Financial Report: How to Make Things as Clear as Mud

The section on “The Main Conclusions” of the National Bank’s financial stability report for 2015 – 2017 is we believe the most controversial one. The absence of the will to push themselves outside of the limits of the corporate responsibility and the lack of the knowledge of the political history have played a wicked joke on the analysts who prepared this document.

In the article Did They Forget about Kelimbetov?, we told the reader that, on May 22, 2018, Chairman of the National Bank of Kazakhstan Daniyar Akishev presented “A Report on the Financial Stability for the Years 2015 – 2017”.  It is a complex and multi-leveled document that matters not only for what is written, analyzed, noted, and underscored in it but also for what is not said or mentioned in passing. The document is intended for the financial market professionals and is quite complex for the general audience to comprehend. Therefore, we have decided to present a series of comments to this document underscoring the points we believe to be most significant.

We will start with the authors’ statement that, “The risks for the financial stability of Kazakhstan that have been realized in the past years or created a threat of losses are unusual in their scale, causes, and dynamics of their manifestation”.

We agree with the assessment that, for the young Kazakhstan state, with its still forming bureaucratic apparatus and the low-quality and ineffective ruling elite, the negative manifestations of the past years have truly been unusual in their scale, causes, the dynamics. However, in our opinion, the outdated authoritarian political regime, the old super-presidential vertical, the absence of the feed-back mechanism between the power and the people, the absence of the alternative to the economic policy and the systemic weakness of the semi-market economy are some of the main causes of such large-scale economic and social losses the country has suffered as a result of the crisis.

Obviously, our thesis may be disputed. The Kazakhstan’s problem, however, lies in the fact that the political limitations including the absence of the venues for the public discussion and the unpreparedness of the expert community and business to push themselves beyond the limits outlined by the authorities result in the fact that the politics continues to dominate the economy and the quasi-reforms are carried out in the way that is not to disturb the proverbial “domestic political stability”.

Then, in the section “The Main Conclusion” of the Report, they present the most significant risks that manifested themselves in the years 2015 – 2017. Here are some quotes (text in bold by kz.expert).

The high and non-declining level of the non-performing loans that had raised the question about the reasons for the low-quality loan decisions in certain banks, the practices of the tied credits, the chronic and unproductive prolongation, the authenticity of the financial reports and the disclosure of the assets quality as well as the capital sufficiency, the low level of the corporate management as well as the limitations of the creditors’ rights with regard to the problem borrowers;

the practical limitations of the regulatory mandate to execute their own judgement with regard to the adequacy of the formed loan portfolio provisions as well as the downfalls of the mechanists of the problem banks management, in particular, the limitations to execute the legal rights for the involuntary management of the bank’s capital structure and transferring the burden of the bank’s losses to the creditors;

the fixed currency exchange rate and its low persuasive power that led to the record-level dollarization, the high and unpredictable interest rates, the loss of the competitive abilities on the part of many producers, the worsening of the balance of payments caused by the abnormal consumption growth in response to the worsening of the external trading conditions and the other avoidable consequences”.

The quotes clearly show that the National Bank’s analysts and top-management have made a standard mistake of the financial market professionals (the one that famous Russian author Kozma Prutkov described as “A specialist is like a gingival abscess, their fulness is one-sided”). In other words, they were unable (did not dare) to push themselves outside of the limits of the corporate responsibility.

Agreeing that the low quality of the loan decisions and the unproductive prolongation did help the high and non-decreasing level of the non-performing loans, we, nonetheless, believe that the non-competitiveness, weakness, and the high level of regulation of the Kazakh economy as well as the excessive presence of the state sector in it played a much more crucial role. The rest including the authenticity of the financial reports and the disclosure of the assets quality as well as the capital sufficiency, the low level of the corporate management, and so forth is the result of the usual and unavoidable compromise between what the managers are supposed to do and what real life dictates.

As for the statement - “the practical limitations of the regulatory mandate to execute their own judgement with regard to the adequacy of the formed loan portfolio provisions”, we consider this an explicit attempts on the part of the National Bank and Daniyar Akishev to solve the sectoral problems that are a part of the general economic problems via the strengthening of their administrative authorities.  

History tells us that travelling this path may lead to some partial successes at the first steps of the way especially if Akorda will let the regulator create a “Special Council” where the “troika” will make the out-of-court decisions obligatory to be implemented by all the market participants, but not more. Unfortunately, such administrative enthusiasm on the part of the National Bank’s officials is nothing but unprofessionalism and the lack of the desire to study the political history.

As for the fixed currency exchange rate and its low persuasive power that led “to the record-level dollarization, the high and unpredictable interest rates, the loss of the competitive abilities on the part of many producers, the worsening of the balance of payments”, we have already commented on that in the first article of the series. Had it not been for Akorda’s direct interest, the high-level of regulation of the Kazakh economy and the systemic priority of the politics over the economy, the tenge devaluations of last years could have happened much earlier. Therefore, they should search for the guilty party on the top, among the authorities, and not on the bottom, at the market-level.  

Further, the Report states (text in bold by kz.expert). “The problems that, traditionally, are thought to be the financial development problems have been the main reasons for the systemic failures of the financial sector, in particular:

“1. The limitations of the regulatory mandate when eliciting problem loans and managing problem banks. The practical limitations to use the regulatory mandate when determining the sufficiency of provisions and the capital have led to a significant growth of undercapitalized banks in which the structure of the motivation contributed to an even greater growth of problem loans”. 

“2. The structural problems of the economy whose most important manifestations are the structural unemployment, the low urbanization level, the low level of the legal and financial literacy, the high cost of the effective labor unit, the high concentration of the economy on the resource sector, the low and uneven earnings among the population, their high dependency on the external trading conditions.

3. The inadequate level of the institutional environment including the legal issues and especially the problems of defense, ownership transfer”.

“4. The Questions and Problems of the Macroeconomic Policy.

The most obvious problems of the macroeconomic policy have been significantly neutralized with the introduction of the floating exchange rate, the start and the successful move to the policy of the initial liquidity management for the purpose of stabilizing the interest rates, the introduction of the framework approach to the inflation targeting. The introduction of the new fiscal rules that ensure the gradual reduction of the transfer from the National Fund and the reduction of the non-oil deficit have also improved the transparency, predictability, and sustainability of the fiscal policy”.

“5. The level of the development and regulation of the financial market institutes that ensure the overcoming of the informational asymmetry including the importance and the integrality of the institutes of the financial, managerial, and regulatory reporting”.

These quotes show that the absence of will (lack of abilities) on the part of the National Bank’s analysts and top-management to push themselves outside of the limits of their corporate responsibilities have once again played a wicked joke on them turning the Report into a demonstration of their professional narrow-mindedness.

This can also be seen from the statement that it was precisely the “the limitations of the regulatory mandate when eliciting problem loans and managing problem banks” that became the most important reason for the systemic failures of the Kazakhstan financial sector.

As for the structural unemployment that the National Bank’s analysts name first on the list of the structural problems, this is either a misunderstanding or an attempt to muddy the waters. Yes, the country is experiencing a deficit of professionals in practically every field. But it is not necessarily true that it is more critical for the successful development of the national economy than the weakness of the business corpus and the ruling elite.

In conclusion, we will cite the statement that “the most obvious problems of the macroeconomic policy have been significantly neutralized with the introduction of the floating exchange rate, the start and the successful move to the policy of the initial liquidity management for the purpose of stabilizing the interest rates, the introduction of the framework approach to the inflation targeting”.

This, in our opinion, is a blatant lie. Perhaps we could agree with that if there was a stipulation that they were talking about the macroeconomic policy for which the National Bank is responsible. But nothing of the sort was mentioned, hence the nonsense.

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