The FINANCIAL — “Solid economic growth (Fitch forecasts GDP to increase by 5% in 2011) provides quite a favourable backdrop for the development of the banking sector. Asset quality metrics should continue to improve as some old problem loans are recovered and banks increase issuance of new credit,” Natalia Smirnova, Associate Director and James Watson, Managing Director of Fitch Ratings said to The FINANCIAL.
“The main challenge faced by banks is likely to be an increase in competition, especially for high-quality borrowers which are relatively limited on the Georgian market. This could put some pressure on margins, and could also potentially increase risk appetite at some banks, which may seek growth in more risky segments,” Fitch Ratings directors told The FINANCIAL.
According to Fitch Ratings the funding of further loan growth is also an important challenge. Although banks have accumulated significant liquidity which can be partially reallocated into loan portfolios in 2011, the sector’s loans/deposits ratio was a high 114% at end-2010, suggesting limited capacity for lending to grow too far ahead of customer balances.
According to Fitch, “The generally solid capital and liquidity positions of Georgian banks were important strengths that helped them weather the crisis”.
“At end-2010, notwithstanding strong growth during the year, the system’s regulatory capital adequacy ratio remained a relatively high 17.4%. Furthermore, Basel capital ratios are usually markedly higher than regulatory ones for Georgian banks, mainly because of the additional regulatory risk weighting applied to foreign currency lending. Banks also remain very liquid, with about one third of the system’s balance sheet held in liquid assets,” said the directors of Fitch Ratings.
According to Directors of Fitch Ratings, taking into account on-going loan growth, it is likely that both the capital and liquidity positions of Georgian banks will moderate slightly in 2011, but we are not expecting a critical deterioration in these metrics, given the current strong positions and quite stringent regulation.
Fitch Ratings is operating in 150 countries with 50 offices worldwide. The company has been operating in CIS countries for 15 years already. Fitch covers corporate, banking, insurance, international public finance and sovereign sectors. The company rates 249 issuers in the CIS region, within which 122 are financial institutions.
Fitch Ratings at present rates six of the 19 banks currently operating in Georgia: Bank of Georgia, TBC Bank, Liberty Bank, ProCredit Bank (Georgia), VTB Bank (Georgia) and Basisbank.
According to Fitch Ratings the two largest banks, Bank of Georgia and TBC Bank, jointly account for around 60% of system assets and are both of high systemic importance. Bank of Georgia’s Long-term Issuer Default Rating (IDR) was upgraded to ‘B+’/Stable Outlook from ‘B’ in August 2010, reflecting improvements in the Bank’s standalone credit profile. TBC’s Long-term IDR, which is also 'B+'/Stable, is driven by potential support from the Bank’s international financial institution shareholders.
VTB Bank Georgia’s and ProCredit Bank Georgia’s ‘BB-’ IDRs are driven by potential support from their majority shareholders: Russian state-controlled VTB Bank and Germany’s ProCredit Holding AG. In the beginning of March 2011, we revised the Outlooks on these banks’ IDRs to Positive from Stable, following the revision of the Outlook on Georgia’s sovereign’s ratings to Positive.
The ‘B’ Long-term IDR of Liberty Bank is underpinned by potential support the Bank could receive from the Georgian authorities due to its important social function in distributing pensions and social benefits in the country.
The ‘B-’ Long-term IDR of Basisbank reflects the stand-alone strength of the Bank. The rating was upgraded from ‘CCC’ in August 2010.
In their interview with The FINANCIAL, Natalia Smirnova, Associate Director and James Watson, Managing Director of Fitch Ratings analysed the Georgian banking sectors, before and after the crisis period challenges and outcomes.
Q. Which are the most active banks in the Georgian banking sector currently? Which banks would you name the most active in crediting corporate and physical clients?
A. After the quite serious stress which Georgian banks underwent in 2008-2009, when new credit was very limited, in 2010 we observed a resumption in bank lending, with system loans growing by 21%. Within the sector the pace of growth varied from bank to bank, depending on how quickly banks recovered from the crisis and were able to adjust their strategies, and the extent to which the crisis impacted their risk appetites. Bank of Georgia and TBC both demonstrated above sector average loan growth in 9M10, while Liberty, KOR Standard and HSBC have all grown rapidly from low bases. This in particular applies to Liberty, which has pursued aggressive growth, primarily in the retail sector.
Q. How would you evaluate the performance of the Georgian banking sector in 2010?
A. After two years of losses, 2010 was a profitable year for Georgian banks. This was driven first of all by reduced credit costs, which in 2008-2009 had weighed on the profitability of the banking system. Revenue generation has also strengthened on the back of more active lending and still solid net interest margins.
Q. What were the main challenges the banks had to face after the post war and post crisis period?
A. In Georgia, as in many banking systems globally, banks initially faced funding challenges and then subsequently more deep-seated asset quality problems. Georgian banks coped with the funding challenges in part due to generally quite strong liquidity positions pre-crisis, which helped them withstand deposit outflows in August 2008 and in the first half of 2009. In addition, TBC and Bank of Georgia benefited from the ability to refinance much of their foreign debt with longer-term facilities made available by international financial institutions.
The extent of asset quality problems varied from bank to bank in Georgia, but tended to be higher at those institutions which had lent most heavily to the real estate and construction sectors. Most banks had relatively little experience pre-crisis of dealing with such an asset quality downturn, and so often needed to retrain staff or import skills from shareholders or consultants to help manage loan the workout and recovery process.
Q. What are the major weaknesses of the banking sector currently?
A. The Georgian banking sector remains highly dollarized, with more than 70% of loans provided in foreign currency. This makes Georgian banks very vulnerable to exchange rate volatility and gives rise to potentially significant additional credit risk.
More generally, the Georgian banking system continues to operate in what is still a relatively small and concentrated, low income emerging market economy.
Q. Capital ratios and financial indicators play a vital role for investors while choosing investment opportunities in emerging markets. In your opinion, how attractive is the Georgian banking sector for potential investors? How competitive are capital ratios and financial indicators of Georgia compared to other emerging markets?
A. Capital ratios in the Georgian banking sector are higher than in most other emerging markets, which is positive for creditors, but from the perspective of equity investors can weigh on banks’ return on equity. In terms of other financial indicators, Georgian banks’ net interest margin remains relatively high, which in part reflects the still quite early stage of development of the market and the risk premium charged to lenders by banks.
Q. What is the potential of Georgian banking sector development compared to other emerging markets of the world and to neighbour countries like Armenia, Azerbaijan, Kazakhstan, Ukraine, Russia?
A. The level of Georgian banking sector penetration, as measured by its loans/GDP ratio, is significantly lower than in larger CIS countries, such as Russia, Kazakhstan and Ukraine, but broadly in line with Armenia and Azerbaijan. This suggests significant growth potential for Georgian banks in the medium term, however the quite narrow base of the Georgian economy and limited sources of long-term funding, in particular in local currency, are constraints.
Q. In your opinion, what was a good lesson for Georgian banks to learn from the financial crisis?
A. The crisis forced many banks to reconsider their assessment of credit risk and, to a lesser extent, refinancing and liquidity risk. However, the considerable international assistance received by the Georgian economy in general and some banks in particular limited the impact of the crisis, and hence perhaps also the degree to which the crisis will result in changes in risk management practices.
Q. Finding external funding for further lending is still the case for Georgian banks. In your opinion, how should banks create more reserves?
A. Although refinancing risks for the sector have reduced markedly as a result of funding made available by international financial institutions, the sector’s overall dependence on wholesale borrowing, as reflected in the loans/deposits ratio, remains high. Relatively low income and savings levels are constraints on deposit growth, although very rapid deposit expansion in 2010 has helped to rebalance banks’ funding structures.
Q. High Dollarization is still an actual topic and the majority of banks have declared that the level of dollarization is still quite high in the sector. What additional steps should National Bank of Georgia take for increasing the share of GEL in lending and saving?
A. The high share of loans provided in foreign currency is a direct result of banks’ funding structures, which comprise mainly foreign currency deposits and international borrowings. In the long-term, an increase in GEL deposit funding is likely to be dependent on a sustained period of moderate GEL inflation and a significant differential between the interest rates offered on local and foreign currency deposits.
Q. In your previous interview with The FINANCIAL you declared that interest rates are definitely higher in Georgia than in most emerging markets. The high interest rates on deposits make it attractive for foreign investors to open deposits in the country. In your opinion, in the long run will it lead to increased volume of deposits in the country?
A Fitch does not expect non-resident deposits to become a significant source of funding for Georgian banks in the foreseeable future. Interest rates on other forms of foreign funding (e.g. bilateral and syndicated loans) are subject to very different dynamics to those on the local deposit market.
Q. How would you compare the interest rates on deposits and loans of Georgia to other neighbour countries? In your opinion, what are the trends governed by?
A. In Georgia, as in most other emerging markets, deposit and loan rates increased markedly at the beginning of the crisis as banks sought to retain their customer funding and became more risk averse in respect to their lending. However, as the crisis has abated, so rates have returned to close to pre-crisis.
Q. The leading banks in Georgia provide similar offers on deposits and loans. In your opinion, why are Georgian banks developing in the same direction?
A. The relatively close alignment of interest rates at different banks is essentially a result of competition between them. Banks may offer somewhat higher or lower deposit rates than the market depending on their loan growth plans and liquidity positions, or may offer somewhat lower loan rates in an attempt to acquire new clients.
Q. In your opinion, how real is it that Georgian banks will develop niche markets and serve clients from niche markets? (i.e. special services only for children, for students)
A. Banks will continue to be innovative in their attempts to design deposit and other products for particular customer groups. However, relatively low income groups, such as students and pensioners, are unlikely to constitute a significant proportion of sector deposits or loans in the medium term.
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