Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Central & eastern EuropeSeptember 1 2011

Armenia's banking caution looks set to pay off

Although the global financial crisis led to a significant contraction in the Armenian economy, the country’s banks were largely unaffected by the turmoil. With low banking penetration and regulation that is both progressive and cautious, the future for these institutions looks bright.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Armenia's banking caution looks set to pay offArmenia's agriculture sector

As the city swelters, a girl in the five-foot-high foam iPhone costume tries not to wilt. Parading around the Kentron district of Yerevan, home to such luxury shops as Armani and Burberry, she aims to appeal to those affluent Armenians whose choice of phone is not merely a status symbol, but a statement of intent. Can this really be the heart of one of the world’s worst performing economies?

It is if Forbes magazine’s July 2011 ranking is to be believed: Armenia, it said, has the second worst economy in the world, behind only Madagascar. A relative rather than absolute measure, Forbes focused on the economy’s performance over the past three years. The reaction among Armenia’s politicians ranged from disbelief to fury. A stung Ministry of Finance made its own calculations, coming to quite different conclusions; Forbes’ assessment, it asserted, must have been based on incorrect data. More likely, the difference was one of methodology. Either way, it has been a tumultuous period for the Armenian economy, whose reliance on the country's diaspora heightens its vulnerability to external shock.

After the crash

It was not always so. Armenia’s gross domestic product (GDP) grew by 13.7% in 2007, fuelled by an army of emigrant workers and their regular stream of remittances. But the financial crisis put paid to all that, with the country's economy contracting by a staggering 14.1% in 2009. The construction sector fared particularly badly: its share in GDP fell from 24.7% in 2007 to 16.9% in 2010. Global food prices also hit the country, and inflation rose to 8.2%.

Yet there are strong signs of recovery. Armenia's GDP, which was expected to grow by 1.2% in 2010, actually increased by 2.6%, despite the agribusiness sector declining by 14.2%. 

The International Monetary Fund forecasts 4.6% inflation for 2011. And perhaps no sector of the economy has been as resilient as the country’s banks. Well-capitalised and strictly regulated, Armenian banks were largely insulated during the global financial meltdown. Of course, they suffered the aftershocks – such as a sharp increase of non-performing loans, shortage of liquidity, and a fall of 30% in remittances – but there were no direct fatalities.

Banking positivity

Armenian banking sector - share of assets

Armenia has 21 banks, which accounted for more than 91.4% of total financial assets in the country at the end of 2010, according to the European Bank for Reconstruction and Development (EBRD). Their total financial assets grew by more than 16% to $4.3bn in 2010.

“Banks recovered public trust and the economy rebounded,” says Artak Hanesyan, CEO of Ameriabank, the country’s second largest bank by total assets. “With the recovery of the economy, banks had a better chance to finance less risky projects.”

After the 2009 slump, financial intermediation within the country has grown as well and is estimated to be about 45% of GDP, in line with the average for countries in the Commonwealth of Independent States. As of June 2011, five banks – ACBA Credit Agricole (ACBA-CA), Ameriabank, HSBC Bank Armenia, VTB Bank Armenia and ArmBusinessbank – dominate the sector, accounting for about 45% of all assets, according to the Union of Banks of Armenia (UBA). ACBA-CA alone held about 11% of banking system assets, and HSBC’s local subsidiary customer deposits accounted for 14% of those in the banking system. Roughly three-quarters of Armenian banks have foreign shareholders.

In 2010, Ameriabank acquired Cascade Bank, with $20m of capital and $45m of total assets, in a rare example of merger and acquisition activity in Armenia in the past five years. In a country of 3.5 million people, banks are fighting over the same customers. This fierce competition is likely to lead to further consolidation, which the EBRD considers to be desirable.

Karapet Gevorgyan, former central bank official and current acting CEO of Ardshininvestbank, Armenia’s sixth largest bank, thinks this is inevitable. “At the beginning of 1995, there were about 60 banks. Now we are down to 21. I expect the number to decrease further in five years’ time.”

Margins falling

In spite of the global crisis, Armenia's banking sector has been growing over the past three years. Total assets grew by 22% in 2008, 30% in 2009 and 16% in 2010, reflecting the gradual withdrawal of government financing in the economy. Compared to other central and eastern European companies, Armenian banking customers are not as leveraged, which limits systemic risk in the economy.

“We’ve been quite lucky so far in this market as the margins are high and we’ve been able to ask for security,” says Astrid Clifford, a UK citizen who is CEO of HSBC Bank Armenia, the country’s third largest bank. “It is general practice among banks to ask for security to cover the whole facility, so in that sense I think that has prevented customers from getting too leveraged.”

According to Alexander Babayan, the EBRD’s senior banker in Armenia, the general stability of deposit volumes, high liquidity and capitalisation are the system’s main strengths. Armenian banks had no need for the government bail-outs that occurred in other countries. But Mr Babayan is clear that things are likely to get tougher. “The main weakness is low profitability, due to a drop in margins driven by the slow recovery of the country’s economy and the limited number of creditworthy businesses,” he says.

The EBRD has invested $590m in Armenia since the mid-1990s in the form of equity purchases and direct loans, and 40% of its investments are in the banking sector.

The times of easy profits are gone, but there is plenty of room for growth: few people own bank accounts and the government is tackling the country’s informal economy, which remains strong. If it succeeds, more cash transactions will go through the banking system, says Ashot Osipyan, CEO of Araratbank and chairman of the UBA.

Strict regulation

The Central Bank of Armenia (CBA), one of the country's more progressive state organs, deserves much of the credit for the banking sector’s rude health. Its programme of tough, risk-based regulation limited the banks’ exposure.

The CBA has begun to ease its stance of late, though it remains vigilant. It adopted prudential measures to contain dollarisation in 2010, such as maximum open currency positions and increased Armenian dram obligatory reserve requirements. Early this year, it further tightened the obligatory reserve requirements: 50% (instead of 25%) of the overall 12% reserve requirement should be held in Armenian drams. That makes it more expensive for banks to attract dollar deposits.

“The CBA is progressive in its consistent approach to reduce dollarisation and implement strong supervision of the system,” says Mr Babayan. “It also introduces appropriate policies for the restructuring of doubtful credits, which helped a lot to go through the crisis, and directs a considerable amount of local currency through the banking system for lending to micro, small and medium-sized enterprises.”

One key measure taken by the CBA during the crisis was to enable banks to restructure the loans’ maturity without additional provisioning. If there was a temporary decline in sales, but the business was still able to survive and meet its obligations towards the bank in the longer term, the CBA allowed restructuring.

“This really allowed the banks to diversify their strategies with specific companies, adjusting to the changed situation,” says Aram Pinajyan, HSBC Bank Armenia’s head of commercial banking. “There was a decline in almost all businesses, some were not able to repay the loans on time, but they were still able to generate cash.”

But the CBA’s vigilance comes at a cost. The banking sector is stable, but small. Strong regulation provides stability, but can constrain growth. “At times we feel restrained by the daily control, but we see now how important it is,” says Mr Osipyan.

Capital market growth

With a new law on compulsory vehicle insurance passed this year and reform of the pension sector scheduled for 2014, executives hope that the country's nascent capital markets will receive a new stream of capital, boosting corporate growth.

“The reform will open an additional field of activities for investment banking and asset management companies and unlock huge potential”, says Mr Osipyan. “Russian firms in particular are interested; Armenia is a green field for investment companies.”

Astrid Clifford, CEO, HSBC Bank Armenia

Astrid Clifford, CEO, HSBC Bank Armenia

Currently only two banks – Ameriabank and ArmSwissBank – offer investment banking products besides limited brokerage of treasury bills and corporate bonds. Armenia’s capital market development is hampered by the size of the country. According to Mr Babayan, sustainable economic development and political stability are two key factors for stable capital markets. But there are other issues too.

“We need to develop an investment banking culture in our country. It is a complex system that requires a lot of coordination, training and know-how from abroad,” says Karen Zakaryan, the 32-year-old acting CEO of the Nasdaq OMX Armenia Stock Exchange.

In fact, the new stock exchange platform is a significant step in this direction. Started as a self-regulatory organisation in 2001, the local stock exchange was catapulted onto the world financial scene after it was acquired by Nasdaq OMX in 2008. Entering a global group brought expertise and state-of-the-art technology to Armenia, essential elements to boost investors’ confidence.

“We are the example of how the market grows by itself if offered an efficient mechanism. Last April we launched the inter-bank overnight credit market, one year on it is our largest market,” says Mr Zakaryan.

Sowing the seeds

The painful path out of the crisis has led to substantial change in the structure of Armenia's economy, with construction ceasing to be the main driver. The economy has rebounded and rebalanced and, as a result, the IMF considers it to be more stable.

The three fastest-growing sectors for bank credit in 2010 were transport and communication, agriculture and industry. Total retail loan portfolios grew by 6.1% in 2010. The micro, small and medium-sized enterprises sector – a major focus for institutions such as ProCredit, the Frankfurt-based banking group operating in transition economies which entered Armenia in 2008 – represented about 26% of the total sector portfolio at the end of last year, and 40% of total corporate loans.

Agriculture, the country’s main employer, is a potential source of growth. Banks are increasing their range of products, thanks also to the support of international organisations such as the World Bank and EBRD. As of January 2011, lending to the agricultural sector increased by 19% year on year to a total of $143m, according to the UBA. The leader in the sector is ACBA-CA, which in March received a $20m loan from the International Finance Corporation, the private arm of the World Bank, to enable the bank to provide more long-term financing.

“The agricultural loan portfolio currently comprises 25% to 30% of our lending,” says ACBA-CA's CEO Stepan Gishyan. “We finance 70% to 80% of Armenia’s agriculture. As developing the sector is among the government’s priorities, ACBA-CA is active in financing greenhouses, storage facilities, and similar projects.”

Too much red tape

Artak Hanesyan, CEO, Ameriabank

Artak Hanesyan, CEO, Ameriabank

Forbes is not alone in its relatively harsh judgement on Armenia. The country ranks 98th in the World Economic Forum’s global competitiveness report and 48th in the World Bank’s ease of doing business survey, where neighbouring Georgia is ranked 13th. Making the economy more competitive is one of the main challenges ahead, according to HSBC's Ms Clifford.  

“Some businessmen have started to relocate to Georgia because they find the investment environment more attractive,” says Mr Gevorgyan of Ardshininvestbank. “The pace of reforms has not been as fast as needed. The customs system, procedures to register a business and licensing all need improvement.”

The IMF and World Bank are supporting  the country’s plans to tackle remaining structural weaknesses in infrastructure, institutional capacity and the business environment. Corruption is a key concern: Transparency International ranked Armenia 126 (out of 178 countries) in its annual Corruption Perceptions Index in 2010. This is linked to low tax compliance and a lack of domestic competition, which are blamed on the country’s oligarchic structures. As a result, Fitch Ratings categorises Armenia’s long-term issuer default rating as BB-.

“A more competitive business environment would attract more foreign direct investment and would help combat inflation,” says Charles Seville, a director in Fitch’s sovereign ratings team in London. “The government has an anti-corruption strategy. The question is how well it will follow it through.”

Neighbourhood watch

Armenia’s difficult relations with its neighbours also hamper business. The country’s borders with Azerbaijan and Turkey have been closed since the early 1990s, inhibiting diversification of the economy and contributing to high transportation costs. A World Bank 2001 study found that opening the two borders could add 30% to Armenia’s GDP by doubling exports.

“A reopening of the borders, especially the one with Turkey, would change the current scenario,” says Ms Clifford. “There’s a huge potential there to enhance the level of competition in goods markets.”

That is unlikely to happen any time soon. But given Armenia’s recovery, nobody expects Forbes to call Armenia the world’s second worst economy in 2012. In the words of Jean-Michel Happi, head of the World Bank office in Yerevan: “The Forbes evaluation is momentary." There seem to be plenty of Armenians willing to echo that sentiment.

Was this article helpful?

Thank you for your feedback!

Read more about:  Central & Eastern Europe , Armenia