III. An Analysisof Bank Credit Growth1
1. Kazakhstan’s banking sector has expanded rapidly since the late 1990s. Bank lending has grown by about 50 percent per annum in real terms, prompting questions about its sustainability and the potential consequences of a sharp slowdown—or contraction—in credit growth. Against this background, this chapter seeks to address the following questions:
- To what extent is the rapid credit growth in Kazakhstan similar to the type of “catch up” observed in other transition economies?
- What is the sectoral and currency composition of bank lending, how has it changed over time, and how does it compare with other countries?
- What are the key risk exposures of the banking system, and how has the quality of banks’ loan portfolios evolved?
A. The Banking System—A Profile
2. The banking sector in Kazakhstan has undergone substantial consolidation in recent years. There were 35 banks operating in Kazakhstan at end-2004, compared with 71 licensed banks in 1998. The number of bank branches declined as well—from 458 in 1998 to 377 at the end of last year. The three largest banks account for roughly 60 percent of banking sector assets, and foreign banks make up about one third.2
3. Interest rate spreads, though generally narrowing, remain high. Lending interest rates, for both local currency as well as foreign currency credits, have declined markedly over the past half decade, reflecting increased competition and, for tenge loans, lower inflation. On the deposit side, foreign currency interest rates have eased in recent years in response to lower global interest rates. Tenge deposit rates offered by banks have also declined as banks’ tenge liquidity has increased.
4. There has been a substantial process of remonetization in recent years, and deposit dollarization has declined markedly since 2001. The ratio of total bank deposits—tenge as well as foreign currency-denominated—has increased steadily, standing at 23 percent of GDP at end-2004. Deposit dedollarization likely reflects growing confidence in the tenge as inflation declined and the tenge appreciated in nominal terms against the dollar. Deposit dedollarization has also taken place in other transition economies, although the recent pace in Kazakhstan has been more rapid than in other countries.3
|LIBOR (1 year)||6.8||3.9||2.2||1.4||2.1|
Weighted period average interest rates.
Weighted period average interest rates.
|(In percent of total deposits)|
|Foreign currency deposits|
|(In percent of GDP)|
5. Bank credit has increased rapidly in relation to GDP, reflecting the ongoing process of financial deepening. While a similar process has taken place in other transition economies, the increase in Kazakhstan’s credit-to-GDP ratio has outpaced that in other countries. Credit grew by over 50 percent last year, and by end-2004 the ratio of bank credit to GDP was about 27 percent, significantly higher than in most CIS countries and close to the average level in the EU accession countries.
Credit to GDP Ratio
Sources: Kazakhstani authorities; IFS; and Fund staff estimates.
1/ Includes the Kyrgyz Republic, Tajikistan, and Uzbekistan.
2/ Includes the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic, and Slovenia.
B. Aggregate Credit Growth—Catch up or Bubble?
6. International experience suggests that excessively rapid credit expansion raises the risk of a subsequent sharp correction, which is usually accompanied by severe economic costs. A recent study—IMF (2004a)—analyzed credit growth in 28 emerging market economies during the period 1970–2002. Among these countries, 18 episodes of excessive credit expansion (or credit “booms”)—an expansion that is unsustainable and eventually collapses of its own accord—were identified.
7. Some features of typical credit boom episodes in emerging market economies are evident in Kazakhstan. For example, IMF (2004a) found that the median real credit growth in the three years preceding the peak of a typical credit boom was 17 percent. By this measure, credit growth in Kazakhstan has been well in excess of that in the typical credit boom. It should be noted, though, that only one fourth of sustained rapid credit growth episodes were associated with a subsequent credit collapse.
Real Credit Growth Rates
Sources: WEO 2004, IFS, and Fund staff estimates.
8. Other features of the recent credit expansion in Kazakhstan suggest, however, that the typical emerging market episode is not readily applicable. As noted in IMF (2004a), credit booms in emerging markets typically lasted 3½ years, with a range of two to five years. In Kazakhstan, as in several other transition economies, credit growth well in excess of the rapid growth threshold for emerging markets has been sustained for six years already. This likely reflects, at least in part, the ongoing remonetization and financial deepening during the transition to a market economy.
9. In fact, statistical analysis indicates that the present credit levels in Kazakhstan are broadly in line with the longer-term trend. Application of the Hodrick-Prescott filter to quarterly data over the period 1993–2004 facilitates identification of the trend. According to this technique, real credit outstanding at end-2004 was actually slightly below the estimated trend level. The steep upward slope of the estimated trend is consistent with the ongoing financial deepening seen in transition economies. This result should be interpreted with caution, however, as it is likely affected by the relatively short time series and the major structural changes that Kazakhstan has undergone over the past decade.
Real Credit and Trend
Sources: IFS; and Fund staff estimates.
10. Based on the above, it is difficult to make a clear case from aggregate bank lending data that credit growth in Kazakhstan has been “excessive.” Nevertheless, sectoral patterns of bank lending—and borrowing—may give rise to increased risk.
C. Composition of Bank Lending
11. Real estate and consumer lending has increased sharply in recent years. The share of propertyrelated loans in total bank lending rose from about 7 percent in 2000 to 19 percent in 2004, implying increased exposure to property price developments and to the risks associated with a sharp correction in real estate values.4 The share of consumer lending also expanded sharply, from about 2 percent to almost 10 percent. By contrast, the shares of the industrial, agricultural, and trade sectors declined substantially, although these sectors experienced, in aggregate, annual growth rates of credit of about 60 percent in nominal terms.
|Credit by use|
|Construction and reconstruction||4.8||5.3||5.4||5.6||4.6||10.9||10.3|
|Construction and acquistion of real estate by individuals||1.9||1.7||1.1||1.1||1.6||3.8||8.7|
12. The share of foreign currency lending in total bank credit, though declining, remains high. The bulk of mortgage loans—almost 90 percent—are foreign currency denominated, possibly reflecting the less attractive interest rates for tenge loans, as well as the strengthening of the tenge in 2003–04. That said, the share of foreign currency lending in Kazakhstan is not out of line with that in other transition economies, and the decline in this share in recent years has been more rapid than in other countries.
13. Banks have also expanded their cross-border lending, mostly in other CIS countries. Credits to borrowers abroad were equivalent to about 14 percent of banks’ total credit operations at end-2004,5 compared with less than 1 percent in 2000. Kazakhstan’s banks have also bought minority and majority stakes in banks in Russia, Ukraine, Belarus, and the Kyrgyz Republic in recent years.
14. On the liabilities side of their balance sheets, Kazakhstan’s banks have become increasingly active borrowers in international financial markets. Banks have borrowed from abroad through syndicated loans, securitization, and issuance of bonded debt.6 At end-2004, net external liabilities constituted over 35 percent of total assets of the commercial banks, compared with just over 5 percent in 2000.
15. Net foreign currency denominated assets of the banking system turned negative last year. This likely reflected, at least in part, expectations of continued tenge appreciation. While the potential direct currency mismatch remains relatively small, banks are exposed to indirect currency risk via their foreign currency lending to borrowers with limited (or no) foreign currency earnings.
Net Foreign Currency Assets of the Banking System
Source: Kazakhstani authorities.
D. Banking System Soundness
16. The banking system’s financial position appears sound, but there are some potential vulnerabilities. Banks’ loan portfolios are relatively young and, for the most part, have not yet been tested by sharp changes in macroeconomic conditions or a severe asset price downturn. The 2004 Update of the Financial System Stability Assessment for Kazakhstan concluded—on the basis of information through early 2004—that although the capital adequacy ratio of the banking system seemed comfortable, stress testing revealed potential vulnerabilities, including credit risk and reliance on external wholesale funding.7
17. Banks remain profitable and well capitalized, and continue to have ample liquidity. At end-2004, the average capital adequacy ratio was 15.9 percent, well above the required prudential norm of 12 percent. The banking system’s liquidity ratio—measured as liquid assets (mainly t-bills and cash) to short-term liabilities (mainly demand deposits)—amounted to over 100 percent, more than three times the minimum requirement of 30 percent. On average, banks’ return on assets has ranged from 1 percent to 2 percent over the past six years, and their return on equity from 8 percent to 14 percent.
18. However, the quality of banks’ loan portfolios has deteriorated somewhat over the past year. Loan losses have increased in relation to total loans outstanding—from about 2 percent at end-2003 to almost 3 percent at end-2004—despite the rapid increase in the volume of outstanding loans. The proportion of classified loans has also risen, from 37 percent to 41 percent, although the bulk of classified loans continue to be serviced on time and banks have set aside increased loan-loss provisions.8
Source: Kazakhstani authorities.
(Percent of total loans)
|Asset category||Required provisions|
(Percent of asset value)
|1. Substandard, payments current||5||25.8||31.9|
|2. Substandard, payments in arrears||10||3.1||1.4|
|3. Unsatisfactory, payments current||20||4.6||5.3|
|4. Unsatisfactory, payments in arrears||25||1.4||1.0|
19. Substantial cross-relationships between financial institutions and industrial groups also heighten concerns. These relationships have contributed to the emergence of financial-industrial groups with holdings in both the banking and real sectors, often under complex ownership structures. While progress has been made in monitoring banks’ related party exposures and exemptions from prudential limits on exposure to a single borrower are reportedly no longer granted, continued scrutiny is warranted on related party lending and aggregated large exposures.9 More generally, the rapid credit growth environment points to operational challenges for banks, particularly the need to strengthen their internal risk management systems.
20. While credit growth in Kazakhstan has been rapid even by transition economy standards, it is difficult to conclude that such growth has been “excessive” from aggregate data. Recent developments in the pattern of bank lending and borrowing, however, have led to increased exposure to the property sector and international financial markets. Although basic indicators of banks’ aggregate financial position appear sound, the moderate deterioration in loan quality over the past year points to the need for continued vigilance.
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BartholomewP. F.2004 “Analyzing Credit Quality,” mimeo.
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International Monetary Fund2004c “Republic of Kazakhstan—Financial Sector Assessment Program Update—Technical Note—Bank Profitability and Competition,” IMF Country Report No. 04/336October.
Nicolo DeG.PatrickHonohan and AlainIze “Dollarization of the Banking System: Good or Bad?,” IMF Working Paper 03/146Washington: International Monetary Fund).