In Fitch Ratings’ view, Uzbekistan’s recent policy changes in respect of macroeconomic reforms, including structural reform of the banking sector, may lead to improvements in the sector corporate governance practices, decrease in concentration of the local economy and loan dollarization levels, and an overall improvement of foreign investors’ sentiment towards Uzbekistan.
Uzbekistan’s sovereign ratings balance a robust sovereign balance sheet, low government debt and a record of high economic growth, on the one hand, and high inflation and commodity dependence relative to rating peers in addition to structural weaknesses (low GDP per capita and weak institutional and governance levels, etc.), on the other hand.
Sizeable gross international reserves (29.2 billion USD at end-2019) and low government debt (estimated at 28.9% of GDP in 2019) with a favorable structure in terms of costs and maturity are key supports for the sovereign ratings. In our opinion, this provides certain financial flexibility for the authorities should they be required to provide support to state-owned banks. We view the sovereign’s ability to provide such support, in case of need, as solid, given the moderate size of state-owned banks’ assets relative to the economy (amounted 24.2 billion USD at end-2019 or 42% of 2019 GDP)
Banking Sector Reforms: Main Objectives and First Steps
Banking sector reform, initiated by the government of Uzbekistan in 2H19, is aimed at liberalization of the banking sector. The reform considers commercialization of state bank’s operations and a shift away from directed (policy) lending as well as their gradual privatization in the medium term, changes in terms of preferential lending to the strategic sectors of the economy, stimulus measures for private sector development, etc.
In 4Q19 state-owned banks transferred significant portions of directed loans along with the relevant funding to the state-related Uzbek Fund for Reconstruction and Development (UFRD). Some of the state-owned banks’ debt financing from UFRD has been converted into equity. Starting from 2020, new policy (subsidized) loans will be carried out by the three designated banks — Joint Stock Commercial Xalq Bank of the Republic of Uzbekistan (Xalq), Joint-Stock Commercial Bank Agrobank (Agro) and Microcreditbank (MCB)). Eligibility criteria for these loans have been tightened and the interest rate subsidies are provided directly to borrowers.
Privatisation of several state-owned banks will include sales of their minority stakes (up to 25%) targeted at institutional investors, most likely – international finance institutions. Further sales of majority stakes are possible in the longer term. First privatisation deal is expected to be closed in May 2020 with the controlling stake in Asia Alliance Bank (ranked #18 by assets at end-2019) planned to be sold to a strategic investor from Japan. The following banks rated by Fitch are expected to be privatised: Uzbek Industrial and Construction Bank Joint-Stock Commercial Bank (UPSB), Joint Stock Commercial Bank Asaka (Asaka) and Ipoteka-Bank (Ipoteka).
Corporate governance is also planned to be transformed in state-owned banks. To date, composition of supervisory boards at several banks has been changed to include independent directors; at some banks, which are planned to be privatised, top management bodies will also exclude government officials. Furthermore, banks have started hiring senior managers and advisors with international banking background.
Fitch believes the above mentioned reforms are positive for the development of the banking sector. Thus, the first steps taken indicate a decrease in the sector loan dollarisation (to 48% at end-2019 from 58% at end-11M19) and concentration (the share of 5 largest banks decreased to 69% from 74%, respectively).
Fitch’s Outlook for 2020
We expect moderation of the sector loan growth in 2020 (after a 35% growth in 11M19, net of foreign currency exchange rate movements and before loan transfers to UFRD) as large infrastructure projects will be financed directly from the UFRD. Central Bank of Uzbekistan (CBU) will likely to continue its policy of cooling down excessive lending growth.
At the same time, Fitch notes potential risks associated with the continued rapid retail lending growth in Uzbekistan (including lending in foreign currency) given households’ relatively low real incomes (GDP per capita was at USD1,800 in 2019) and only developing regulation of underwriting standards. Potential loosening of underwriting standards by banks in pursuit of market-share gains give rise to the additional credit risks. Banks’ internal underwriting standards and risk controls, including assessment of the borrowers’ repayment capacity are yet to be tested, including during the economic downturn.
However, given the low base effect, retail segment will still be a moderate share of total lending of up to 20%-25% of gross sector loans by end-2020 (16% at end-2019), in Fitch’s view.
Profitability of the banking sector, indicated by return-on-average equity ratio, will remain in double digits, in Fitch’s view in 2020 (14% in 2019). On the one hand, the performance of state-owned banks should benefit from the shift to commercial (from policy) lending. On the other hand, Fitch expects the overall decrease of the market interest rates due to intensified competition, which will impact banks’ net interest incomes (particularly at privately-owned banks). In addition, banks’ net interest margin may come under pressure due to potential reduction of the CBU key policy rate in 2020.
Capitalisation of Uzbekistan’s banking sector will remain adequate, considering already high minimum capital requirements set by the CBU (10% and 13% for Tier 1 and total regulatory capital, respectively). At the same time, Fitch expects gradual decline of the sector capitalisation compared to end-2019 levels (20% and 24% for Tier 1 and total regulatory capital, respectively) as growth of risk-weighted assets will likely outpace banks’ internal capital generation.
The share of state funding will decrease further in 2020 as a result of the banking sector reform. We expect the share of foreign funding to increase gradually, including through issuance of Eurobonds by the largest banks after the debut Eurobonds placements by the government and UPSB during 2019.
Fitch-Rated Banks in Uzbekistan
Fitch currently rates 10 Uzbek banks, having increased its coverage in 2019 with the assignment of ratings to three state-owned banks: Ipoteka, Xalq and JSCB Qishloq Qurilish Bank (QQB). CBU disclosures indicate that Fitch-rated banks accounted for 58% of total sector assets as of end-2019.
Fitch assigns several ratings, according to the Bank Rating Criteria. Viability Ratings (VRs) capture a bank’s intrinsic creditworthiness, while its Support Rating (SR) and Support Rating Floor (SRF) reflect the likelihood of it receiving external support, in case of need. A bank’s Issuer Default Ratings (IDRs) and issue ratings are derived from the VR and support ratings and usually rate to default risk on senior obligations to third-party, non-government creditors.