Guy Norton in Almaty -

It's all change in the Kazakh banking sector. Over the course of the next couple of months, the Central Asian state is set to witness a complete makeover of its financial institutions through a combination of the completion of long-awaited debt restructurings at BTA Bank and Alliance Bank, and a much-anticipated overhaul of the regulatory system governing the sector.

The hope is that these twin events will help draw a line under a summer of discontent, which has seen the country's reputation take a battering and left many investors feeling upset about the authorities' handling of the problems that have beset the banks.

Top of the pile profile-wise will be the long-awaited completion of the restructuring of $10bn worth at debt at Kazakhstan's former leading bank, BTA. With some investors perhaps looking at an 80% haircut, there's plenty of cause for concern about the implications for further foreign investment in the country. As Neil Smith, chief investment officer at Russia/CIS fixed-income specialist Florin Investment Management notes: "The banking sector of Kazakhstan has disappointed beyond belief and, of course, the aggressive writedowns of debt by BTA just demonstrate how uncommitted the government is to re-injecting liquidity into the banking system and encouraging future foreign investment."

The lack of liquidity within the Kazakh banking sector is set to act as a brake on the corporate sector of the economy as well. "Corporate risk will, of course, be higher than the banking system, since it relies on the latter to provide it with financing - only corporates with access to international markets can survive on a conventional basis," he says. "However, it is becoming increasingly clear that the corporates are maintaining their liquidity through more forceful means - effectively putting themselves into a situation of non-performance with their banks and the banks being unable to foreclose because the asset value would be meaningless with respect the original loan."

Regulatory changes

Proposed changes to the regulatory environment, which will be implemented in the next few weeks, are likely to further limit the amount of funding available to both corporates and individuals.

Among the proposals on the table, according to National Bank of Kazakhstan (NBK) chairman Grigory Marchenko, is a cap on external financing, with overseas liabilities to be capped at 30% of total liabilities. In the pre-credit crunch era, foreign borrowing accounted for as much as 70% of total funding in some instances. Another proposed measure is to cap loans/deposits at 150% - a far cry from the 400% levels at some banks in the pre-credit crunch era.

While these measures will undoubtedly prevent a repeat of the excesses of the early part of the decade, when banks borrowed heavily abroad and lent aggressively at home - a prime cause of the real estate bubble that has burst spectacularly in Kazakhstan, sending prices crashing by as much as 70% - they will likely further exacerbate the rising cost and scarcity of capital. "Caps on foreign borrowing and loans to deposits meant to make banks more resilient, will be a drag on asset growth. Internal funding will not match global markets dollar for dollar, while ongoing debt service and legacy assets will further deflate balance sheets and depress earnings," says Bahit Jolaman, chairman of Almaty-based investment group Paragon.

Although Jolaman expects the banks to post asset growth levels in excess of the underlying economy, they will be a far cry from the 55% annual average levels recorded between 2000 and 2007. As a result, he does not believe there is a compelling case for investing in Kazakh banking stocks at present. "Kazakh financials' stock prices are expensive both on fundamentals and peer group valuations, and this against the backdrop of ongoing re-regulation and deleveraging."

Other measures intended to shore up the rickety banking system include the possibility that foreign firms operating in Kazakhstan will be required to keep a share of their funds with Kazakh banks. According to local analysts, the measure, if enacted, could have a positive impact on the banking sector. At the same time, however, it could adversely impact the investment climate in Kazakhstan and cause investors to curb their activities in the country.

While there is undoubtedly plenty of pessimism about the prospects for the Kazakh banking sector among portfolio investors, it's also fair to say that there is also a fair degree of optimism among strategic investors who feel that they are well placed to pick up market share. "We believe the current situation in the market is very attractive, especially for us," says Danila Smirnov, chief executive officer of Alfa Bank (Kazakhstan), the local subsidiary of Russia's leading privately owned bank. "We don't have any major problems with the quality of our portfolio. Our target is to attract corporate clients, which we will be able to do because we have money, we are ready to lend, and we don't have any problems with capital. Actually, we are over-capitalised at the moment."

Alfa Bank is, therefore, looking to cherry pick the best corporates as customers, confident that they will not only survive the current global economic crisis, but ultimately go on to thrive in the ensuing economic upturn. "This is a worldwide crisis. However, I think Kazakhstan has very big potential for the future. It's a huge territory with a lot of minerals, metals and oil. Kazakhstan's government is faced with a big challenge in dealing with the problems in the banking sector, but I believe the government will be able to resolve the problems it faces," Smirnov says.

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