The FINANCIAL — In today’s Georgia the banking sector has emerged as one of the most successful and dynamically developing segments of the economy. Since 1995 by the assistance of international financial institutions (International Monetary Fund, World Bank, European Bank of Reconstruction and Development and others), the banking system has been growing and developing according to international standards, and in 2005-2007 the annual growth of bank assets reached 60-65 percent on average, being the highest indicator of the last period.
Official international reserves of the National Bank of Georgia for 7 months in 2008 increased by 7.6 percent and equalled USD 1,465 million.
Inflation – chronic disease of Georgia’s economy
For the first time since October 2007, the official inflation indicator has gone below a two-digit figure and by the end of July 2008 comprised 9.8 percent . Nevertheless, note that the average inflation indicator for the last years tended to grow (2003 – 4.8 percent, 2004 – 5.7 percent, 2005 – 8.3 percent, 2006 – 9.2 percent, 2007 – 8.2 percent, 7 months of 2008 – 11.2 percent). In July 2006 the annual indicator of inflation reached 14.5 percent. According to unofficial information the inflation level for that period was even higher. After 2005 it was obvious that inflation had acquired a chronic nature in Georgia.
Dolarization indicator tending to decrease
Starting from 2003 the dolarization coefficient of deposits has tended to gradually decrease. Despite this trend its level still remains high. In end-July 2008, it equalled 60.5 percent. Concurrently it is especially high in terms of physical persons’ deposits which account for 73.3 percent. Another significant trend that was noticed in the first half of 2008 refers to the structure of currency deposits. By the end of 2002 97 percent of currency deposits came in USD deposits, the share of deposits in EUR was only 3 percent. Later the EUR became more popular with depositors and by end-July 2008 the volume of EUR deposits among currency deposits comprised 30 percent.
Growth of the banking sector of Georgia is approaching a European level
The average growth rate of assets in the banking sector in 2000-2004 was within 15-23 percent. After 2004 growth significantly increased and in 2005 it accounted for 39 percent, in 2006 – 67 percent, in 2007 – 71 percent and in 7 months of 2008 – 41 percent. Eventually compared to the end 2004 at the end of July 2007 banking assets had increased 5.2 times. Due to a relatively high growth rate compared to GDP, the bank assets and GDP ratio lately has especially grown (2003 – 15.6 percent, 2004 – 17.3 percent, 2005 – 21.9 percent, 2006 – 30.7 percent, 2007 – 42.4 percent). It is estimated that if this growth rate is maintained, the growth of the banking sector of Georgia will approach the level of Central and Eastern European countries.
Other indicators are also going up: in the analogous period net loans increased 6 times, gross deposits – 3.6, gross deposits of physical persons – 3.7 (o/w term deposits 3.6 times), borrowings – 8.5, and capital – 5 times. Note significant growth of gross deposits of physical persons that grew from GEL 493 million to GEL 1831 million confirms the positive trend of recovery of the trust of the population towards the banking system. If at the end of 2000 deposits of physical persons comprised 39 percent of gross deposits, as of July 2007 it equalled 44 percent.
Relevantly other financial indicators of the banking system grew also. If in 2004 the gross income of commercial banks was GEL 276 million, and net profit GEL 27 million, in 2007 it equalled GEL 949 and 109 million respectively. In 2007 banks paid GEL 302 million (o/w GEL 126 million on term deposits) as interest. Significant changes also occurred in the structure of the income and expenditure of banks. In 2007 compared to 2004, the share of interest income in gross income grew from 56 percent to 73 percent. Also, if in 2004 the interest expense in gross expenses was 18 percent; in 2007 it comprised 32 percent. Correspondingly the non-interest expense share decreased from 67 percent to 40 percent (including the share for office maintenance – from 23 percent to 19 percent).
Competition in the banking sector grew
Although the share of key players on the banking market of Georgia still remains high, it shows a downward tendency. If in early 2007 the relative share of the two largest banks was 58.8 percent, by end-July it had decreased to 57.2 percent, and the share of the top five banks (Bank of Georgia, TBC Bank, Republic Bank, ProCreditBank and VTB Bank) decreased from 85.5 percent to 82.9 percent.
Starting from 2007, competition on the banking market grew. Banks were rigorously opening new branches and service centres. Only in the last year and a half has their number increased by 52 percent and only by end-July 2008 it comprised 640 (o/w 129 were branches and 511 – service centres). Along with opening branches and service centres, new products and services were being offered. A large portion of banks extended working hours (from 9:00 to 22:00); service centres functioning 24 hours emerged. Compared to previous years the quality of credit accessibility significantly improved. Small consumer and instalment credits were possible to obtain without additional guarantees. Consumer, car trading outlets and construction business were actively involved in this process. Mortgage crediting was initiated. Either purchasing insurance companies or setting them up was quite common for large banks. Electronic services were also extended. In 7 months of 2008 the number of cash dispensers increased by 43 percent and comprised 1,189. In the same period the number of post-terminals increased by 40 percent and comprised 7,253. The number of debit cards increased by 43 percent and reached 2.7 million pieces, and the number of credit cards increased by 165 percent and exceeded 427 thousand pieces.
High inflation caused credits to go up starting from 2005
Along with increase in competition between economic activity and banks in recent years, interest rates on deposits and credits in Georgia naturally went down. However, this trend tended to slow down and already in 2005 had reversed both on deposits and bank loans. It was also natural that banks started to increase interests first on deposits (starting from late-2004), and increase in the value of resources and high inflation caused credits to go up in price from late-2005. This process was especially tangible from July 2007. Market interest rate on loans during a year increased by 4.6 units and by July 2008 reached 22.2 percent (which is 26 percent growth).
Banking system was visibly decelerating
It was obvious that although interest rates had been increased and huge resources had been invested to carry out various marketing measures (promotion campaigns, introducing grace periods, lotteries), banks found it more and more difficult to attract resources both on domestic and foreign markets and to satisfy increased demand on credits. The share of loans in the consolidated assets of the banking system was going up. For example, if the average net loans and average net assets ratio in 1999-204 did not exceed 52 percent, by end-July 2008 it had reached 61 percent. Naturally this led to a significant decrease of the share of liquid resources in bank assets and increase in risks both in the entire banking system and particular banks, correspondingly.
If in 2006-2007 the average growth rate indicator of bank credit portfolios was 4.2 percent per month, in February-July 2008 it comprised 3.3 percent; of which in May-July – 2.6 percent. Concurrently low level of attraction of resources on the local market is more obvious. Growth rate of gross deposits in 2006-2007 comprised 3.6 percent, in February-July 2008 – 1.5 percent, of which in May-July – 1.1 percent and in case of physical persons’ deposits – 3.3 percent, 2.5 percent and 1.7 percent in the relevant periods. Furthermore, during 2008 there were months when these indicators tended to decline, for example, gross deposits in the month of February decreased by 2.5 percent and by 0.5 percent – physical persons’ deposits in May. I.e. the banking system in the last year certainly was decelerating.
Banks dramatically suffer from liquidity problems
As a result the banks demonstrated negative tendencies in regard to attraction of resources. We have witnessed the outcome that usually accompanies the above mentioned process if banks’ supervision bodies do not intervene and regulate by relevant leverages. Particularly, if before 2004 monetary resources (cash and monetary resources on the correspondent accounts) ratio to assets, net loans and total liabilities in 1999-2004 retained stability (in some cases even went up), starting from 2005 all above mentioned quality indicators tended to deteriorate and before the August events liquidity problems in the banking system had become tangible. The indicator of monetary resource and net loans ratio after 2004 until end-July 2008 declined from 60 percent to 33 percent, in liabilities – from 40 percent to 25 percent, and in assets – from 31 percent to 20 percent.
Concurrently, the deposit average term indicator being one of the indicators determining the population’s confidence degree towards banks started to decline. If in 1996-1999 the average term indicator of term deposits comprised 6.9 months, it increased significantly from early 2002 and equalled 9 months. After certain ‘failures’ 2003 witnessed an improvement process that lasted until early 2004 and comprised 12.3 months. This is the only period when the average term of term deposits exceeded the average term of loans. However, after that period average term for term deposits has demonstrated a permanent downward trend (with small exceptions, though) and had decreased to 9 months by end-July 2008.
Unlike that the indicator of loan term tended to grow and in the period from early 2000 to early 2008 increased from 8.6 months to 14.7 months. However, during 2008 it practically did not go up. It is apparent that discrepancy between assets and liabilities (in the part of deposits) in regard with the term in the banking system deteriorates GAP of the banking system and particular banks. Certainly the average term on loans and deposits is not necessarily equal but the fact that they are fluctuating not in parallel but in opposite directions is problematic.
Finally, if we compare two trends in regard to the deposits attracted by banks – average term decrease on term deposits and deposit interest rate growth, it becomes obvious that it demonstrates, on the one hand, problems with resource attraction and liquidity, and with making resources more expensive and deterioration of financial indicators, on the other. As a result despite the fact that recently banks were generating more income, the indicator of profitability was declining. If in 2002-2007 ROA (profit on assets) on average was 3.1, in 7 months of 2007 it dropped to 1.7. As for ROE (profit on capital) it fell from 13.5 to 8.3 in the corresponding period. One more negative trend that emerged prior to the August events is connected with the recent deterioration of the quality of the bank loan portfolio. For the last years the ratio between banking system loan potential loss reserves and the credit investment volume was declining and by July 2007 dropped to 3.3 percent. The share of the outstanding loans in the gross portfolio back then was 0.7 percent (however, by unofficial data in some of the commercial banks this figure was rather high). For one year after that the credit portfolio quality significantly deteriorated and the ratio of the above mentioned reserves and the credit portfolio increased by 4.3 percent and the share of the outstanding – by 1.7 percent.
The problems in the banking system of Georgia existed before the war
One thing is clear, before the famous August events of 2008; the banking system of Georgia was already facing substantial problems which were sizeable and obvious. True the banking system of Georgia endured processes developed during wartime but the above mentioned events only deepened the already existing problems. The August crisis had a significant impact on the banking system of Georgia and on the economy in general. The assets of the banking system in August-October 2008 declined by GEL 1026 million (13 percent), and the losses of the banking system as of January 1, 2009, comprised GEL 215 million. The conflict actually revealed all inner banking contradictions and disproportions existing prior to that period. And in September-November when the world economic and financial crises further enhanced, these disproportions further deepened dramatically affecting short and middle-term development of the Georgian banking sector.
What should be done to overcome the problems?
There are certain opinions about what is a priority in the current condition. It is obvious that banking supervision has to work more flexibly and adequately. Despite confidentiality elements this service along with NBG has to work more transparently in every direction. Also everybody should try to increase the participation of international financial institutions in Georgian banks; consequently it is desirable to identify strategic investors for the leading banks.
It is essential that the best practices of corporate management be implemented in Georgian banks. Particularly, it is important that the functions between the supervision board and management be distinguished and the institute of an independent director be introduced in the banks. Furthermore there are some other issues to be resolved. The further process of enlarging and merging in the banking system shall be encouraged.
Reflecting on these issues, developing complex approaches and implementing them quickly and prudentially shall trigger the improvement of the system and encourage its further development.
By Irakli Kovzanadze, Doctor of Economic Sciences, Professor
Exclusively for The FINANCIAL