Why the Banking Sector Is So Profitable

The Tax Code is under active discussion. As I wrote in my previous post, it is more constructive to analyze where we can find additional revenue. Earlier I suggested taking a closer look at the construction industry. Today I would like to return to the banking sector and explain why it is so profitable.

According to the consolidated report of the National Bank of Kazakhstan, the banking sector earned KZT 3 trillion before tax in 2024. Corporate income tax (CIT) came to KZT 451 billion, leaving total after-tax income of KZT 2.55 trillion, a record for the past 15 years.

The first thing to calculate is the effective CIT rate. Simple arithmetic gives 15%. In theory, since not all expenses are deductible, the rate for an ordinary company should be slightly above 20%. In the banking sector, however, income from securities is exempt from taxation, and as a result the effective rate was 15%. As I understand it, the exemption for government securities is due to be abolished from 2026. This distortion not only reduces the CIT paid but also weakens the incentive to lend to the real sector of the economy. In reality, the effective rate on government securities is 20% higher than the nominal one. For example, if the government securities rate is 15%, the effective rate against which lending decisions are benchmarked is 18.75%. In other words, the risk-free lending rate is 18.75%.

Now let us look at how a bank works, in simplified terms. A bank raises funds from clients through deposits and other financial instruments and places them in various assets: loans, securities, and deposits with the National Bank and other financial institutions. The base rate is a kind of floor price of money. If a risk-free asset enjoys a tax exemption, the floor rises by the amount of the tax. Whatever the bank has not placed in the market, it therefore deposits with the National Bank at the refinancing rate minus 1%. If the rate is now 15.25%, the National Bank pays interest of 14.25% on unplaced funds. For foreign-currency balances, the rate is set by international prices and is roughly equal to the Fed rate minus a certain margin. I believe the National Bank accepts dollars at about 3.5%.

Total interest income of second-tier banks for 2024 was KZT 7.41 trillion. Dividing this by average annual assets, excluding cash and fixed assets, gives an average rate of 14% per annum. Given that roughly KZT 10 trillion of the KZT 53.4 trillion is placed in foreign currency at, say, 4%, we can calculate that the effective tenge placement rate in 2024 was 16.3%.

Thus, through the base rate the National Bank sets the minimum placement price. Liabilities are a different story. One would expect them, too, to be close to the base rate minus a small margin, but in practice they are not. Let us consider the aggregate cost of funding for second-tier banks.

In 2024 second-tier banks incurred KZT 3.97 trillion in interest expenses, against average liabilities of KZT 47.4 trillion, or 8.38% per annum. Let us also calculate the foreign-currency part, which amounts to KZT 10 trillion: KZT 4 trillion of it is raised at 0% and KZT 6 trillion at 1%, which gives an effective funding rate of about 0.6%. It is then easy to calculate that the tenge portion of bank liabilities is raised at an average of 10.46%, well below the base rate, which was around 15% in 2024.

This is the main source of the banks' excess profits. Second-tier banks raise money far below the minimum rate that the National Bank pays them. This is a consequence of regulation, which has proved extremely lucrative for the banking sector.

Let us calculate how much the banks earned in 2024 thanks to regulation, and what to do about it. In fact, deposits are normally raised at rates close to the base rate, at 12–14%. In 2018, however, the National Bank banned the payment of interest on current accounts. This covers money sitting in card account balances, budget funds in current accounts, the revenue of trading companies that has not yet been moved to a deposit, and other idle funds. In 2024 the total of such funds averaged KZT 9.2 trillion, of which KZT 3.6 trillion was in foreign currency. These are funds that second-tier banks raise at 0% and place at the National Bank and Fed rates. It is not hard to calculate that last year, in tenge, the banks earned KZT 762 billion from this arbitrage (the NBK rate averaged 14.61% minus 1%, so the average placement rate was 13.61%; KZT 5.6 trillion × 13.61%), and KZT 126 billion from foreign-currency balances (KZT 3.6 trillion × 3.5%). In total, current accounts earned second-tier banks KZT 888 billion in profit, thanks to banking regulation.

But these are not the only profits secured by restrictions on banks. There are also limits on interest rates on foreign-currency deposits. At one time, restrictions of 1% per annum on foreign-currency deposits were introduced for the sake of dedollarization. They did not create significant arbitrage until the Fed raised rates. Now that the Fed rate has risen considerably, second-tier banks have a risk-free arbitrage of at least 2.5%. Total foreign-currency deposits in 2024 were KZT 6.4 trillion, which brought an additional margin of 2.5%, or KZT 160 billion in profit.

In total, the profit of banks secured by regulatory restrictions in 2024 came to KZT 1.048 trillion. This is profit that budget organizations, households and legal entities did not receive. Among legal entities, the main holders of tenge current balances at second-tier banks are budget organizations, with KZT 3.3 trillion, or KZT 449 billion that the budget failed to receive.

So when the state plans to raise CIT by 5% without eliminating the regulatory arbitrage, it will not be a major blow to second-tier banks. If, however, all the arbitrage is removed, the budget and households could receive an additional KZT 1 trillion in profit, and the profitability of the banking sector would no longer look so high. If we add up what second-tier banks have earned from regulatory arbitrage since 2018, the figure comes to several trillion tenge, far more than the support the state has given the banks over the past 10 years.

Abolishing the regulatory arbitrage would also encourage banks to lend to the economy. Shareholders accustomed to current earnings will not want to lose profit, which means they will have to take on additional credit risk and expand lending to maintain current returns. The banking sector may claim that it will have to raise lending rates, but with high competition and caps on rates under state programs, the likelihood of rates rising is extremely low.