A Long Read on the Causes of Weak Corporate Lending

I decided to write a long read on corporate lending, because at every level we keep hearing that corporate lending in Kazakhstan is in a bad way. Lending exists, but it does not grow steadily and is not a catalyst for economic growth. I have written about this many times, but never brought my thoughts together in a single piece. Here I will try to set out the main reasons why lending is not growing and what needs to be done about it.

Discouraging banking regulation by the National Bank

Lending rates in the country will always sit above the base rate, because the National Bank absorbs any excess liquidity from the market at the base rate minus 1%. It does not matter what the banks' liabilities cost them. Yet if we take all the banks' balance sheets and calculate the cost of their liabilities, it comes out well below the base rate (by my estimates, around 8-10%). The reason is the ban on paying interest on current accounts, which can make up a third of banks' total liabilities: balances of budget-funded organizations, balances on card accounts, and receipts that land on corporate current accounts after the end of the business day all cost banks zero percent. So banks have no incentive to lend to the economy when the margin from re-placing funds is quite sufficient, and by placing them in risk-free financial instruments they earn a 5-6% margin. This ban means budget-funded organizations lose out on billions of tenge, while banks buy Ministry of Finance securities with that money and secure themselves a very comfortable profit. Paradoxically, only here does the Ministry of Finance borrow tenge at 14-15% from banks, which take money from budget-funded organizations at zero, while those organizations in turn receive that money from the Ministry of Finance, which borrows it from the banks.

The situation is the same with foreign-currency balances. The National Bank caps deposit rates at 1%, while on the markets funds can be re-placed without risk at 4% or higher, so banks have no incentive to re-place them in risky assets. In addition, there is in effect a capital disincentive for foreign-currency loans (I will write about this later). The rule was introduced to fight dedollarization, when dollar rates on capital markets were close to zero. Today only the banks earn from the high rates. It seems to me that, given the huge withdrawals from the National Fund, abolishing this rule would help keep the tenge exchange rate within a more market-based corridor and avoid accumulating imbalances, as is happening now. Still, I understand the National Bank, for which inflation is what matters and for which a strong tenge is necessary. The budget imbalance and economic growth are not the National Bank's mandate. Although it would be quite right to start calculating unemployment statistics and to hand the National Bank a mandate on the unemployment rate as well, so that it does not get carried away with strengthening the real exchange rate in pursuit of its main mandate. But credit where it is due: the National Bank is a hostage of the state's overall economic policy, which does not meet recognized international standards in any way.

Inefficient fiscal policy of the Government

Of course, many will ask what fiscal policy has to do with corporate lending. Let me try to explain. The state's fiscal policy rests on the efficiency of public revenues and expenditures, and any inefficiency here discourages lending.

Tax exemptions. At one time, to develop the stock market, the state abolished taxation of income from securities. On the one hand, this allowed the stock market to develop reasonably well; on the other, the main players in the debt market are banks and the UAPF, and most of the traded securities are those of the public and quasi-public sectors. Banks, like all stock market participants, do not pay CIT on this income. As a result, if the Ministry of Finance borrows at 14-15% per annum, then for banks to have an incentive to lend at risk, the rate must be at least 20% higher, since a second-tier bank will pay 20% CIT on income from loans. So with a base rate of 14.25%, the effective rate for a second-tier bank is 17.8%. Add a cost of risk of 3-4%, and we get an effective rate of 20-21% for business. In other words, because of tax exemptions, our base rate is heavily distorted. The exemption on tax-free income should be kept only for individuals and removed for legal entities, including second-tier banks. Incidentally, this would bring an additional KZT 200-300 billion into the budget.

Business subsidies. Many will of course be strongly against removing subsidies, but with limited resources, subsidies are a constraining factor at the macro level. From the standpoint of an individual enterprise, the situation is roughly one of survivorship bias. If we base decisions only on those who survived thanks to subsidies, the instrument seems to work. But if we look at those who cannot obtain subsidies and failed to grow because of the non-market advantage enjoyed by those who did, we get a picture in which lending as a whole does not grow. This is hard to accept, but it is so. An entrepreneur without subsidies will not take a loan, because his competitors operate with subsidies, and our subsidies run out around March-April. This limits the appetite for borrowing. Many ask for cheap loans, but these can be achieved only through lower inflation, lower risk and greater competition. Inflation is not falling because of government spending, risk is not falling because of the lack of significant progress in our institutional environment, and banks' margins are not falling because of the lack of competition. It is all in the hands of the state, but it requires major changes in each of these areas.

Excessive government spending and rapid growth in social spending. Government spending that grows out of proportion to the economy leads to large imbalances, and the issue is not only that our budget deficit has widened, but also that consumer lending is growing. Let me explain why. In 2020-2024, government spending grew mainly because of rising public-sector wages, pensions, social benefits and so on. On the one hand, such growth raises the well-being of many citizens; on the other, these people's creditworthiness increases, so that with a 25% wage rise a given person becomes able to obtain a loan two or three times larger than his previous limit. Public-sector employees are the best clients for banks, because they have stable salaries, and hence we see growth in consumer lending, where margins are very high. On average, if the corporate sector borrows at 20%, consumer loans are issued at 30-40%. A consumer lending boom fuels inflation, because demand rises without a rise in supply. And inflation eats into people's real incomes, so all efforts to raise wages have only a very short-lived effect. Consumer lending also drives up imports and puts pressure on the exchange rate. Government spending must be cut, and its growth should not exceed inflation in the country. So to lower inflation and the base rate, growth in government spending must be restrained.

Tax benefits for SMEs in the form of special tax regimes. On the one hand, tax benefits are meant to stimulate SME development; on the other, they strongly encourage medium-sized companies to split up and stay opaque. This prevents them from growing, because they become poorly managed, non-systemic and non-transparent. As a result, it is very hard for banks to analyze groups of small companies, consolidate them and produce a reliable analysis. Their creditworthiness therefore falls sharply, and instead of medium-sized companies growing overall, we see growth in uncreditworthy small business. It seems to me that benefits should go, for example, to those who have an audit report, have a Board of Directors and are not structured as a group of companies. This would encourage a system of corporate governance, which would also have a positive effect on the corporate lending sector as a whole.

Gaps in the regulation of the banking sector

The banking sector has been through a harsh clean-up over the past 8 years and is now in good condition. But, as the saying goes, "once burned by milk, you blow on water", and there are areas where regulation should ideally be eased.

Foreign-currency lending. At one time most banks did not monitor the currency risk of their borrowers, and as a result many banks suffered huge losses. Foreign-currency lending to individuals was consistently banned, and foreign-currency lending to legal entities was restricted. Given that foreign-currency funding is quite cheap for us, it is more advantageous to borrow in foreign currency even after allowing for currency risks, but unfortunately second-tier banks cannot lend in foreign currency in full measure. We have long had a floating exchange rate and no one-off devaluations are expected, which means currency risk can be managed. Restrictions should be eased gradually. At present, foreign-currency loans are risk-weighted at 200% if the borrower has no foreign-currency revenue. This could now be cut to 150%, and foreign-currency revenue should be defined not only as net foreign-currency receipts but also as revenue that correlates with foreign-currency prices. For example, if a company sells imported goods, its prices correlate fully with the foreign-currency price, and if the tenge depreciates, traders automatically adjust prices. Likewise, if a company provides services to subsoil users, service companies usually price their services in dollars and take international service companies as their price benchmark. Capital relief can already be given to these categories of borrowers.

Forced restructurings and bucket requirements. Investment projects in Kazakhstan are always exposed to risk and do not always go the way the borrower and the bank want. Here there are excessive demands both from the ARDFM and from the risk officers of second-tier banks. As a rule, risk officers like to cut the amount of financing and the loan repayment terms in order to keep the borrower tied to the bank. Borrowers have no bargaining power against the bank and agree to any proposal from risk officers, so they end up with a loan that is insufficient and a term that is unmanageable. But it is easier for the borrower to renegotiate later than to spend time negotiating now, because time is very valuable in projects. In effect, at the moment of making the decision the risk officer does not think about provisions, and later, when a project-finance borrower asks for a grace period, the loan immediately lands in the third bucket and provisions are required. It seems to me that banks should be encouraged to give reasonable terms on investment projects. This requires standardization of decision-making at the regulator level.

Collateral policies. For the last five years or so, second-tier banks have only faced tighter rules on enforcing and handling collateral and on dealing with problem borrowers. Perhaps some tightening is justified with respect to individuals, but with respect to problem borrowers who are businessmen it is a disincentive. Long ago, after the BTA crisis, banks were prohibited from holding equity stakes in companies, then the intake of property onto balance sheets was restricted, then holding land for more than three years was prohibited, then the discount on disposal was limited, then selling to collectors was prohibited, and so on. By favoring problem borrowers, the state completely discourages business lending, because second-tier banks always start from risks. And, taken together with the high returns I described above, second-tier banks have no reason at all to lend to big business. All this has meant that collateral in Kazakhstan no longer plays any significant role in recovery and is not a guarantee of loan repayment. For example, if a second-tier bank takes a plant as collateral and the borrower becomes a problem, then by the time the bank takes the plant onto its balance sheet it has turned into a heap of scrap metal and a plot of land with a residual value many times lower than the collateral value. So it is important to let second-tier banks install their own management and take possession of collateral as quickly as possible, in order to preserve the value of the plant and sell it at an adequate price, sufficient to cover the credit risks. For this it is very important that second-tier banks have the right to hold equity stakes in companies, especially in large projects. Holding a stake in a company also allows banks to earn not only on interest but on the appreciation of the company's value, as is done in the civilized world. Having a second-tier bank as a partner in large companies also has a very positive effect on a project's corporate governance and greatly reduces risks, since the bank has access to the project's current state. It is also very important to completely revise subsoil use policy so that banks can quickly enforce against subsoil use contracts and then sell them. Today all this depends entirely on the authorized ministries. And subsoil use is our main driver of economic growth.

Revising the requirements for micro-business lending. In many second-tier banks the statistics on lending to individuals are distorted, because almost half of all collateralized consumer loans are taken for business rather than consumer purposes, since a consumer loan is much easier to obtain. It takes only one document and collateral, whereas for business purposes a ton of documents must be provided. So we need to analyze the current portfolio of collateralized loans to individuals and completely simplify business lending for this segment. I think the limit should be in the region of KZT 150-200 million.

Requirements for opening new banks. In response to the problems we had in the banking sector, over 20 years requirements for banks have been tightened considerably, and there is now a very high barrier to entry into the banking industry. On the one hand this provides stability, but on the other, competition is falling rapidly and today we have practically none. The number of banks that actually work, that is, that do not merely serve as representative offices or provide settlement and cash services for big business, is no more than 10-12. To reduce second-tier banks' margins, competition between them needs to increase, and accordingly so does their number on the market. For this, besides the environment, comfortable requirements for opening banks must be created. I think we should start with a reform of niche banks and neobanks, for which capital requirements could be eased considerably, while strengthening control of liabilities (deposits taken) through insurance, concentration of interest rates and so on. By obtaining limited banking licenses, these financial organizations will over time move into the sector of ordinary banks.

Institutional environment and other initiatives

The institutional environment is one of the most important parts of attracting investment. Proper development of the institutional environment will lead to a great many positive outcomes, including growth in corporate lending.

Bankruptcy, rehabilitation and the rights of secured creditors. The Bankruptcy Law is supposedly being constantly improved, yet it still does not work fully. Second-tier banks do not like to push borrowers into bankruptcy, and borrowers often use the rehabilitation scheme to avoid repaying loans. The courts issue extremely contradictory decisions that show no uniformity whatsoever. There is a great deal of subjectivity, and it is very hard to call our courts impartial in their decisions. So the Bankruptcy Law needs to be completely rewritten, removing the scope for subjectivity and allowing the main creditor to obtain control even before the final decision is issued. I am not a lawyer, but it seems to me that clear deadlines should be set for when the main creditor must obtain control over the company, even if with limited powers, for example within 30 days. Secured creditors should obtain the collateral into ownership within 90 days at most. This would significantly raise the value of collateral and reduce risks in corporate lending.

Law enforcement and the judiciary. Probably the most important part of any reform should be aimed at the judicial system. It seems to me that within a couple of years most of our large disputes will be heard at the AIFC, since the AIFC court and arbitration operate under English law and all the judges there are foreigners. But the AIFC court simply cannot serve our whole economy, so order needs to be brought to our own courts. There is no uniformity in our courts, and contradictory decisions are often issued. For second-tier banks this is a matter not only of protecting themselves, but also of protecting borrowers, who are very vulnerable to their customers, to the tax authorities, to law enforcement, and to the state and the quasi-public sector. This increases risks, and second-tier banks take all of it into account when reviewing projects. For example, the leadership of an Akimat changes, and an entrepreneur has a long-term contract with that Akimat. The new Akim wants to bring in his own company and simply starts squeezing out the previous entrepreneur, creating terrible conditions for him: he does not sign acceptance certificates, delays payments and so on. And often such a borrower simply loses in court and then goes bankrupt, and the bank suffers too. I remember that, back when I was running a bank, we stood up for one borrower in a similar story and, unfortunately, lost such cases to Akimats. I even went to a couple of meetings, and I was told directly that I had no chance in court, and indeed there was no chance. The law enforcement system, represented by the AFM and the Police, also takes a very subjective approach to criminal prosecution, and bank employees are often under pressure and in fear. A total reform is needed here. For example, when a bank goes bankrupt, many mid-level staff suffer and face criminal prosecution, although everyone knows that many decisions are signed under threat of dismissal. Even decisions taken collectively can be interpreted differently, and so credit committee members play it very safe, creating a barrier to lending to large projects.

Banks need access to tax data so that they can proactively analyze companies and offer loans. Borrowers submit tax reports in any case, since it is now a mandatory requirement, so if bank clients grant permission for access, this would not violate tax secrecy and banks could speed up lending decisions.

Individual banking products need to be developed, especially real estate leasing, which could greatly reduce credit risk and review times. Separately, supply chain finance needs to be developed, which would make it possible to provide unsecured trade finance.

The list of initiatives could go on, but overall, without a comprehensive approach from all government bodies it will be extremely difficult to change corporate lending in the country, because all the elements of managing the country's economy are interconnected, and it is extremely hard to resolve the lending question simply by raising CIT rates for second-tier banks and applying administrative pressure.