ANALYSIS: Kazakh banking sector in search of new business model in wake of crisis

analysis

ANALYSIS: Kazakh banking sector in search of new business model in wake of crisis

By SRI ⋅ January 12, 2009 ⋅

(SRI) - Kazakhstan’s banks have been forced to revamp their business model in wake of the global financial crisis. From being almost entirely dependent on foreign borrowing, they increasingly focus on domestic depositors as a source of financing.

Kazakh banks’ attitude towards foreign debt has dramatically shifted over the course of last year. While as late as in the first half of 2008, the ability of the banks to raise funds on international capital markets was seen as a stamp of approval by foreign investors, today, Kazakh lenders measure their success by lack of foreign obligations.

The outstanding foreign debt for the entire Kazakh banking sector is approximately USD40 billion, of which USD10.6 billion is due in 2009, and a number of institutions face tough repayment schedules.

Foreign borrowing

In the last year and a half, the entire Kazakh banking sector has been forced to change its business model from one almost entirely dependent on foreign borrowing for growth to one focused on customer deposits and other domestic capital sources.

During the heady years of Kazakh banking, from early 2000s until the summer of 2007, the growth strategy of most Kazakh banks was simple. They raised cheap short-term debt on European capital markets denominated in Euro and dollars, and used the funds to provide credit to the growing customer base in Kazakhstan at a much higher interest rate.

Debt raised in Frankfurt, London and Paris fueled construction booms in Almaty and Astana and provided the newly emerging middle class with the money to buy everything from flat screen televisions to SUVs.

No other institution represents those times better than Alliance Bank, Kazakhstan’s fourth largest bank, whose shares trade on the London Stock Exchange (LSE).

Alliance was one of the fastest growing banks in Kazakhstan, quickly transforming itself from a regional player to one of the country’s largest banks. Unlike its most established peers like Halyk Bank or Kazkommertsbank, it strongly focused on retail lending as part of its growth strategy. Since 2004, it grew from being the tenth largest retail lender in the country to being the market leader.

Yet, the strategy of borrowing short on international markets and lending long at home bore significant risks. Should foreign banks freeze lending, Alliance would be stuck with billions of dollars of fast maturing debt and be cut off from its main source of financing. Of course, exactly that happened in the summer of 2007 when the liquidity on global capital markets dried up and interest rates skyrocketed.

In a chain reaction, Alliance, along with most Kazakhstan’s banks, sharply curtailed lending, effectively ending the construction boom and sending real estate prices plummeting.

As a consequence, Alliance’s profit in 2008 fell sharply from previous years, and its shares on the LSE tumbled.

Alliance, as one of the fastest growing banks in Kazakhstan, used enormous amounts of foreign debt to fund its operations but it was by no means an exception. Most banks used foreign borrowing to fuel the credit boom in the country and, simultaneously, their own growth.

New business model

As late as in 2008, the overall loan to deposit ratio among the ten leading banks was 214 percent, meaning that for every dollar deposited, the banks have issued USD2.14 in loans. As a rule of thumb, the ideal ratio is 100 percent.

Suddenly, the banks were forced to seek an alternative to the Eurobonds and syndicated loans to fund their operations. They had to turn to the old-fashioned yet proven business model and start attracting customer deposits as a source of financing.

Not as sexy as loans issued by leading banks in European financial capitals, deposits are the most stable and long-term source of financing, Zarina Taima, managing director of Eurasian Bank, said.

Until 2007, Halyk Bank, the third largest bank, led the way in focusing on attracting deposits, rather than loans, to fund its operations. Yet, the credit crunch soon caused others to follow.

Kazkommertbank, Kazakhstan’s second largest bank with a strong focus on corporate banking, first started its retail operations in 2000. But only in late 2007 did it begin to push its mass retail business when it rebranded its retail arm as Kazkom and opened new branches across the country.

Other banks, like BTA Bank, Kazakhstan’s number one, and Alliance Bank, also began a drive to attract customer deposits, offering higher rates of interest on deposits and expanding their product lines.

To support the banks, Kazakh government urged state-owned companies to deposit their funds with Kazakh banks. It also passed a legislation significantly expanding the state insurance on customer deposits.

Outlook

This, naturally, has been a difficult adjustment for some banks. Borrowing abroad at a low rate and lending at home at a high rate seemed the natural order of existence. The credit crunch of 2007 was a wakeup call.

Yet, the banking crisis may actually benefit the Kazakh banking system in the long run.

The banks will be forced to get their balance sheets in order. They will need to orient themselves increasingly towards domestic depositors in order to attract financing. And they will have to convince international lenders and rating agencies that they will be reliable partners in the future.