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Resilient Georgia set to emerge in sound economic health

Georgian banks suffered in the global financial crisis, but with low banking penetration accompanied by conservative and prudent financial regulation, they appear to be on sure footing to growing profitability. 
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Resilient Georgia set to emerge in sound economic healthUnder the National Bank of Georgia's guidance, the country's banks are on a sound financial footing

Sipping Georgian red wine at a reception to celebrate the launch of a new computer system to manage the country's foreign exchange reserves, National Bank of Georgia (NBG) governor Giorgi Kadagidze looks boyish and relaxed.

His appearance belies the 31-year-old bank governor's fierce drive to bring Georgia's financial system in line with some of the world's most developed countries. The automated management system used by central banks in France, Germany and the Netherlands, among others, will improve NBG's ability to manage its $2.7bn of foreign exchange reserves, which have reached an historic high and mark another step along the country's road to financial modernisation.

Georgia's banking sector has the lowest penetration ratio of its peers in central and eastern Europe and the Commonwealth of Independent States (CIS) countries. At the end of 2010, bank assets to gross domestic product (GDP) stood at 51%, loans to GDP at 30% and deposits to GDP at only 28%, according to figures from Georgian investment bank BG Capital. This compares with loan-to-GDP ratios of more than 100% in Latvia and Estonia and deposit-to-GDP ratios of almost 40% in Russia.

Georgia banking sector

Don't panic

But the figures should not cause despondency, says Mr Kadagidze. Georgian companies and individuals are not leveraged to the level of other central and eastern Europe (CEE) banking customers, which lowers systemic risk in the economy.

"For international players and investors there is huge room to grow and huge opportunities. The banking sector is still in its infancy but investors will reap the benefits over the next five to 10 years," he says.

In the aftermath of financial crisis, Georgia's GDP contracted 3.9% in 2009 but bounced back to 6.4% growth last year. The International Monetary Fund is predicting at least 5.5% GDP growth in 2011.

Low banking penetration accompanied by conservative and prudent financial regulation and very high capital adequacy ratios for local banks protected Georgia at the height of the financial crisis.

"In the past two years we've had every difficulty you can imagine: internal political tensions, a five-day war and trade embargo with Russia and the financial crisis, but we haven't had to bail out a single financial institution, which shows our resilience," says Mr Kadagidze. "What doesn't kill us makes us stronger," he adds.

Strengthening monetary tools

The high level of dollarisation in the Georgian banking system remains a significant risk to financial stability though. About 70% of bank deposits are in dollars and only 30% in Georgian lari, and the local banks' balance sheets reflect that ratio. This protects the banks themselves from foreign exchange risk, but simply passes that risk along to their customers.

"If you look at the balance sheets of the banks' major customers you'll see a big mismatch – some 70% of their revenues are in local currency, so they are vulnerable to fluctuations in the exchange rate," says Mr Kadagidze. The dollarisation of the economy also weakens the impact of monetary policy, he adds.

NBG has embarked on a long-term programme of 'larisation' to boost the use of local currency in Georgia's economy, but the central bank governor says it is a long-term process that will have to be underpinned by growing confidence in the wider economy – and it cannot be hurried.

"If you look at countries that have successfully made the shift from a dollarised economy to a local currency one, such as Israel, Poland, Chile, it was a long process which relied on a gradual increase in confidence in the local currency."

Georgia has the advantage of coming to financial liberalisation some years after other emerging economies, so is able to learn from the mistakes of others. It will work to develop local currency and bond markets through market incentives and will not put any administrative restrictions in place to curb use of foreign currency.

The issuance of treasury bills has been a success since 2009, with La450m ($274m) now trading on money markets and strong interest from foreign investors, but money markets remain limited by the size of the economy.

Development plans

Between 1989 and 1993, the Georgian economy shrank by 70% showing the worst performance of all the post-Soviet states, according to estimates from the country's central bank. "We lost two-thirds of our economy in just four years and this hurt confidence in the financial system, so it will take time to build it back up," says Mr Kadagidze. He believes plans to become a financial, tourism and cultural hub for the rest of the CIS are the key to success over the next five to 10 years.

"Even our biggest critics say that Georgia is one of the least corrupt, most secure and liberal countries in the region," he says.

Georgia's advantage is in its position between Asia and central Europe. Even with strained relations with its largest neighbour, Russia, the country still offers easy access to central Asia, Turkey, Armenia and Azerbaijan.

With reform of the pension sector scheduled for 2012, the country's nascent capital markets will receive a new stream of capital which will boost corporate growth and could fund a wave of initial public offerings.

"Pension fund reform could unlock large growth potential. Just look at what happened in Poland in the mid-1990s. Georgia could be a capital markets centre for the Caucasus and central Asia the way Warsaw is for the CEE region," says Vakhtang Butskhrikidze, CEO of Georgia's second largest bank, TBC.

Capital market development in Georgia is limited by the size of the country – the population is only 4.5 million people. But Lado Gurgenidze, a former prime minister and now CEO of Liberty Bank, the country's fifth largest, says Georgia's favourable tax regime and the business environment all underline the country's potential to be a regional hub.

"It takes less than a day to set up a business in Georgia. We have double taxation treaties with 26 countries and this is an attractive market for international investors and high-net-wealth individuals," says Mr Gurgenidze.

Banking concentration

TBC and Liberty are two of Georgia's five largest banks, which between them hold more than 78% of the country's banking market, according to investment firm BG Capital. The dominance of a handful of big players reflects the size of the market.

"The banking sector is more concentrated than we would like to see, but that comes down to the size of the economy and will change with growth and more globalisation as Georgia becomes a regional hub over the next five to 10 years," says Mr Kadagidze.

The country's largest bank, Bank of Georgia, held a 36% market share by assets at the end of 2010, BG Capital estimated.

Georgi Chiladze, deputy CEO at Bank of Georgia (BOG), says the bank has trimmed back its overseas operations to focus on its home market, where it has a competitive advantage. The bank sold its Ukrainian subsidiary in February this year and is keeping its eyes peeled for an opportunity to sell off its holding in Belarus, which it purchased for $34m in 2008.

"Our competitive advantage is in Georgia. We're the largest bank in a small country, whereas we can only ever hope to be marginal player in Ukraine. If you come later to a market overseas, you cannot hope to match the infrastructure and product offerings of the big international banks," he says.

BOG will focus on using its network of more than 140 domestic branches to reach new customers and target existing ones in new ways. One innovation is the SMS loan scheme, where customers with good credit records are sent an SMS telling them they are pre-approved for small loans that they can then access through BOG's ATM network.

The bank has also teamed up with American Express to beef up its credit-card operations and signed a seven-year deal with the American credit card company at the height of the crisis in 2008, which is now paying dividends. The bank is also setting up premier banking services for more affluent customers.

SME banking

One area where BOG does not dominate the Georgian market is small business banking. The dominant player in the small- to medium-sized enterprise (SME) banking sector is German-owned ProCredit Bank, which began life as a microfinance institution. It has expanded over the past nine years to build up a solid network of small business customers.

ProCredit is Georgia's third largest bank, but it does not offer consumer loans. Instead, it concentrates on savings for individuals at the lower end of the income scale and lending to small businesses. Educating customers about financial products and explaining the offerings and terms of loans in a clear language is key to demystifying the financial sector, which will reduce the fear of using banks.

"We are the leading bank for SME business because we started much earlier than other banks, and our clients have grown to trust us," says Maya Meredova, ProCredit's CEO in Georgia.

She believes there is potential to expand banking services for mid-sized companies with a turnover of $300,000 to $500,000 a year, such as small chains of shops employing about 10 people. These companies would typically need loans of between $50,000 and $300,000, says Ms Meredova.

ProCredit is the only bank that deals with individual farmers and holds 50% of the country's lending to the agricultural sector – an area that is tricky to assess for credit-worthiness because of the small size of plots, the seasonality of crops and changes in agricultural cycles. The sector’s growth has also been stymied by a lack of production and storage facilities.

"You simply cannot get tomatoes in Georgia in the autumn. Fresh produce needs to be sold within a couple of weeks because there is nowhere to store it," says Ms Meredova.

Growth plans

TBC bank, which bought microfinance lender Constanta in May this year to expand its presence in the SME lending sector, is enthusiastic about lending to agricultural processing companies to boost the sector's growth. "The country needs investors with this know-how and we are keen to finance that," says Mr Butskhrikidze.

TBC is also eyeing project finance for the country's hydro-electric sector, where another $2bn-worth of deals are expected to be inked in the next three to five years.

By contrast, Liberty Bank's Mr Gurgenidze sees the firm's strongest growth in the retail sector, where it has implemented a slew of innovative products including a gift card that can be redeemed at dozens of participating retailers to capitalise on the country's gift-giving culture.

With the financial crisis behind the country and low levels of consumer and corporate debt, Georgian banks appear to be on sure footing to growing profitability, assisted by rising foreign investment and the country’s potential regional economic role.

According to Akaki Gelashvili, analyst at BG Capital, banking sector profits stood at $88m in 2010 and reached $49m in the first four months of 2011. Non-performing loans (NPLs) spiked to 18.8% in mid-2009, but have fallen steadily with Georgian banks holding loan loss reserves of 9% now.

"It already looks like a better year [in 2011]. Loan quality is improving and NPLs are not a big concern anymore," says Mr Gelashvili.

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Read more about:  Central & Eastern Europe , Georgia