Breaking Down the Draft Banking Law

The draft law on Banks and Banking Activity, which the entire market has been waiting for, has been published. It is a very important document that should transform the current banking sector and expand lending opportunities in order to stimulate the country's economy. There are a great many innovations, and it is hard to describe them all in a single article. On the whole, the proposed changes are well thought out, and many of the provisions can be called quite progressive by our standards. If all of the innovations are implemented, it will be a huge step forward for the development of the banking sector.

However, I believe that a full-fledged discussion requires a more detailed look at the main proposals, along with critical analysis and suggestions. I will try to offer my recommendations over several publications.

I will begin with the most significant innovation: the basic and universal licenses, which are meant to make market entry considerably easier for small players.

The main difference between the basic and universal licenses lies in the capital requirement and the restrictions on activities. The basic license requires capital of KZT 10 billion, caps total assets at KZT 500 billion, and limits individual deposits to KZT 10 million.

Banks with basic licenses will not be allowed to issue guarantees, provide brokerage and dealer services, or offer leasing and factoring.

Let us start with the main purpose that banks with basic licenses are meant to serve. According to the ARDFM's plan, 12 microfinance organizations (MFOs) will be able to transform into banks with a basic license under a simplified procedure. As we know, MFOs in Kazakhstan operate mainly in consumer lending, as well as in high-interest, high-risk lending to SMEs. Becoming a bank would allow MFOs to lower the cost of the funding they attract and to offer their clients basic payment and transfer services.

It is not yet entirely clear what the capital adequacy requirements will be. But even if we assume that a normal Tier 1 ratio will be 10%, then with capital of KZT 10 billion the loan portfolio will range from KZT 50 billion to KZT 150 billion, depending on the bank's business model, and at the upper capital threshold of KZT 20 billion, from KZT 150 billion to KZT 300 billion. Overall, a KZT 500 billion asset ceiling looks acceptable.

Here, however, I believe the KZT 10 million limit on deposits from individuals may become a barrier to serious competition in the market. First, KZT 10 million was set as the insured amount quite a long time ago, and cumulative inflation since then has been at least 50%. Second, it seems more logical to peg the limit to the monthly calculation index (MCI), so that the amount does not have to be revised every year and is adjusted automatically as the MCI rises. Third, it is not entirely clear whether the limit applies to current accounts, and what should be done if, for example, a transfer of more than KZT 10 million arrives in an account, or if accrued deposit interest pushes the balance above KZT 10 million. For example, banks planning to engage in mortgage or auto lending will find it difficult to sell assets worth more than KZT 10 million. It is also unclear whether the limit applies to sole proprietors, who are technically individuals as well and make up the core of the SME pool.

The restrictions on types of activity are also rather controversial. In general, a basic license should cover those operations that carry lower risks. Brokerage and dealer activity, leasing, factoring and bank guarantees are precisely among the lowest-risk activities for banks. On the contrary, such activities should not be restricted: the main goal, as I see it, should be to develop lending to the real sector of the economy, whereas the current basic license model implies mostly small-ticket consumer lending, which does little good beyond fueling inflation.

The result is a rather paradoxical situation in the proposed version of the law: banks will be motivated to raise funding from legal entities and then issue consumer loans. The model works, of course, but it greatly limits variety and demands a focus on a diverse range of clients.

But I believe the main goal of basic licenses should be the development of lending to the real sector of the economy, especially to SMEs.

I therefore believe that, in order to develop real-sector lending, the following steps are necessary:

The limit on deposits from individuals should be raised to KZT 100 million and pegged to the MCI, while banks should be allowed to accept any amount, provided that such amounts are held for no more than 30 days. This would cover a large number of sole proprietors and allow banks to offer them a full range of services.

The restrictions on banks with basic licenses regarding work in the stock market, leasing, factoring and bank guarantees should be removed. Instead, it would be better to require approval of products, scoring models and the loan issuance process. Standardized products with clear risk parameters are less risky than individually structured loans. For example, the amount of a single loan could be capped at KZT 200 million. This would make it possible to extend more loans to SMEs and expand lending to the economy.

It is important to give banks with a basic license the right to a simplified procedure for obtaining a universal license. Banks that reach assets of KZT 500 billion will most likely have capital of more than KZT 20 billion and will formally already meet the requirements for a universal license.