State Aid to Second-Tier Banks

I have been planning to write about state aid to second-tier banks for a long time. The topic is much discussed, everyone sees it from their own vantage point, and everyone presents it differently in the media.

In fact, second-tier banks have received a great deal of state aid, which falls into two groups: direct and indirect. Broadly, all support to the banking sector can be divided into three categories:

Direct state aid is money the state gave to second-tier banks through the National Bank or quasi-state companies, and on which the banks booked a profit through revaluation. We will discuss this below.

Purchases of problem assets by the Problem Loans Fund (PLF). Here the profit arose because the PLF bought assets at nominal value, while their real value was substantially lower and had been reflected on the banks' balance sheets through loan loss provisions. Releasing those provisions gave the banks additional profit and increased their capital. For example, suppose a problem asset cost a bank KZT 1 billion, while its market value was KZT 200 million. The bank created a provision of KZT 800 million, or should have created one and did not, arguing to its auditors that the asset was worth KZT 1 billion. The state bought such an asset for KZT 1 billion, and the bank recognized a profit of KZT 800 million. It is hard to estimate how much profit banks booked through such transactions, but I think it was at least 70% of nominal value.

Indirect support through various state programs, mainly for individuals. These include the program to refinance foreign-currency mortgage loans, the refinancing of loans to socially vulnerable groups, the write-off of consumer loans of up to KZT 300 thousand, and so on. In these cases, banks' loan portfolios improved at the state's expense: problem borrowers reduced their debt through refinancing or write-offs, and banks reduced their problem loans, which allowed them to release provisions or avoid creating additional ones.

If one were to put a figure on all the state aid programs, the total would of course be enormous. So let's eat the elephant piece by piece. Today I will talk about the direct aid program, how state aid is actually calculated, and why, in my view, early repayment is the norm today.

Officially, six banks took part in the program through the Kazakhstan Sustainability Fund, for a total of almost KZT 700 billion (RBK Bank KZT 240 billion, Eurasian Bank KZT 150 billion, ATF and Tsesnabank KZT 100 billion each, BCC KZT 60 billion and Nurbank KZT 47 billion). We can also add the aid to Kazkommertsbank before its sale to Halyk Bank: through state securities worth KZT 1 trillion and a deposit from the PLF of KZT 250 billion, the bank received a total of KZT 1.25 trillion in cheap funding. This is in addition to the fact that, before the deal, the PLF was to buy problem assets from KKB and Tsesnabank, but I will write about that another time. Tsesnabank also received cheap deposits from the quasi-state sector. RBK Bank, for its part, exchanged its liabilities for its own bonds through DSFK, and on these bonds our quasi-state sector took losses through revaluation. Put simply, the essence is much the same as with the Sustainability Fund, except that here the lenders were quasi-state companies, which lent RBK, through DSFK, about KZT 335 billion at a low rate for 15 years.

In nominal terms the amounts look quite large, but in practice state aid is measured only by the profit that the banks receive from this cheap funding. Let's assume that total funding through revaluation came to KZT 1 trillion.

In 2017, when all this took place, the base rate was around 11%, and the banks revalued the entire amount of state aid received at about 14% per annum. This gave each bank a profit of about 60% of the nominal value of the aid received. In other words, on every KZT 1 trillion the banks received a one-off profit of KZT 600 billion through revaluation, which increased their capital.

The revaluation is calculated as follows. The state aid was issued at 4% per annum for 15 years. Had the banks borrowed at a market rate, it would have been 14% per annum, so the 10% difference is the bank's potential profit. IFRS allows this 10% to be calculated at once for all 15 years and booked as profit, though that profit must still be discounted by year for the time value of money. The loan on the books is then reduced by the amount of the revaluation, and the interest is accounted for at the market rate of 14% per annum. In other words, the balance sheet now shows KZT 600 billion in profit and a KZT 400 billion loan at 14% per annum. But then something interesting happens. In 2022 the base rate rose to 16%, and second-tier bank funding through bonds of this type would have been around 18% per annum. The bank gains an additional 4% in profit every year. Over 3 years, on a KZT 400 billion loan, that comes to an additional KZT 48 billion. For the remaining term, if rates do not fall, over 10 years it is another KZT 160 billion in nominal terms. After discounting, the amount will be somewhat smaller.

So the banks have received, and continue to receive, additional profit from state aid because the base rate has risen, and the larger the state aid, the higher the profit.

But, as I have written before, this is nothing compared to the profit banks earn from current accounts and foreign-currency deposits, on which the regulator has capped rates. Banks hold about KZT 7 trillion at zero percent, and since 2019 they have already earned about KZT 3.5 trillion on this, far more than from any state aid. They will keep earning, because the regulator has neither the desire nor the inclination to remove these imbalances. I have written about this many times.