Clare Nuttall in Almaty -

Emigrating to outer Mongolia to manage a failed agricultural bank is hardly an obvious career move, but it worked for Peter Morrow. Eight years after he took the helm, Khan Bank is Mongolia's largest lender by assets and has expanded from its rural roots into corporate and institutional banking. International expansion is now on the agenda.

Khan Bank's origins go back to the Soviet-era State Bank of Mongolia, which was broken up in 1991. In the carve-up of the former monopoly, Khan Bank took over most of its offices in Mongolia's provincial capitals and rural areas. But the government's ambitious plans for a private sector banking industry collapsed in the 1990s with the failure of the entire system.

Morrow attributes this to a complete lack of experience. "Before 1991, there were no real banks, no understanding of credit risk or other issues, and no modern technology," he says. With 30 years in the banking industry under his belt, he was invited to take over Khan Bank in 2000, when it was already in receivership. The Mongolian government had decided the bank had to be kept alive because it was the only one with a sizeable presence in rural areas, where it handled tax collection, pensions distribution and other services.

Morrow and his new management team were given two years to turn things around, with the incentive that if they were successful, the bank would be privatised. In fact, it was three years before the bank was sold, but overall things went according to plan.

Khan Bank is now 100% privately owned, by the International Financial Corporation and private investors from Mongolia, Japan and the US. Since 2003, it has been transformed from a retail bank focused on rural areas, to a full service bank - working with retail, corporate and institutional clients - with a strong presence in the Mongolian capital.

The move into Ulaan Bataar was a significant step, says Morrow. When he took over, Khan Bank's head office was in the capital, as were a handful of branches to serve its rural clients - in areas around the bazaars and near universities where students from rural areas were studying. However, there had not been a coherent strategy to penetrate the market. Today, Khan Bank has more than 70 branches across Ulaan Bataar, including a flagship branch at its headquarters on Seoul Street, which is better known to the older generation of Ulaan Bataar residents as the site of the Soviet children's theatre. The theatre is still open for NGO meetings and other business, the consequent thoroughfare of people giving the bank the atmosphere of a busy community centre. When Morrow gave his tour of the building, a children's dance troupe were rehearsing their juggling routine in the theatre, while outside preparations for ING Bank's Ulan Bataar launch party were in progress, and a local artist gave a presentation of her work in the neighbouring salon.

It's hard to see where the old theatre ends and the modern extension at the front begins. With their gleaming white paint, marble floors and vast expanses of plate glass through which the early September sun is glaring, the Khan Bank offices look more like an art gallery than a bank. The walls in Morrow's office and those of his staff are hung with paintings from famous and up-and-coming Mongolian artists, some of the 240 works of art the bank has accumulated in recent years.

Out on the steppes

Far from cosmopolitan Ulan Bataar, Khan Bank is working with individuals and mining companies at isolated outposts in the Mongolian steppe and the Gobi desert. Its corporate business is focused on loans and trade finance, but it has also become an important service provider to Mongolia's mining industry. A dedicated mining department operates the only office at Mongolia's largest mining operation Oyu Tolgoi, and the Dornod uranium fields.

"We have an advantage because we have the combination of modern technology and a branch network across rural Mongolia," says Morrow. "Where there is no office we figure something out." The logistics are still not easy. To service customers such as QGX's operations in the south Gobi, where engineers live in traditional Mongolian gers with no electricity or mobile coverage, Khan Bank sends a van equipped with a wireless POS terminal and satellite connection out once a week from its nearest branch 59 kilometres away.

Khan Bank has been bringing all its branch offices online - to date 410 of its 475 branches are online - using generators and satellite technology in areas not served with electricity or mobile coverage. This will be helped by the government, which says it will cover the entire country with wireless by the end of the year. All the company's branches will be online by 2009.

Technology is important to the bank with its urban customers as well as in rural areas. There are already close to 1m cards - mainly debit cards - in Mongolia, and electronic POS terminals are widespread in the major cities. Khan Bank operates a network of 70 Visa ATMs, which it plans to add to significantly. While low computer ownership means internet banking is unlikely to become as important in the west, mobile phones are ubiquitous prompting Khan and other major banks to provide mobile banking services.

"The market is extremely competitive," says Morrow. "We have a very good legal and regulatory structure, a good central bank, and the system is fundamentally sound." Like several of his peers in Mongolia, however, Morrow considers that with no less than 16 banks serving a population of around 3m, "Mongolia has far too many banks". As a result, it is unlikely to see any international competitors in the retail segment, despite the arrival of ING and Kazakhstan's Halyk Bank.

Sexy SMEs

Looking to the future, Morrow says that the "bricks and mortar" part of its expansion is virtually complete, and Khan Bank will focus on selling new products as the country's economy develops. "There is a lot of potential upside in the [small and medium-sized enterprise] business," says Morrow. "For Mongolians, the 'sex' in mining is not the mining industry itself, but the supply chain to the mining industry."

With pending new legislation, that means mega-projects like Oyu Tolgoi can get going. While much of the money will go to international experts and companies, between 5% and 20% is expected to stay in Mongolia. "There is huge potential. We already have 5-10% of the SME market, which we hope to increase to 25% in future," says Morrow.

Khan Bank has been preparing for its future expansion, announcing on September 10 that it had established a $300m global medium-term note programme, which will give it access to a range of international institutional investors. It has, however, historically been cautious about how much money it raises on international capital markets, and on what terms. "Kazakhstan has shown us what not to do when raising capital," Morrow says. "As we have seen, Eurobonds have a nasty habit of coming due. We declined to accept that kind of money, though we have been offered loans with some big numbers."

But what the Mongolian capital sector does have in common with Kazakhstan is that with a limited domestic market, there comes a point where banks that want to continue to growth need to expand beyond their own market, Morrow says. Khan Bank already has a representative office in South Korea, where there are between 30,000 and 40,000 Mongolian guest workers.

"We want to be in Korea, and it might be possible to get a banking licence to set up a branch there," says Morrow. "Japan is also a possibility, whereas moving into Russia, Kazakhstan, Kyrgyzstan or South East Asia would be more difficult." The most obvious option for both geographic and cultural reasons - opening up in inner Mongolia just across the Chinese border - is also off the agenda for the time being due to restrictions on foreign banks entering the Chinese market, but as Morrow points out, "If China opens up, this would make a lot of sense."

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