Three Ideas for the Financial Market: SME Scoring, Subsoil Use, Debt Recovery

On Thursday, the Agency for Regulation and Development of the Financial Market (ARDFM) held a roundtable on the development of the financial market. There were a great many interesting presentations. Speakers were given 8 minutes, so I could not set out all of my thoughts, but I did manage to raise some of the practical problems.

I will try to describe the main points here. There were three ideas that could improve our financial market and make it more attractive. I did not talk about trends in development, fintech, digitalization, ecosystems and so on, since these depend largely on the banks themselves rather than on the regulator.

1. The problem of SME development. In recent years Kazakhstan has seen a boom in unsecured consumer lending, and 43% of all loans are now unsecured. Unsecured consumer lending has grown because there is enough information to assess credit risk and build scoring models (the State Pension Payment Center, the First Credit Bureau, the Ministry of Justice and so on). These models predict the cost of risk quite well and make it possible to build sound lending models. Microbusinesses and small businesses are similarly numerous, so, given good information for assessing solvency, scoring models could be introduced for small business lending. This requires access to tax payment data, the customs database and so on. All of this would help develop fast loans with low administrative costs and a sound assessment of credit risk. Loan processing times would become shorter and loan quality would improve.

2. Subsoil use and the utilization of foreign currency liquidity. Kazakhstan currently has restrictions on placing foreign currency abroad in the form of the domestic asset ratio (DAR), a higher risk weighting on foreign currency loans to companies without export revenue, and a ban on foreign currency lending to individuals.

These measures were adopted to reduce currency risks. As a result, banks can invest foreign currency assets only in loans to companies with export revenue.

If we look at the structure of exports, we see that 70% of exports are products of subsoil use. Yet if we look at direct investment in this sector, we see that it comes mainly from foreign investors, at fairly high interest costs for our subsoil users. Smaller subsoil users, meanwhile, have difficulty obtaining external financing. Every dollar of interest paid on an external loan is a minus for our current account. At the same time, more than 45% of all deposits in Kazakhstan are denominated in foreign currency. The main problems in subsoil use are the proper valuation of subsoil use rights and the difficulty of foreclosing on them.

First, a bank cannot take subsoil use rights onto its balance sheet through foreclosure; it can only sell them at court auctions, which makes the process practically unworkable.

Second, during foreclosure the subsoil user does not fulfill its license and contract terms, and the state has the right to terminate the contract.

Third, registering a pledge with the relevant ministries takes a very long time, which prevents banks from financing subsoil users promptly.

Therefore, banks should be allowed to take subsoil use rights onto their balance sheets through foreclosure. It should also be possible to suspend a contract and have it extended automatically for the duration of the suspension, covering the period of foreclosure and of the rights being held on the bank's balance sheet.

In addition, the registration of pledges over subsoil use rights should be transferred to public service centers (TsONs) in order to shorten registration times.

This would help develop the market for subsoil use rights and build up statistics on their sale. That, in turn, would make it possible to raise the coefficient applied as a discount to the market value of subsoil use rights and to increase domestic investment in subsoil use, which would allow banks to utilize foreign currency liquidity. And that would benefit the country's economy.

3. Debt recovery. This is the third problem I tried to raise. One of the reasons banks turned to unsecured lending is that it spares them the work of recovery: all the risks are simply built into the interest rate. Hence the rather high interest rates on consumer loans. Where you see installment plans, the interest rate is, as a rule, baked into the price of the goods, which, incidentally, adds to inflationary pressure. In general, consumer lending in Kazakhstan so far has been more of an inflationary force, through imports and interest embedded in the price of goods. But that is a separate topic.

Secured lending carries less risk, which is reflected in lower interest rates, provided that the recovery infrastructure works; in other words, when it is easy for banks to recover property. Unfortunately, there are currently a great many problems in this area, and we see that even the initiatives that have been introduced essentially do not work. Notarial enforcement inscriptions, private arbitration, out-of-court sales, the law on bankruptcy of legal entities: all of these are tied to the recovery problems. Collateral recovery can take years, while the collateral itself loses value. That is why quick recovery of collateral matters so much in secured lending. It would shorten the time needed to recover invested funds, reduce the share of non-performing loans on banks' balance sheets, and improve the quality of the collateral sold, thereby returning it to economic circulation faster. This would benefit the country's economy as a whole and increase banks' capitalization.

Those are roughly my thoughts.