Answers on Banking Sector Reform

A list of questions for preparing a concept paper on problems in the domestic banking sector and ways to address them.

What changes (legislative, administrative, managerial, etc.) are needed in the banking services market for commercial banks to reach the global standards of international banks?

Kazakhstani banks by and large meet global banking practices today, but this has been achieved not through systemic reforms but through an administrative "clean-up" of the banking sector. The main problem with second-tier banks is that each is controlled by a single person or a group of affiliated persons, which creates serious risks of abuse by shareholders. To eliminate shareholder influence over banks' operations, all banks should be made public, and no single person or group of affiliated persons (other than the state) should be allowed to hold more than 25%. Shareholders and their close associates should also be barred from chairing the Board of Directors; the chair should be an independent director. This would systemically change how banks are governed: they would focus more on delivering results than on carrying out the decisions of a sole shareholder. Banks should also be required to disclose more about lending to affiliated persons and about problem debt.

Which areas of the Kazakhstani banking system are underdeveloped, and could their development help banks make a qualitative leap and become large regional banks?

In terms of their development, Kazakhstani second-tier banks could in principle become regional banks. However, there are no countries in Central Asia with an acceptable investment climate. Otherwise, the state would have to protect our banks in other countries by hand. More capital is also needed to enter more developed countries. Of the existing second-tier banks, only Halyk, Kaspi and Jusan could become regional players.

Given our "underdeveloped" type of banking sector, what legislative changes are needed to attract new institutional investors beyond the traditional ones (EBRD, ICBC Standard Bank Plc and others)?

The main reason institutional bank investors do not come to Kazakhstan has nothing to do with banking legislation. It lies in the institutional environment in which banks operate. That environment does not allow second-tier banks to operate with a predictable level of risk. To attract foreign banks, the legislation on recovering problem debt must change. At present it favors borrowers, which prevents banks from lending to the full extent. The recovery timeframes need to change: they are very long, and from the moment a loan becomes overdue until it is fully recovered, banks incur losses that are hard to cover with future profits, especially at the current cost of money. We need to amend the law on valuation activity, bring order to the work of private enforcement agents, introduce uniform court practice, tighten requirements for companies that are obliged to undergo audit, tighten requirements for audit firms, and so on. Institutional investors also value macroeconomic predictability. In other words, the NBK and the Government must use market-based methods to manage an economy that does not generate imbalances, so that country risks can be forecast in the future.

What prevented Islamic banking from developing effectively in Kazakhstan, and why was its adaptation insufficiently successful?

In financial terms, Islamic banking is no different from conventional banking. The only difference is that interest is built directly into the principal of the loan. At the same time, there are not enough people who would use Islamic banking to generate normal demand. Islamic banking can therefore only be a part of conventional banking in our country. At present, Islamic banks are separate from conventional ones. Conventional banks should be allowed to obtain a license for Islamic banking.

Which sectors of the economy could give additional impetus to the development of the financial, banking and stock markets?

In Kazakhstan, these are only subsoil use and agriculture. But radical changes are needed in both. The current changes are piecemeal and will not alter the landscape of these sectors.

What explains the decline in lending to the real sector in favor of earning profit by investing surplus liquidity in government securities and National Bank notes?

Any commercial organization will maximize profit, and the main issue here is risk. These are the same problems I described in question 3. The main reason banks do not lend to the real sector is a poor environment for recovering problem debt, the absence of uniform court practice, the state's social orientation, and the lack of punishment for dishonest borrowers. We need to institutionally tighten requirements for companies in terms of audit, valuation, and liability for deliberate bankruptcy. In addition, at the current base rate, demand for money is falling, but this is a short-term phenomenon that will last until inflation returns to normal.

What measures other than taxation should be introduced to redirect banks toward lending to business? (state guarantees, tighter requirements for borrowers, loan insurance, etc.)

Everything is the same as in questions 3 and 6. I would also recommend revisiting the requirements for foreign-currency lending. Currently it is almost impossible to lend in foreign currency, and it seems to me that regulators have been overly cautious on this point, whereas rates on foreign-currency loans are now acceptable for business.

Is there a need to change the regulatory activities of the National Bank and the ARDFM to improve the situation in the banking sector?

In my view, the regulator should not have been split into the National Bank and the ARDFM. The National Bank should have been relieved of functions that do not belong to it, such as the UAPF, the National Fund and the Financial Stability Committee (KFU), and these should be transferred to the Ministry of Finance. KASE should be merged with the AIFC. The National Bank and the ARDFM should be combined and should work in a unified way to develop the financial sector. It looks to me as though the ARDFM was spun off more to evade responsibility.

How does the traditional practice of lending to companies affiliated with shareholders affect the banking market, in terms of the deterioration of banks' financial soundness?

It has a very negative effect. As we can see, all the second-tier banks that were liquidated had lent to their own shareholders. The regulator's professional judgment needs to carry more weight. This provision was adopted, but in practice it does not work, and banks' reporting today does not reliably show how much has been lent to affiliated companies. This may cause problems in the financial sector again. The influence of shareholders on banks' operations also needs to be reduced.

What measures should be taken to prevent the illegal withdrawal of banks' funds and the deliberate worsening of their condition?

The only method that will work is the one I described above: make all second-tier banks public and prohibit any single large participant from owning more than 25%. Shareholders should be removed from management, and the chair of the Board of Directors should be an independent director who will bear responsibility.

Why is there no interest among foreign banks in entering the Kazakhstani banking market? Are there administrative barriers?

I addressed this in question 3. I would add that the small size of the market plays a role: in essence, all of Kazakhstan is like one metropolis. The military conflict between Ukraine and Russia and our heavy dependence on Russia and the EAEU also matter.

What is the level of interaction between Kazakhstan's traditional banking system and the Astana International Financial Centre, and what changes would provide a regional advantage?

Interaction is very weak, and the conflict between KASE and the AIFC is plain to see. There is as yet no legal practice, especially in enforcement proceedings, and the regulators' work is not synchronized. In my view, KASE and the AIFC should be merged, taken out from under the National Bank's authority, and kept as a single platform.

Does it make sense to break up large banks into several smaller ones to change the situation in the banking market?

There is no point in breaking them up artificially. The administrative levers that allow quasi-public companies to steer banks should be removed. If quasi-public companies' requirements for banks are reduced, smaller banks will have more room to lend. Requirements for setting up a bank should be simplified, especially the requirement to operate without taking deposits in the first year. We should also consider creating niche banks subject to lighter requirements: for example, mortgage banks, banks operating solely in investment banking, and online banks without physical infrastructure. This would attract more small fintech companies, which could grow into large banks in the future.

What caused the reduction in the number of second-tier banks in Kazakhstan?

Excessive regulation and the wrong approach to bank rehabilitation. Merging the banks was a bad decision. At a minimum, Kazkommertsbank, ATF and Tsesnabank should have been preserved. As practice has shown, the money allocated to rescue these banks would have been enough for them to operate on their own, without the help of other banks. International practice is to convert debt into equity, whereas here debt was converted into long-term debt at a zero rate. All the large creditors should have been made shareholders of these banks, with proper management installed in each, and the banks kept on the market. The situation in the market would be completely different now, and there would be many more public banks.

How can international banks be attracted to the domestic market, and does the market need this?

For now the market does not need it. The right environment must be created, and players will come on their own, though not right away. We will have to wait about five years.