The Financial Report: More Power to the National Bank

Studying the text of the 2015-2017 Financial Stability Report, we have concluded that it, among other things, represents Daniyar Akishev’s attempt to directly influence Nursultan Nazarbayev. It looks like the National Bank’s Chairman desires to strengthen his administrative abilities which is impossible to achieve without the direct Presidential order.

To prove our point, we will use the text of the document. But first, we will remind the reader that we are devoting a whole series of publications to the 2015-2017 Financial Stability Report. This complex and multi-leveled document is intended for the financial market professionals and is quite complex for the general audience to comprehend. With that, what matters in it is not only for what is written, analyzed, noted, and underscored in it but also for what is not said or mentioned in passing. The first two articles of the series are Did They Forget about Kelimbetov? and The Financial Report: How to Make Things as Clear as Mud.

We will start the third article with the quotes from sub-section “The Financial Regulation and Ensuring of Stability” of the “Risks Map” chapter. Here is what is written in it ad verbum (text in bold kz.expert).

“14. The operational independence of the regulator is the necessary condition for implementing the tasks on the financial and price stability. Increasing the regulator’s independence requires giving the agency a number of the operational rights that correspond to the regulator’s responsibilities.

15.The absence of the right for the experienced judgement is still limiting the regulator’s effectiveness. In 2017, the National Bank worked out the legislative amendments to introduce the experienced judgement within the framework of the risk-oriented regulation. The amendments are planned to be put into action in 2018. In practice, the effective execution of the experienced judgement will require the development of the analytical apparatus, the access to the data at the level of a loan, the development of the credit risk models.

16. The introduction of a number of the Basel-3 norms including LCR and the stricter capital requirements is encountering the structural and institutional limitations of the banks’ abilities to abide by them. The attention to solving the structural and institutional issues including the specific for Kazakhstan problems at the stock markets, of risk management, of improving the reporting reliability is required.

17. The current mechanisms to manage the problem banks have a number of serious downfalls restricting and decreasing the effectiveness of their use. In particular, the National Bank’s mandate is limited by law and does not allow to use the instruments employed by the regulators of the progressive countries. In 2017, the National Bank prepared a series of the legislative amendments that will give the regulator the rights corresponding to agency’s responsibilities on the operative management of the problem banks minimizing the state support and systemic consequences”.

In our opinion, the cited text does not require any comments since it clearly shows the position of the National Bank and its Chairman. On the other hand, the very fact of the attempt to indirectly influence Nursultan Nazarbayev on the part of Daniyar Akishev demonstrates that his actions and intentions are met with a serious resistance in the state apparatus and the ruling elite, otherwise, the subject would not have received that much attention in the Report.

As it is, it even has a special section devoted to it called “The Institutional and Structural Problems and the Way to Solve Them”. Here are some of the key passages from the document that, in our opinion, represent and clarify the position of the National Bank of Kazakhstan (text in bold by kz.expert).

“In 2017, taking into consideration the institutional and legislative restrictions and the existing funding structure, the National Bank continued the 2015-2016 work on developing and implementing a complex of the measures aimed to resolve the crisis and avoid its repetition in the future. These measures include the sanitation of the systemic Kazkommertsbank, the sustainability improvement of the other socially important banks as well as the change in the regulatory environment to improve the quality and the effectiveness of the regulatory responsiveness and the management of the insolvent banks”.

Therefore, during the years 2016-2017, we had been conducting a systemic revision of the supervisory and regulatory policies of the National Bank. Our priorities included the analysis and diagnostics of the real status of the banks’ assets as well as taking the measures to effectively sanitize the banking sector.

Starting from 2013, to determine the quality of loans and to form provisions, the banks use the IFRS standards which gives them enough freedom to employ the subjective factors to assess provisions. Therefore, to determine the real status of the assets quality, we first had to develop the universal methodology to assess the provisions sufficiency. In the framework of this approach, the National Bank, via inspections and distance supervision, conducted an analysis of the banks’ loan portfolio quality reports made on the bases on the IFRS regulatory method. As a result, we had elicited significant discrepancies in the size of the loan portfolio losses as estimated by the banks using the IFRS standards and by the National Bank using its own methods. By the National Bank’s estimates, the volume of the non-performing loans is significantly higher than what the reports say, and the expected losses significantly surpass the formed provisions.

The banks that experience capital efficiency use a number of tricks not to recognize the losses tied to the loan portfolio quality reduction. The most widespread are the loan restructuring via a loan maturity prolongation and the overinflating of the security value. The prolongation enables a bank to classify a practically non-performing loan as a standard one and do not form provisions based on the IFRS standards. The overinflating of the security value enables a bank to reduce non-performing loans provisions required by the IFRS.

The problem of the high level of the non-performing loans is worsened by the equally low quality of the banks’ securities in the form of the real estate and money that is to be received in the future, the insurance contracts that have many reasons for the payout refusal, the physical bodies’ and small businesses’ warranties. In some banks, the share of such loans had surpassed 80% of their loan portfolios.

The non-sufficient provisions allow banks not to show the real capital losses tied to the assets quality reduction as well as to keep the values of the capital sufficiency in accordance with the prudential standards. Since the capital norms are not violated, the National Bank has no legal basis for executing decisive measures in regard to such banks. 

Certain banks widely employ the practice of giving loans to the persons that, legally, have no evident affiliation attributes, de-facto however, they are the affiliated persons of either the shareholders or the bank’s management. The tied crediting is one of the most severe violations of the loan-giving standards that allows to finance risky projects of a shareholder without the required credit risks assessment and provides the limitless credit arm for it. As the bank’s standing declines, the tied loans continue to finance the capital and later become a channel for assets withdrawal. The problem of regulating the tied crediting lies in the difficulties of uncovering this schemes since the formal attributes of affiliation can easily be avoided.

The solving of the problem lies in eliciting affiliated persons via the indirect attributes such as preferential treatment, giving loans to financially unsustainable borrowers without high-quality securities, putting the burden of proof on the bank and giving the regulator the right for the supervisory judgement when discovering the fact of the parties’ affiliation.

The spreading of such practices became possible due to a variety of the institutional downfalls: the low sense of responsibility for the quality of the reports on the part of the banks’ management, auditors, and assets valuators, the increase of the level of subjectivity and the banks’ role when forming provisions according to the IFRS standards as well as the legal limitations in using the supervisory judgment by the regulator.

Despite the seriousness of the problem, the effective solution remains unattainable since the National Bank is restricted by the law in using the experienced judgement within the framework of the supervisory authorities. Apart from that, the National Bank does not have the necessary array of tools for the effective regulation of the insolvent banks, thus the regulatory measures may cause the systemic risks and the mandate to conduct the orderly supervision of the problem banks has been and remains extremely limited”. 

Hopefully, Daniyar Akishev and his team will forgive us but, in this case, the agency’s position reminds us of the Kazakhstan local administrations’ attempts to tidy up and keep clean their regions via strengthening the authority of those who was responsible for that. With that, the officials forgot that the suddenly given right to randomly impose fees on violators without a possibility to appeal would not make a place clean. But the people’s habit not to litter would.

For this reason, the National Bank Chairman’s intention to increase the agency’s administrative authorities, even if the attempt is successful on paper, is doomed to failure in real life. Simply because many representatives of the Kazakh elite are de-facto much more influential than Daniyar Akishev despite the fact that he occupies one of the key state positions in the country and is solving such an important for Akorda task of rescuing and reforming the banking sector and the entire financial system of the country.

The Report, by the way, is a clear proof of that as we have already pointed out in the first article of the series.

Daniyar Akishev’s “lament” about the National Bank’s administrative restrictions is not limited to these quotes, however, to save time, we will cite only the key paragraphs from the section (text in bold by kz.expert).

“Freezing and prolonging the solving of the problem, as it has been done in the previous years, leads to a significant increase of the systemic risks in the banking sector. Therefore, taking into consideration the institutional limitations and the existing structure of the funding, the National Bank has developed a complex of the measures aimed to resolve the crisis and avoid its repetition in the future. The measures include:

3) formulating amendments to the laws of the Republic of Kazakhstan that stipulate the strengthening of the regulatory-supervisory mandate of the National Bank by enshrining at the statutory level the operative control and the risk-oriented supervision requirements. This task will be realized via introducing the risk-oriented supervision of the banks and the effective regime of the insolvent banks’ regulation in accordance with the best practices and recommendations of the international organizations”.

“The current supervisory process is based on the formalized approach that implies taking measures on the part of the National Bank only if there are direct violations of the prudential norms or law requirements on the part of the banks. However, as practice shows, banks can employ different schemes that allow them to formally comply with both regulatory norms and the law requirements”.

“On the other hand, the current system of eliciting and regulating insolvable banks has a number of serious flaws that significantly limit the National Bank’s capabilities and decrease the effectiveness of the regulatory measures. In particular:

1) The National Bank does not have a mandate to conduct involuntary restructuring of insolvent banks liabilities (bail-in) used internationally to minimize state expenditures on the regulation and lessening the risk of the moral hazard. The current legal norms provide only the possibility of voluntary restructuring of the liabilities with consent of not less than 75% of the creditors. The restructuring of the international debt instrument liabilities (the Eurobonds, for example) regulated in accordance with the foreign states laws is an even bigger problem. The restructuring of these instruments puts the restructuring procedure at legal risk.

2) The decisions of the National Bank on regulating an insolvent bank can be appealed by the shareholders and creditors. This does not correspond with the best international practices. In accordance with the international principles of the effective regulatory regime (FSB, 2012), the regulatory decisions of the authorized body must not be appealed in court and are limited to the issues of the monetary compensation. This is because the shareholders or other interested parties may willfully prolong the process via court appeals and claims whose purpose is to fulfill the demands of the affiliated creditors and to withdraw the assets by the shareholders. As a result, the assets value rapidly declines and the losses of the other unaffiliated depositors and creditors increase.

3) The problem banks identification process as well as the system of the triggers for recognizing a bank as an insolvent one and taking measures for its supervision are not standardized legislatively. This leads to the prolongation of taking the decisive measures in regard to the problem banks, decreases the sense of responsibility and motivation to capitalize the bank on the part of the shareholders, puts the National Bank at the reputational and legal risks.

5) The use of selected regulatory instruments in the current legislature requires the approval of the creditors and depositors. Particularly, the approval is required in the case of transferring the insolvent bank’s assets and liabilities to the stabilization bank. In practice, this makes the transfer impossible if at least one creditor opposes it. The early fulfillment of an obligation of an individual creditor must not be realized since it infringes upon the interests of the other creditors.

6) The National Bank does not have the authority to recognize the insolvent bank’s deals that have the attributes of assets withdrawal as invalid through legal action. This limits the National Bank’s abilities to execute the recovery of the assets that have been withdrawn as a result of the bank’s unethical practices via recognizing these deals as invalid”.

The section is concluded with a wish-list of what the National Bank wants to get from the President. We will skip it, but stress Daniyar Akishev’s acknowledgement of the fact that even a mass state support cannot make the Kazakhstan banks able to compete and give them an opportunity to survive. De-facto, this acknowledgement sums up Akishev’s work as the National Bank Chairman.

“However, as the domestic practices show starting from the 2008 crisis, such support is not enough to solve the problems in the long-run and is nothing but a tool for a short-term improvement of the banks’ financial standing”.

In other words, the state support given to the six privileged financial institutes including Halyk Bank last year provided them and the entire financial system only a short break. The new problems it seems are just around the corner.

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