The FINANCIAL -- Increasing activity on the lending market is predicted to be one of the main challenges for the Georgian banking sector this year.
The FINANCIAL -- Increasing activity on the lending market is predicted to be one of the main challenges for the Georgian banking sector this year. It is not recommended for growth of the loan portfolio to happen at the expense of lending standards. External shocks provide a reason to worry, but from a prudential side banks remain well insulated against them. Despite the high growth rates of the past, the size of the Georgian banking system is still relatively low and has significant future growth potential.
“The banking sector has displayed robust risk management and operational flexibility to address some of the important challenges that have emerged in 2013. The low economic growth environment in the first 3 quarters of 2013 dampened loan demand and required banks to reorient their business models towards the segments that were more resource intensive but had relatively higher growth potential. Banks have concentrated on SME and retail sectors, rather than on large corporate. As demand for loans declined, competition on the loan market has intensified and led to a decrease in interest rates. This was also supported by an increasing saving rate in the overall economy. Increased competition has created incentives for banks to increase their efficiency. Efficiency gains did not compromise risk management. On the contrary, we are observing gradual improvements in risk management practices. Improved overall asset quality is the primary result of this. We also observe a declining share of procyclical sectors in the portfolio making the overall financial system more resilient,” Giorgi Kadagidze, Governor of the National Bank of Georgia, told The FINANCIAL.
“Despite intensified completion, improvements in the efficiency and greater scale economies stemming from banking assets growth should enable banks to maintain reasonable profitability targets in 2014. This expectation will likely be impacted by unexpected external shocks and will largely depend on the development of the economy and the political situation in the region as well,” said Kadagidze.
Q. You will maintain your position as President of NBG till 2016. What is the task that you want to fulfil while governing Georgian banks?
A. The ultimate goal is for the financial system to become more supportive of economic development and to insure individuals and businesses against economic shocks by affordable and readily available access to finance. Growth of the financial system along its benefits also brings an increase in systematic risk as sectors whose shocks were uncorrelated become connected through the financial system. This can help the propagation of shocks and increase the so-called market beta of leveraged firms. To fight the increase of such risks it is necessary for the financial system to maintain greater resilience as financial depth grows. Operationally, this means constant enhancement of risk management practices in banks, constant enhancement of supervisors’ capabilities to identify and mitigate risks, greater capabilities to look beyond micro prudential risks and enhance macro prudential oversight. This is a continued process and what was enough 5 years ago is not enough today, and what is acceptable today will be outdated in 5 years.
Efficiency has greater benefits for society but the cost of financial crises could be significantly larger. We always keep in mind tradeoff between efficiency and risks when designing prudential and monetary policy. Good policy is one that does not compromise this tradeoff but moves the system to higher efficiency and lower risks. Risk-based supervision and streamlining of the supervisory process is one example of such policy. Ongoing convergence to European capital and other banking directives will further support such policy, increase investor confidence and prepare grounds for the sector’s integration with EU financial markets.
Q. Commercial banks avoid issuing long term credits. That hampers the development of business in Georgia. What can stimulate and ensure that banks issue long term business loans?
A. This is one of the main challenges for NBG, to create an environment where banks will be able to issue more long-term loans with affordable interest rates. Banks, while doing their job collecting short term liabilities and issuing long term loans, are facing two main risks: interest rate risk and liquidity risk. Our job is to minimize these risks. To do this we have supported the emergence of floating rate loans that are the most widespread type of loans in other countries. To create additional liquidity buffers, so banks can do more maturity transformation, we expanded the collateral base for monetary operations, worked with the Government and IFIs in order for them to issue more securities that are used in liquidity management by commercial banks. All these measures have been successful. During 2013 long-term crediting in the local currency has significantly improved, interest rates have decreased sharply, 15-20 year mortgages in the local currency and loans to legal entities have become popular. These have improved monetary policy transmission and supported economic growth.
Q. In February you increased the rate of refinancing and it currently stands at 4%. Increased interest rates on loans were the immediate result of your policy. Why did you see the importance of increasing the refinancing rate and how far can the interest rates on loans increase?
A. The monetary policy rate changes made by the National Bank of Georgia are directed towards our main mandate - price stability. By changing interest rates according to this objective, we will achieve lowest possible interest rates on long term lending that will in turn support high and sustainable economic growth in the long run.
NBG makes decisions based on future inflation not on current inflation. If expected inflation is above the target rate in the medium-term, NBG increases its refinancing rate. We explain our decision in a press release that follows the committee meeting and later in “Inflation Report”.
With the move NBG started to withdraw the accommodative monetary policy but at the moment policy stance is still expansionary. Further change on the policy is data dependent, we need to see in the coming months how fast domestic demand picks up. In other words policy rate will change according to the business cycle of the economy and if we look in the long term perspective the policy rate on average will be at its neutral rate, which is around 6.5 percent taking into account that the inflation target is 5 percent starting from 2015.
Q. What is the social responsibility of banks in Georgia? Do you think that banks should invest more in their social projects?
A. Considering the importance of the issue, socially responsible banking has been one of the priorities for Georgian banks. This is reflected in credit standards as banks study the creditworthiness of the applicant before granting a loan. Banks do not engage so-called “asset backed loans” practice which could result in severe social consequences. In should be noted that the number of foreclosures for commercial banks is very low compared to the general statistics. In addition, banks frequently try to initiate and engage in educational events aimed at raising the financial literacy of existing, as well as potential consumers. For example they deliver public lectures, visit schools and universities, provide SMEs with the basics of business education and advice such as budgeting, etc.
Q. What is the percentage of borrowers who have lost their property due to their debt to banks? Do you think that there should be more protection for bank customers?
A. Collateral is a fundamental characteristic of the loan and around the world it is used to mitigate credit risk. Banks primarily use collateral as a means to enhance incentives of the borrowers to honour their obligations. Expected source of repayment when granting a loan is always the income of the borrower and banks study the debt repayment capacity of the borrower in greater detail. Repossession of the collateral is an extreme and inefficient measure (there is regulatory disincentive on repossessed assets in the form of progressively increasing provisioning on reposed property) and banks always try to avoid it. Repossessed assets are small.
NBG tries not to interfere in the financial market mechanism unless severe market externalities are evident which interfere with the efficiency of the market and/or create financial stability risks. Consumer protection rules were designed to increase transparency of the contracts, make them more user-friendly and increase disclosure of information on products. This facilitates better decision making on the market. We are well aware that consumer protection rules impose a degree of standardization on products and too strict regulations could discourage innovation of new, consumer’s welfare improving products on the market. Therefore it is important to try to keep the optimal balance between consumer protection rules and innovation and advance consumer protection agenda as financial products develop and become more complicated. Our consumer protection team is very active and interferes vigorously on behalf of customers whenever inappropriate bank behaviour is observed.
Q. NBG asked banks to simplify contracts and make it clearer for easy understanding. But as we observed, there has been no visible progress in this regard. What is the reason for that?
A. Banks do observe consumer protection rules and all qualified contracts are modified accordingly. NBG is very vigilant with regard to compliance to these rules. “Mystery shopper” and other techniques are employed to find compliance problems. Anybody who has evidence that there are cases of non-compliance can contact the consumer protection unit on our hotline 2 406 406.
Q. There is large public interest in information regarding the official and concrete owners of commercial banks. Do you support its publication?
A. We do support it and have been doing this for many years already. The list of ultimate beneficial owners of banks is transparent and published on our website. Transparency is one of the cornerstones of our approach and not only the beneficial owners but also the financial information of banks is disclosed quarterly. Disclosure requirements will be further enhanced as Basel’s pillar 3 will become operational from next year.
Q. Which were the most prioritized types of businesses for financing for commercial banks in 2013 and which will be in 2014?
A. As was already mentioned, banks mainly expanded in the retail and SME sectors. Economic growth patterns of 2014 will strongly influence the composition of the sectorial growth of the portfolio. In terms of resources. banks are well capitalized and posed to support the growing sectors of the economy.
Q. What will be the main challenge for the Georgian banking sector in 2014?
A. In this year banks’ main challenge will be to increase activity on the corporate lending market. There is greater awareness that growth of the loan portfolio should not happen at the expense of lending standards. The international conference organized by NBG in January was intended to highlight potential shortcomings and ways to enhance risk management in this regard.
External shocks remain a significant risk but from the prudential side banks remain well insulated against them as banks have diversified sources of funding and hold additional resources for riskier sources of funding.
Low Larization level is one of the persistent problems and creates many problems in the sector including currency induced credit risk, procyclicality and lower transition channel for monetary policy. Measures undertaken by us to increase Larization had a positive effect but remain limited. Unfortunately, despite many years of macroeconomic stability, sound performance of the GEL as a currency and significant interest rate premium, the Georgian population predominantly still saves in FX and significant markets (property and car markets) remain dollarized. All this feeds in to inefficiency and higher risks of the banking sector which has to deploy additional risk management tools and costly risk mitigation strategies.
In 2014 Basel III regulation, including LCR’s liquidity requirements, becomes effective. Banks have to update risk management capabilities and enhance to better manage their economic capital which will be reflected in the ICAAP submission process and subsequently assessed by supervisors.
Q. What are the main advantages and disadvantages of the Georgian banking sector?
A. The main advantages of the sector are its flexibility and solid fundamentals reflected in good capital and liquidity buffers. The regulatory environment is conservative and at the same time open and transparent. Still, low financial depth creates potential for sustainable growth prospects for the sector. A well-developed credit information bureau is an important factor contributing to the better risk management on the retail market.
The disadvantage of the sector is its relatively small size which inhibits one from fully utilising economies of scale. A significant problem remains low accounting standards and transparency of borrowers. Georgia has a well developed banking sector that by its nature supplies low risk and relatively short term capital to the economy. The high risk and long term segment of the financial market is extremely underdeveloped. This has an adverse effect on the economy and on the development of the banks themselves which usually complement this type of capital by loans. A future challenge for financial development is to jump start and enhance these sectors of the financial market as well.