is still immature and has to be developed and tested further.

With effect from January 1, the central bank increased the minimum required amount of charter capital for newly created commercial banks (ie. joint-stock and foreign banks) and for foreign banks private banks.

Recent tax changes appear positive. Before 2007, Uzbek banks were liable to so-called "receipts tax" paid at the rate of 12%. Since January 1, 2007, the receipts tax has been replaced by a tax on profits calculated at the rate of 17%. In accordance with a presidential decree "On measures to ensure a further reform and liberalisation of the banking system," commercial banks have been granted an exemption, until 2010, from tax on profit derived from the extension of long-term investment credits to local enterprises, on the condition that the profit is used to boost their equity.

Uzbek banks are still obliged to perform a number of non-core functions, including acting as tax agents (withholding taxes and, in certain cases, monitoring of their correct payments by the banks' customers), registration of export and import contracts and accounting for foreign trade operations, control and accounting for settlements with creditors and debtors for certain clients. It is expected that the banks' non-core functions will cease by 2010.

Olga Ulyanova is assistant vice president, Elena Redko is associate analyst and Anton Gelin is senior associate at Moody's Investors Service

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