Towering presence: Uzbekistan's National Bank headquarters in Tashkent

Uzbekistan's banking sector is lagging behind the country's broader economic growth, stymied by the interfering hand of the state. Writer Michelle Price

Sandwiched between Kazakhstan and Turkmenistan, the former Soviet Bloc country of Uzbekistan is one of the lesser-known economies situated in the Commonwealth of Independent States (CIS). Boasting a much larger population than its neighbouring countries at 28 million people, however, Uzbekistan is thought to have great economic potential, especially in terms of commodity wealth: it is already a world top 10 producer of gold and uranium, while gas and oil are also major exports.

The government of president Islam Karimov, who has ruled the country with an iron and often bloody fist since it first gained independence in 1991, has spent the past 20 years cautiously unpicking Uzbekistan's state-controlled command economy through a process of gradualist privatisation and industrialisation.

In the view of some economists, these efforts are beginning to bear fruit, with agro-processing, textiles, food processing, car manufacturing and chemicals processing, among others, growth sectors for the country. "Uzbekistan has been more successful at industrialisation than any other country in the region through an induced-policy approach such as that seen in Asia's tiger economies," says Juan Miranda, director-general for central and west Asia at the Asian Development Bank (ADB). With projected gross domestic product (GDP) growth of 8% for 2010, Uzbekistan is certainly performing well.

Lagging behind

But the country's banking system - regarded by market-watchers as one of the smallest and most opaque in the CIS - has lagged behind Uzbekistan's broader growth. Comprising only 29 banks in total, the Uzbekistani banking sector is both small and highly concentrated, dominated by eight state-run banks that control more than 80% of banking system assets and capital, according to data from Standard & Poor's (S&P). Equating to only 30% of GDP, banking system assets are slight, while lending penetration is also extremely low at 17% of GDP. Lending growth, however, has proved extremely robust in recent years, standing at 30% in the first half of 2009.

Largely isolated from the international markets, the Uzbekistani banking system has, however, proved immune to the contagion of the global financial crisis. "We didn't feel any direct influence from the crisis but we felt it through our clients, who had problems with exports," says Aleksey Kim, head of the international and correspondent banking division at Asaka Bank, a state-owned institution accounting for about 12% of system assets.

In order to bolster the banks against asset-quality deterioration, the Uzbekistan government moved during late 2008 and the first half of 2009 to raise minimum capital requirements, insure 100% of deposits, and provide state-owned banks with fresh and, in several cases, extremely sizeable - relative to existing capital - injections equating to about $285m in total. Forming part of the government's 'anti-crisis' programme, these measures have largely proved successful in protecting Uzbekistan's banks against broader macro-economic stress, and by June 2009 banking system capitalisation stood at a solid 23%, according to S&P.

But the country's banks have not escaped the global financial crisis entirely unscathed. Corporate lending accounts for the majority of the system-wide loan book in Uzbekistan and the banking community's biggest and beefiest borrowers are also state-owned. According to Moody's, state-owned banks are frequently used by the government to direct funds into pre-approved state-owned borrowers and projects. Foreign exchange liabilities, for example, are frequently directly guaranteed by the government and on-lent to pre-approved projects. "We feel the pressure from the government to provide attractive conditions and terms for state-owned customers," says one banker at a major state-owned bank.

Nor are joint stock banks or fully private banks free from government meddling. Many of the country's joint-stock banks are still owned indirectly through state-owned company shareholdings. And according to one Moscow-based analyst who wished not to be named, the government also interferes in the business of private banks by specifying loan-book composition and pricing.

A hands-on approach

As Uzbekistan's exporters began to suffer at the hands of the global recession, the government stepped in further to ensure that the banking system supported problem corporations - but the support demanded was more hands-on than simply rolling over troubled loans.

In late 2008, President Karimov issued two decrees stipulating that commercial banks should assume the direct day-to-day management of failing companies - either public or privately owned - on their loan book. The precise details of the conversion process remain hard to come by, but ratings analysts believe the banks were required to write off the loans, reclassify them as equity investments, and bring the troubled enterprises on to their balance sheets.

As a result, some banks are burdened with unwelcome troubled assets. By 2010, for example, National Bank of Uzbekistan (NBU) - the country's largest and most important state-owned institution - was left with the industry's largest portfolio of 13 troubled enterprises of which it now takes operational control. The bank hopes to successfully restructure these companies through its asset management subsidiary, NBU Investment Group (NBUIG), which was established in the first quarter of 2008 with $25m in funds. NBUIG is looking to privatise its 13 subsidiaries, which comprise textile manufacturers and agro-processing plants, among others, through foreign investment. Azim Akhmedkhadjaev, chairman of NBUIG, says the group has already successfully rehabilitated two companies, and he is hoping to negotiate a joint venture with a foreign strategic partner to help develop the company into a fully fledged investment bank.

"Banks dealing in [the] production [of companies] is not normal," he says. "But in Uzbekistan this has proved very successful. The banks weren't badly affected by the crisis so they had enough funds to invest in companies. This is a new direction for Uzbekistan." According to Yulia Bredneva, banking institutions coordinator at NBUIG, the group is currently in the middle of negotiating a tie-up with two foreign partners.

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Juan Miranda, director-general for central and west Asia at the Asian Development Bank (ADB)

Sector privatisation stalled

If NBUIG is able to attract the right sort of investor, this particular anti-crisis policy - unusual though it may be - could at least prove a minor success for the government's financial sector privatisation programme, which has more or less stalled.

The privatisation project was unveiled in 2007 as part of a broader banking reform programme. According to the plans, NBU was to be transformed into a joint-stock bank, while the government would sell a 51% stake in Asaka Bank to private investors. But the bank got as far as hiring BNP Paribas to make a private valuation when the international banking crisis hit, forcing the government to put the brakes on. "The valuation was supposed to come in 2008 but we're still at the stage now that we were at two years ago," says Asaka Bank's Mr Kim.

Market-watchers fear that the government's capital injections will not simply delay the privatisation process but will also increase the already extremely high levels of government control over the banking system. Ongoing interference disrupts the normal, market-driven pricing mechanism and undermines growth and competition, say analysts, and this is borne out in the wide margin differentials between the largest state-owned institutions and the mid-sized banks. At the former, margin differentials are low at about 1.5% to 3%, according to data provided by Moody's, while margins at mid-sized banks hover at about 8% to 10%.

This is why foreign investment is so important. Banks such as Asaka do not need the capital: they need the expertise. "We are looking to attract a foreign strategic partner to help with technology and to help us expand our product base, and inject new ideas," says Mr Kim, who adds that the bank has held discussions with potential Western investors. Although the global slump saw capital flows briefly dry up, Uzbekistan sits on the periphery of what will be the primary location for global investment in future years - Asia - and the country is already enjoying the benefits. According to Reuters, foreign direct investment accounted for 27.8% of all investment in Uzbekistan in 2009, compared with only 5.3% in 2002, and during the ADB's annual meeting in Tashkent in May, the government made a big show of its desire to attract much more.

Compared with many other Asian banking markets, Uzbekistan remains extremely under-penetrated by foreign banks - with Royal Bank of Scotland's ABN Amro inheritance in the country the most notable Western brand on the ground. According to Gerard Lyons, chief economist at Standard Chartered Bank - which can normally be found in upcoming frontier Asian banking markets - the country and the region more broadly is of interest to the UK-headquartered bank. "Even though we're not on the ground here, we have taken a very close interest in the region more and more so. It is strategically important - central Asia is very tied in with what's going on in the rest of Asia," he says.

The ADB is hoping to expedite the privatisation process and attract the likes of Standard Chartered to the Uzbekistani banking sector by potentially making a number of equity investments in local banks, according to Mr Miranda. Although the ADB is currently in the due diligence stages, Mr Miranda hopes that any such future investment will spearhead change. "It will also signal to the market that things are up for sale. I know [the local banks] are looking for partnerships that will really stay for the long term, offer value for money, and bring things that they don't have," he says.

Client diversification

If ownership structure is one area of much-needed improvement, so too is the sector client base. "The key question is whether the clientele - the corporate sector - grows, and whether the public sector companies will be more disciplined," says Mr Miranda.

Indeed, many banks would benefit from diversifying their client base towards private sector clients, and Asaka Bank is already trying to do so, says Mr Kim. But they are extremely dependent on the broader pace of private-sector growth. Mr Miranda is especially forceful on this issue, however, arguing that the private sector has undergone a "major transformation" in recent years.

The small and medium-sized enterprise (SME) sector is one area of private enterprise that has enjoyed major growth, says Mr Miranda, and one the government likes to heavily promote - although official figures on SME-sector expansion are disputed. Lending to SMEs is extremely low, accounting for just 10% of system-wide loans, but institutions such as Asaka Bank and Credit Standard Bank, one of the country's largest privately owned institutions, have identified this as a growth market.

For Asaka Bank, agricultural small-holdings, such as chicken farms, are target customers, while Credit Standard Bank has devised a new corporate strategy centred on retail and SME lending in the urbanised Tashkent, Samarkand and Fergana regions, says Aziz Rinatovich, the bank's chairman. "Within two years we will open 15 retail offices in three regions," says Mr Rinatovich. Moody's forecasts reasonable growth in the retail and SME segments, although it does not expect such lending to exceed more than 15% to 20% of total gross loans during the next two to three years. As such, privatisation in Uzbekistan may be making progress, but the overweening presence of the state is likely to dominate the sector for the foreseeable future.


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