Policy Studies Series [PS/1/218] Banking Sector Monitoring Georgia 218 Ricardo Giucci, Alexander Lehmann, Giorgi Mzhavanadze, Anne Mdinaradze German Economic Team Georgia in cooperation with Berlin/Tbilisi, March 218
I. Banking sector and financial markets in Georgia 1. Banking sector vs capital markets in Georgia 2. Regional comparison 2
1. Banking sector vs capital markets in Georgia Market capitalisation and banking sector assets 1 9 8 7 6 5 4 3 2 1 of GDP Market capitalisation* Banking sector assets 64.3 7.7 79.4 3.7 5.3 6.7 7. 213 214 215 216 88.9 Source: National Bank of Georgia; eop * Due to data limitations, market capitalisation before 216 is calculated by assuming the same structure of the capital market as in 216 Banking sector Good progress in deepening intermediation 89 bank assets to GDP relatively high for an economy at this stage of development Capital markets Relative stagnation may be due to some structural obstacles Uneven development of banking sector and capital markets Georgia s financial sector almost entirely dependent on banks 3
Banking sector assets, 216 12 1 8 6 4 2 1 8 6 4 2 of GDP Market capitalisation, 215 of GDP 6.7 Georgia 49.9 Russian Federation 56.3 2. Regional comparison Romania Ukraine Moldova Armenia Georgia Turkey Latvia Source: National Banks, eop 86. 93.8 Turkey Poland Slovenia Source: Bank for International Settlements, World Bank, IMF and capital market development strategy from the Ministry of Economy of Georgia and National Bank of Georgia; eop Banking sector Georgia ranks highly in terms of overall banking sector depth There are still some problems with access to credit Capital market remains underdeveloped Equity market highly illiquid Liquid sovereign bonds but private bond issuance limited IMF index of financial development suggests considerable growth benefits from further financial deepening 4
II. Market structure, profitability and governance 3. Number of banks 4. Market structure 5. Bank profits 6. Corporate governance and foreign listings 5
25 2 15 1 5 21 Source: NBG, eop 19 16 16 214 215 216 217 Jan215: Merger of TBC and Bank Constanta May215: Merger of BOG and Privatbank 216: Progress Bank cancelled its banking license to become a non-bank institution Sep216: NBG revoked license of Caucasus Dev Bank; bankruptcy of mother company in AZE Nov216: Closure of Capital Bank due to breach of NBG regulations (money laundering) Mar217: Banking license for Credo (microfinance) May217: Merger of TBC and Bank Republic 3. Number of banks 214-217 Numbers of active banks went down from 21 to 16 Six small banks no longer active, TBC and Bank of Georgia acquired smaller institutions But: One microfinance institution received a banking license A dynamic process of entry and exit Drivers of the consolidation process NBG regulation and supervision, e.g. higher minimum capital requirements in effect from 218 But also market forces; search for economies of scale / efficiency 6
Banking sector assets, Dec 217 ProCredit Bank 4 Cartu Bank 3 Liberty Bank 5 Source: NBG VTB Bank- Georgia 5 Other banks 11 Bank of Georgia 35 4. Market structure TBC Bank 37 Share of top 3 banks - regional comparison, 215 8 7 6 5 4 3 2 1 Georgia Moldova Romania Armenia Latvia Turkey Ukraine Source: Global Financial Development Indicators (World Bank) Top 3 banks currently account for 77 of assets; high concentration TBC Bank: 37 of assets Bank of Georgia: 35 of assets Strong presence of foreign capital 15 of the 16 banks with foreign-capital participation 8 of assets under foreign ownership (though by portfolio, not strategic, investors) Unusual, no state-owned bank International experience suggests that even highly concentrated banking systems can be efficient and provide good access to credit for firms 7
2 15 1 Banking sector profit 1 5 8 6 4 2 Return on equity: regional comparison, 216 GEL m 213 214 215 216 217 Profits ROE Source: NBG Armenia Romania Moldova Latvia Turkey Georgia Source: IMF Financial Soundness Indicators 5. Bank profits in 3 25 2 15 1 5 Return on equity (ROE) Increase to 24.6 in 217 likely due to special factors Positive for financial stability Relatively high in regional context but partly explained by good operating efficiency and low impairment charges Policy will need to Ensure open entry into the sector Safeguard against abuse of market dominance and facilitate information sharing Tackle the too-big-to-fail problem 8
6. Corporate governance and foreign listings Weak Georgian legislative framework EBRD assessment of the Georgian Corporate Governance Code Stakeholders and institutions Source: EBRD Rights of Stakeholders Structure and Functioning of the Board Transparency and Disclosure Internal Control for corporate governance TBC and BoG both listed on premium London Stock Exchange segment (BoG in the FTSE25) As such they comply with the UK corporate governance code and a high level of transparency This defines an expanded investor base, and likely reduces costs of funding within Georgia, however at the expense of liquidity in Georgian securities markets Introduces high corporate governance standards within Georgia, which has a weak local framework 9
III. Bank soundness 7. Liquidity 8. Capital 9. Asset quality and non-performing loans 1
Bank deposits 8 GEL bn USD bn 6 4 2 GEL deposits, left hand scale FX deposits, right hand scale Source: NBG, own calculations, excl. interbank deposits 7. Liquidity 6 5 4 3 2 1 Deposit funding stable, and steady growth since 214, despite major regional turbulences and GEL depreciation Limited wholesale funding, in part from IFIs High share of liquid assets Loan to deposit ratios around 1 at all key banks Structure of deposits Current Term 58.2 41.8 GEL FX 33.8 66.2 Depositors appear to trust the banks and the supervisor; absence until now of a deposit insurance scheme has not been a problem Banks adopt conservative funding models Source: NBG, own calculations 11
Capital adequacy ratio 2 15 1 5 Total minimum CAR (1.5*) Basel III Basel I 8. Capital Basel III Source: NBG; *including minimum capital requirement of 8 and capital conservation buffer of 2.5 CAR as of risk-weighted assets of individual banks 35 3 25 2 15 1 5 Capital adequacy ratio (CAR) Regulatory minimum for each bank: 1.5 total CAR (including minimum capital requirement and capital conservation buffer) comfortably met by all banks System-wide ratio about 16 Demanding risk weights for FX loans BoG and TBC as systemic banks also have substantial additional buffers The system is well-capitalized Capital buffers should be maintained, given the external risks, and other vulnerabilities Source: NBG, Note: Data for 4Q217 (after regulatory changes by NBG) 12
213Q1 213Q2 213Q3 213Q4 214Q1 214Q2 214Q3 214Q4 215Q1 215Q2 215Q3 215Q4 216Q1 216Q2 216Q3 216Q4 217Q1 217Q2 217Q3 217Q4 9. Asset quality and non-performing loans NPLs as a share of total gross loans 12 1 8 6 4 2 in Source: NBG by IMF's methodology by NBG's methodology Non-performing loans (NPLs) Long-term decline of NPLs, according to the NBG s definition from 9.5 (Q1-213) to 5.9 (Q4-217) Good provisioning policies by the banks Active restructuring efforts of overindebted companies and a new bankruptcy law should also help No major spike in NPLs following the depreciation of GEL in 215 Potential risks from rapid growth in retail credit, and FX borrowing, but various NBG safeguards are in place 13
IV. Access to credit 1. Credit to the real sector 11. Loan growth 12. Growth dynamics: corporates vs retail 13. SME lending and credit access 14. Interest rates and spreads 14
Credit to real sector to GDP 7 6 5 4 3 2 1 8 7 6 5 4 3 2 1 Source: World Bank, data for 216 1. Credit to the real (non-financial) sector Credit to real sector to GDP: Regional comparison 45 5 214 215 216 217* Source: NBG, own calculations; *own estimation, Note: absolute values in GEL bn Moldova Romania Ukraine Armenia Georgia Turkey Latvia 56 59 Credit to the real sector Credit ratio reasonably high in a regional comparison Growth in excess of GDP growth, and accelerated in recent years Retail lending is the main driver of loan growth Corporate lending constrained by high leverage, and access to external funding by some firms Bank lending seems to work well, though cannot entirely make up for absence of capital market instruments 15
Jan-214 May-214 Sep-214 Jan-215 May-215 Sep-215 Jan-216 May-216 Sep-216 Jan-217 May-217 Sep-217 Loan growth 3 2 1 2 15 1 5 Source: NBG, own calculations GDP growth and loan growth Total real loan growth (left hand scale) GDP growth (right hand scale) 11. Loan growth Total nominal loan growth (FX adjusted) Total real loan growth (FX adjusted) 5.5 4.5 3.5 Loan growth (real & FX adjusted) Loan growth correlated with variation in economic activity, though consistently exceeds it Ongoing deepening of credit relative to GDP Aggregate demand seems to be the driving force for credit expansion There is no evidence of a credit crunch 2.5 Source: NBG, own calculations 16
Feb-214 June-214 Oct-214 Feb-215 June-215 Oct-215 Feb-216 June-216 Oct-216 Feb-217 June-217 Oct-217 12. Growth dynamics: corporates vs retail Corporate vs retail loan growth 35 3 25 2 15 1 5-5 Corporates real loan growth Retail real loan growth Total real loan growth Source: NBG, own calculations Structure of loans of total loans 214 217 Corporate 51.2 45.8 Retail 48.8 54.2 Source: NBG, own calculations, eop With 2 increase yoy, retail credit is the driving force of loan growth The NBG has addressed emerging risks through a number of measures which complement its de-dollarisation strategy (e.g. limits on loan-to-value ratios) Retail credit penetration (about 32 of GDP) relatively high in a regional comparison Rapid loan growth is always a concern, though there seem to be various safeguards for sound lending standards 17
Share of SME lending in total corporate lending 6 55 5 45 4 Source: NBG Access to finance as an obstacle for SME Romania Latvia Moldova Ukraine Turkey Armenia Georgia 2 4 6 8 1 13. SME lending and credit access No obstacle Source: BEEPS survey by EBRD; Question: To what degree is access to finance an obstacle to the current operations of this establishment? Minor / moderate obstacle Major / very severe obstacle Access to credit flagged as the third most important obstacle to business in the World Bank/EBRD survey But the overall share of SMEs which flag such a constraint does not seem to be out of line compared to other countries Share of SME credit slightly increasing over the past 2 years Access to credit by individuals also seems to in line with peer group Low wealth and corporate debt rather than lending policies seem to be the key constraints 18
Interest rates on GEL loans and deposits 25 2 15 1 5 9.3 21.7 12.4 Source: NBG 14. Interest rates and spreads Nominal interest rates on GEL loans Nominal interest rates on GEL deposits Interest rates on FX loans and deposits 15 13.9 1 5 7.7 6.2 Nominal interest rates on FX deposits Nominal interest rates on FX loans 1.3 17.3 7. 5.9 8.5 2.6 Significant decline in GEL and FX interest rates Also reduction in loan-depositspreads in both FX and local currency Despite high profitability banks seem to pass on improved efficiency to loan pricing GEL rates should converge further with USD rates as GEL stability takes hold For now GEL-USD interest rate spreads are the principal explanation for dollarisation, the key vulnerability 19
V. Dollarisation and NBG s de-dollarisation strategy 15. International experience with de-dollarisation 16. Dollarisation in Georgia: recent developments 2
1981 1982 1983 1984 1985 1986 1987 1988 1989 199 1991 1992 1993 1994 1995 1996 1997 1998 1999 2 21 15. International experience with de-dollarisation Deposit dollarisation ratio in Israel and Poland 8 7 6 5 4 3 2 1 Israel Poland Sources: Galindo and Leiderman (25) Deposit dollarisation ratio in Peru 8 75 7 65 6 55 5 21 22 23 24 25 26 27 28 Source: IMF Working Paper 1/169 High dollarisation ratios raise risks to banks solvency and financial stability; it may also constrain macro policy (a fear of floating ) Lack of a credible monetary regime and high FX and inflation variability are the root causes of dollarisation Experience from other emerging markets is encouraging: inflation targeting and stabilisation and the resulting macroeconomic credibility are the foundations of reducing dollarisation ratios Poland, Israel, Peru all managed this process successfully 21
16. Dollarisation in Georgia: Recent developments Loan dollarisation ratio 7 65 6 55 5 Source: NBG, own calculations, excl. interbank deposits 75 7 65 6 55 5 Deposit dollarisation ratio Significant decline in loan dollarisation in 217, likely helped by prohibition of FX loans under GEL 1, Also reduction in deposit dollarisation However: deposit dollarisation cannot be addressed by administrative measures alone Additionally: FX still widely regarded as a sounder store of value Some progress in fighting dollarisation in 217 Source: NBG, excl. interbank deposits 22
VI. Outlook and policy challenges 17. Tackling high dollarisation 18. Capital market development 19. Convergence to the EU regulatory framework 23
17. Tackling high dollarisation Relatively high dollarisation remains the key vulnerability of Georgia s financial system The key macroeconomic pre-conditions for de-dollarisation are in place The recent prudential measures will further help to shift behaviour: higher capital requirements for FX-loans will act as a buffer and reduce risks in the banking sector The introduction of inflation-indexed bonds could also help As will the development of local currency long term debt instruments 24
18. Capital market development Georgia stands out regionally for underdeveloped bond and equity markets. Larger companies therefore lack long-dated local currency debt instruments, and risk-oriented capital Central Europe has demonstrated that both types of security markets can become liquid, even within a small economy The emergence of Georgia s pension funds and the growing interest of foreign institutional investors would be supportive Regulatory priorities will need to be the concentration of liquidity; enhancing transparency at issuance and once a company is listed; and containing self-dealing or insider dealing 25
19. Convergence to the EU regulatory framework Under its Deep and Comprehensive Free Trade Agreement (DCFTA) with the EU Georgia has committed to adopt the entire EU financial framework as it evolves This is in Georgia s own interest, as it imports a credible legal regime that is well recognized internationally But EU rules need to be adapted to the local context The deposit insurance fund is a good illustration of reflecting much smaller local thresholds As in all emerging markets, a framework for orderly bank resolution is essential, though mobilizing a potential bail-in will depend on credible domestic supervision having been established Many capital market instruments are not yet developed. Present EU rules could overburden the supervisor unnecessarily, and discourage further market development 26
Dr Ricardo Giucci giucci@berlin-economics.com Dr Alexander Lehmann lehmann@berlin-economics.com Anne Mdinaradze mdinaradze@berlin-economics.com German Economic Team Georgia c/o BE Berlin Economics GmbH Schillerstraße 59, 1627 Berlin Tel: +49 3 / 2 61 34 64 www.get-georgia.de Twitter: @BerlinEconomics Facebook: @BE.Berlin.Economics Contact 27