Clare Nuttall in Yerevan -

Armenia's banking sector has been growing much faster than the rest of the economy, but with strong competition between the banks in a small economy, the pace of growth is expected to slow.

While Armenia's economy grew by just 4% in 2011, the banking sector expanded by over 30%; assets were up 37% and deposits 36%. Data from the Union of Banks of Armenia (UBA) shows that there was growth across both consumer and corporate segments, with lending to the construction sector (up 36%), the industrial sector (up 30%) and services (up 26%) all growing strongly.

Admittedly, the main driver for this growth was the demand left over from 2009, when the Armenian economy contracted by 15% and banks slowed their activities in response. "There has been very strong growth especially on the lending side in 2010 and 2011, because there was a lot of pent-up demand," says Astrid Clifford, CEO of HSBC Bank Armenia, which almost doubled its commercial loan portfolio in 2010.

Bankers are now waiting to see what impact the ongoing crisis in the Eurozone will have on Armenia's economy. The banking sector still has little direct exposure to international capital markets, and is tightly regulated, but some impact is expected. "We expect growth will continue if we have stability in Armenia," says Seyran Sargsyan, executive director of the UBA. "There may be some indirect influence from the crisis in the Eurozone. We are more integrated with the Russian economy, so problems in Russia would affect Armenia. However, all these risks are manageable."

Search for new business

Whatever the events in the Eurozone, within Armenia the catch-up effect from the previous crisis has been used up, and banks are having to look for new business beyond their existing client bases, which are generally concentrated in Yerevan and other major cities.

Banking sector penetration is still relatively low in Armenia, where many people, especially in rural areas, still prefer to store their savings under the mattress. The shadow economy is also large - although this is starting to change. As of 2011, 51% of Armenia's adult population had a bank account, according to the UBA, up from 30% in 2006 and just 13% in 2000. "Unfortunately, penetration has not reached the whole population, although there has been a steady increase in recent years," Ashot Osipyan, president of the UBA and CEO of Araratbank, tells bne.

He points out that banks have been increasingly moving into rural areas. "Banks are also looking at new areas such as agriculture, where lending was up 36% in 2011. This could become a key sector," he says.

There are growing concerns that in a market until now characterised by conservative lending policies and strict regulation, banks could turn to riskier clients. Some banks are reported to be being less demanding in terms of security and collateral in order to bring in new business.

Armenia's banks have typically been conservative in their lending; non-performing loans (NPLs) are low compared with other countries in the region. However, with competition becoming more intense, and many companies already quite highly leveraged, things may be changing. Given the small size of the Armenian economy, banks are forced to compete for a small pool of potential clients. Clifford notes that interest rates have fallen as competition has increased. "It is a small market so we are all targeting the same people. These days we are seeing more refinancing than new loans."

However, bankers say that a big more towards riskier lending is unlikely. Tight regulation has also ensured that no single bank or group of banks has ever had more than 10-12% of total market volume or dominated Armenia's small but competitive banking sector.

Osipyan, for one, reckons the country has one of the best regulated banking sectors in the world. "With strong regulation, you can have a very competitive bank system with small size," he says. "In a liberal regime, you get big banks and aggressive growth, but the crisis showed it is more important for both the banking system and the country to have strong regulation."