WB Manager on Banking Sector

WB Country Manager on Uzbek banking and finance sector

WB Country Manager for Uzbekistan Martin Raiser spoke to BVV Business Report on the issues of the Uzbek banking and financial sector is facing.

- How do you assess Uzbek banking and financial sector?

While the Uzbek banking sector has made progress in adapting to market conditions, it still faces significant challenges, some of which it shares with many other transition economies, but some of which are also related to the specific path of transition chosen by Uzbekistan.

Among the sectors strengths are the quality of its personnel, following significant training, the move to international standards of risk management and accounting, and reforms of the legal and supervisory frameworks for the sector.

The World Bank, together with other donors such as ADB and EBRD, has been involved in all three areas.

The Financial Institution Building Loan (US$25 million, approved in May 1999) has provided technical assistance to Uzbek banks for training in strategic planning, risk management and accounting, for introducing appropriate management information systems, and for modernising the payments system.

The loan has also helped Uzbekistan modernise the legal framework for the financial sector and strengthen the supervisory capacity of the Central Bank of Uzbekistan.

Despite of these positive steps, Uzbekistans financial sector remains underdeveloped and lacks the benefits of private ownership and competition.

While deposits have been increasing rapidly, this has been from a low base and financial intermediation remains limited. Broad money (M2) to GDP in Uzbekistan is just under 10% of GDP, compared to almost 20% in Russia, around 30-40% in eastern Europe and between 50-100% in most middle income and high income countries. This is a problem Uzbekistan shares with many other CIS countries, but it is not insurmountable, as the recent dynamic developments in Kazakhstan and Russia demonstrate.

Specific weaknesses of the Uzbek banking system are related to the dominance of state ownership in the sector, the continued use of banks as agents of the government for tax collection and financial reporting purposes, and - until recently - the practice of directed lending that has distorted credit allocation and placed a significant burden on banks balance sheets.

Uzbekistans capital markets are also relatively underdeveloped, because of the lack of a secondary market for state securities and ongoing concerns over corporate governance.

- What is hindering to activity of the banks in international standards?

There are three main factors that determine bank performance. First, banks cannot operate well in a situation of macro-economic instability. Their activities will be geared towards foreign exchange arbitrage or investments in the capital markets (such as prior to the Russian crisis) rather than lending to the real economy.

Uzbekistan has taken an important step in 2003 to achieve macroeconomic stability with the introduction of current account convertibility. This provides a basis for moving ahead with structural reforms, including bank and enterprise restructuring, without which the benefits of convertibility in terms of higher external competitiveness and ultimately higher standards of living will not fully materialise.

Second, banking, like any other enterprise, thrives with competition. But in the banking sector, competition needs to be combined with appropriate regulation so that fraudulent practices such as pyramid schemes or excessive risk taking are prevented.

Uzbekistan has been building an appropriate regulatory framework, but it is lacking competition from private banks. One way to obtain such competition is by allowing foreign banks to enter the Uzbek market.

Third, people need to have trust in the banks. A number of measures can be taken to build such trust. Deposit insurance, introduced in Uzbekistan in 2002 is one such measure.

Abolishing the banks role in tax collection and introducing a bank secrecy law would be another key step. Banks also need to be given the freedom to determine credit allocation based on their own market-based risk assessment. This requires a high degree of integrity and professionalism of bank management, sound regulation, but also freedom from state interference.

Bank privatisation is key here. To attract strategic investors, they will need to be given full control, and outstanding issues relating to the portfolio of state-guaranteed loans on the books of state-owned banks will need to be resolved. Tackling these issues is perhaps more difficult than anticipated when the World Bank embarked on helping the government to prepare for bank privatisation through the FIBL project.

- What measures shall the banks and the government undertake to improve situation (your recommendations)?

A number of policy measures have been listed above already. Not all of them can be implemented at once, and some of them require careful preparation.

The following might be one approach to sequencing the necessary reforms although other approaches are also possible.

First, banks should be separated from all tax administration functions and measures taken to ensure the sufficient supply of banks with cash to allow account holders to retrieve the full balance of their liquid accounts in cash at any time.

The Central Bank should move towards issuing CBU notes as an initial means to control liquidity in the domestic money market whilst working with the government on the issuance of T-bills as additional money market instruments.

IMF advice could be sought on how to implement such a transition. At the same time, measures could be taken to support the development of an interbank market for foreign exchange.

Second, the government should take stock of the quality of the loan portfolio in state-owned banks and decide whether to carve out problem loans prior to privatisation or whether to ask private bank management to work loans out based on market principles against appropriate compensation.

Bank restructuring would need to be accompanied by measures that cushion the social impact of associated enterprise restructuring because some non-profitable enterprises will cease to have access to bank loans.

The Government has already make progress in redirecting social transfer to the poor and most vulnerable and these efforts could be built upon.

Third, the government may wish to allow selected foreign banks to enter the Uzbek market to provide an element of competition and a way to benchmark state bank performance once a decision has been taken on how to handle bad loans. In parallel, the government could start privatising selected state-owned banks.

Both measures would need to be accompanied by further efforts to strengthen the supervisory capacity of the CBU.

The World Bank would be delighted to see further progress on these various fronts following its considerable support to the sector to date.