“The Impacts of Sub-Prime Crisis on Kazakhstani Banking Sector and the Long-Term

Consequences for Kazakhstani Financial Market”

Plan:

I. Introduction - What is Financial Crisis

a. Latest Financial Crisis in the World

b. Subprime crisis

c. Impacts on Kazakhstan

II. Reasons of Crisis in Kazakhstan

a. Debts

b. Mortgages

III. Impacts on Kazakhstani Banking sector

a. Devaluation of KZT

b. Ухудшение активов

IV. Long-term consequences for Kazakhstani Financial Markets

a. Intervention of the government

b. Regulation

V. Conclusion
 I. Introduction

In the world history many financial crises took place, including banking crises, wide
economic crises, speculative bubbles and crashes, and international financial crises. Some
economists claim that any financial crisis is a regular situation that happens once in the decade.
Hardly anyone knows when this problem became a global one. But despite this fact, now in the
XXI century more and more specialists try to understand the origin of it and ways of overcoming
it. “There is no precise definition of “financial crisis,” but a common view is that disruptions in
financial markets rise to the level of a crisis when the flow of credit to households and businesses
is constrained and the real economy of goods and services is adversely affected.”1
The financial crises have three phases that will be next described. The first phase starts
with the financial liberalization, meaning simplification of the borrowing processes by general
public to increase lending. This is followed by the growth of the assets prices like real estate or
publicly traded stocks. Usually this phase continues for some time, during which prices
persistently increase, and this generate the appearance of a ‘bubble.’ During the second phase
assets’ prices collapse which leads to the bubble’s burst. The final phase is a default phase which
ends with the failures of firms and other financial institutions.
The latest financial crisis started in 2007 and we are still under its influence. It began in
the United States with the failures of large financial institutions, because of the shortfall of
liquidity in the banking system as well as collapse of a housing bubble. After a while it rapidly
evolved in a global crisis resulting in a number of European bank failures. But this crisis cannot
be defined as an unexpected one, as weakening of housing market’s position was obvious.
Among all of the problems associated with this situation the following ones can be marked out:
1
Averting Financial Crisis
loan-quality problems, interest rates reset and spillovers from weaker home prices. But of course
its scale was not anticipated. The US sub-prime crisis was the first sign of an impending
financial crisis. In order to maximize their profits US financial institutions simplified the scheme
of mortgage loan; banks did not require any collateral, down payment and verification of
solvency. But the majority of borrowers, who took mortgages, actually were unable to pay for it
– the credit default began. As an effect mortgage institutions bankrupted and problems
immediately arouse among the banks that credited mortgage companies.
“The financial crisis became clearly visible on September 15th, 2008, when the imminent
bankruptcy of Lehman Brothers was announced. Immediately after that, the large insurance
company American International Group (AIG) suffered a liquidity crisis following a downgrade
in its credit rating. Following this, many other financial institutions in the US and around the
world were affected, losing large portions of their value…”2 The impacts of the most recent
crisis in many countries could be broken down into three processes: shrinkage in financial
markets’ investments, withdrawals of capital from emerging capitals, and impact on real
economy in many countries. Also it can be noticed that this crisis had many unpleasant
consequences all over the world and Kazakhstan is not an exception.
The combination of weak economic growth, currency-induced credit exposure, and
increased uncertainty led to significant difficulties in the banking system. In this essay I would
try to define the reasons of the financial crisis in Kazakhstan, more particularly, high level of
dependence of Kazakhstani financial system from external borrowings and national ‘mortgage
bubble’. Then the attention will be focused on the impacts of the crisis on Kazakhstani financial
sector, which will be followed by the consequences of this problem.

II. Reasons of Crisis in Kazakhstan

a. External Borrowings and Debts

Over last ten years the Kazakhstani external debt has sharply increased. But the main
reason of this problem is not the governmental borrowings. Initially, in 1990s only government
itself made borrowings from the international financial organizations. However, situation
changed after the formation of a modern banking system and the improvement of the overall
ratings of financial institutions. Since that time the amount of international investments as well
as borrowings rocketed. Boosted by great petrol reserves and looking for quick ways to make a
profit, Kazakhstani banks borrowed significant amount of money from US banks involved in
hedge funds. National banks secured their creditworthiness with the foreign loans – and this
provoked problems. During 2006 alone, Kazakhstani banks obtained more than $ 18 billion in
international credits. As for April of 2010, total external debt equaled to $ 111 billion, and only
1.8 % of this amount or approximately $ 2 billion was the governmental debt. The rest amount
was the debt of a corporate sector and banking sector. Thereby, the yearly GDP growth went to
the payment of the borrowings.
In addition to bank loans, another popular borrowing method was an IPO on London
Stock Exchange. But with the beginning of the crisis share prices of many banks went down. On
the other hand, interbank lending rates in London increased, so in 2008 Kazakhstani banks could
take credits under 5-6 % per annum, compared to 1-1.3 % per annum in 2003. The same thing
took place in our market’s interbank rate credits. Average interbank lending rate increased by 1.8
%. Thus, the national financial system is closely linked to the global financial markets, strong

2
SSRN
growth in which, in recent years was associated with the massive credit and bond borrowings of
‘easy money’. Shortage of liquidity in the banking sector took place simultaneously.

b. Crisis in construction service

Underdevelopment of Kazakhstani stock market resulted in the speculative position in the

real estate market, which led to the active growth in prices. This happened because in those years
(2006-2007) there was an excess of free cash among the agents of financial sector but it was
accompanied by the lack of the sufficient investment opportunities. In fact, construction sector
played a weighty role in the development of financial market. Kazakhstani banks borrowed
heavily from abroad, amassing external debt amounting to roughly 44 percent of GDP to fund a
rapid expansion of credit, largely concentrated in construction and real estate.
From the end of 2002 the active process of allotment of mortgage loans began,
Kazakhstan experienced a rapid growth of prices on real estate. This had implications concerning
the citizens’ standard of living. The cost of housing increased for around 14 times; from $ 250
per square meter in 2002 to $ 3,600 in 2008. But it is well known that the stability of the banking
system and the situation in the real estate market are interrelated. So, the abnormal situation in
this market was observable. In 2007 the lending amount for the construction of new buildings
and reconstruction of old ones amounted to $ 6.01 billion, while the amount of mortgage loans
totaled to $ 6.06 billion. Construction companies became dependent on banks, but banks overdid
with the mortgage loans.
Speculations in the real estate market have almost brought the construction market to the
collapse. The most part of the construction projects were ‘frozen’ because of the shortage of
money. Thousands of people have been unable to obtain their recently bought apartments, whose
construction has been halted. For example, KUAT Construction Company that used to have a
good reputation was sued for the large debts and had no means to finish some of its projects. And
now KUAT does not exist at all. Because alike problematic companies had no money to finish
their constructions, Kazakhstani government had to allocate money from the reserves. In order to
forestall a total market collapse, the government has set up a $ 500 million aid program for
construction companies unable to get credit terms and has bought thousands of apartments in
Astana.
But we cannot say that Kazakhstani mortgage bubble was the consequence of the US
housing bubble. They just took place at the same time, but they are not connected to each other.
Sub-prime crisis in the US has been taken shape from the 2000 and in Kazakhstan everything
started in 2006. The similarity of both processes lies in the rise of the mortgage delinquencies
and foreclosures, and the resulting decline of securities backing mortgages.

III. Impacts on Kazakhstani Banking Sector

a. Banks’ Asset quality

Declining asset quality at commercial banks is in large part an outcome of the credit
boom. Many banks facilitated their lending requirements, and the volume of loans rapidly
increased. The more the volume of loans increased, the more difficult it was to assess the quality
of them; the flow of new standard loans offset problems with existing assets. When the run of
growth ended, banks found themselves looking at a decline in loan quality. Fitch Ratings said
Kazakhstani banking system's asset quality has fallen significantly since third quarter of 2007,
hit by seasoning of loan portfolios, slower growth, tighter corporate liquidity, and falling real
estate prices.
The Kazakhstani banking system has been strongly affected by the global financial crisis.
Reliance on external funds by the largest banks under conditions of limited refinancing
opportunities and narrow domestic markets have led to slower credit activities and declining
financial indicators for all the banks. Since the autumn of 2008 declining revenue and worsening
asset quality became the dominant trends in the Kazakhstan banking system. Profitability of the
banks also had suffered, as further large foreign currency debt repayments were due, and asset
quality was deteriorating.
Reported loan impairment ratios have risen most markedly at Alliance Bank (‘BB-’ (BB
minus)/Negative Outlook), followed by Bank Caspian (‘B+’/Stable Outlook) and
Kazkommertsbank (KKB, ‘BB+’/Negative Outlook). However, loss absorption capacity for the
system as a whole and for these banks in particular, was also significant, reflective of sound
profitability and capital ratios that were above minimum regulatory levels.3
Apart from the asset quality problem itself, the important risk for banking system was
from the action of rating agencies. These agencies were too optimistic with ratings assigned to
the Kazakhstani banks before the banking crisis level and missed the point where extremely high
dependence on foreign borrowings and weaker underwriting standards had to cause concern. The
agencies reacted only after the crisis became apparent. In June 2008, S&P pointed out that the
ratings could be lowered: “if there are no signs of a recover or at least stabilization in asset
quality, and of an improvement in their ability to absorb losses, recognize credit losses, and raise
the corresponding amount of capital.”4 But as we know the ratings finally were lowered.

b. Devaluation of KZT

Financial crisis had also the long-term impact on national currency KZT. The National
Bank of Kazakhstan acknowledged that the weakening position of the Tenge is related to the
sharp increase of capital outflows from the country. Kazakhstan’s international reserves became
increasingly vulnerable due to the currency devaluations conducted by neighboring countries —
with Russia and Ukraine leading the way — as well as low world prices for Kazakhstan’s
commodity exports. The resulting need for Kazakhstan to devalue its own currency obliged the
Kazakh government to provide public financial support to the domestic banks with high external
debt. The devaluation came only days after the Kazakh government vastly expanded its role in
the financial sector by nationalizing two of the four largest banks and taking 25% stakes in two
other lenders.
On 4 February the National Bank of Kazakhstan announced that it would no longer
support the Tenge exchange rate in the KZT117-123/$1 corridor and that it is moving to a new
corridor of KZT145-155 per dollar. The overnight 25% devaluation of the Tenge surprised the
citizens of the country. The decision to devalue the Tenge was necessary to preserve foreign
currency reserves and address the current account deficit. News of the devaluation drove
Kazakhstan's five-year CDS spreads higher by a further 65 basis points to 1,083 basis points,
according to RBC Capital Markets.5
2009 devaluation had a direct influence on foreign obligations. “According to the
estimation of the rating agency “Moody’s” devaluation provoked a growth of assets’ riskiness by
54 % and increase of debt in fact by 25-30 %.”6 Devaluation obviously affected the banking
sectors ability to pay its external debt. However, the government has decided to de facto
nationalize the major banks to prevent default on foreign debt obligation.

IV. Consequences for Kazakhstani Financial Market

a. Intervention of the government

3
http://www.investkz.com/en/articles/1024.html
4
Renaissance_Capital_29_September_2008
5
http://www.marketwatch.com/story/kazakhstan-devalues-currency-amid-bank-crisis
6
Central Asia Business Journal
 In the three years leading up to the crisis, Kazakh banks grew at a phenomenal rate –
virtually doubling their assets and liabilities every year – before being halted in their tracks in
August 2007.The largest banks of the republic had experienced big problems along with the
crisis. But Kazakhstani government had supported major banks, but actually this support meant
the intervention of the government into the banking system.
The Kazakhstan government acquired controlling stakes in BTA Bank and Alliance
Bank, two of the country's four biggest lenders. The acquisitions had been conducted through the
Samruk-Kazyna National Welfare Fund. Samruk-Kazyna allocated KZT476 billion to various
banks and financial organizations on behalf of the government. The main recipients were the
country’s four biggest banks: BTA Bank (KZT212 billion), Kazkommmertsbank (KZT120
billion), Halyk Bank (KZT120 billion) and Alliance Bank (KZT24 billion). The transfers were
subject to the support of the construction sector and small and medium enterprises.
The government paid about $2 billion for a 78% stake in BTA Bank, while it acquired
76% of Alliance Bank for a symbolic sum of less than $1. In addition, government took 25%
stakes in Kazkommertsbank and Halyk Bank.
Government claims that this nationalization is only temporary, but specialists are in
doubts. So Tanya Costello, an analyst at Eurasia Group said that “The government may remain a
significant shareholder and key decision maker in the country's major banks for the longer term -
a change that could have negative implications for transparency and investor relations”7
The period of 2008-2010 became critical for the banking sector in terms of servicing
liabilities. Banks took substantial measures on normalizing liabilities, rethinking the funding
structure and improving the balance liquidity with a view to service their debts.
Next, I want to describe the situation based on particular examples.

i. BTA Bank

BTA bank is the second largest (pre-crisis) bank in Kazakhstan in terms of assets.
Consolidated bank assets according to IFRS as of October 2007 were $ 24 billion, equity - $ 3.6
billion, net profit in 2007 - $ 492 million. However, according to the FSA in May 2009 bank’s
total assets totaled to $ 22.2 billion, while shareholders’ equity $ - 6.5 billion.

On June 30, 2009 total external debt of BTA equaled to $ 12.15 billion, and internal
amounted to $ 2.38 billion. Total amounts of bonds issued were $ 6.21 billion, with $ 5.19
billion accounted for Eurobonds and $ 1.02 billion in domestic bonds. Trade finance debts were
$ 3.56 billion. According to FSA in January-September period bank’s assets totaled to $ 17.75
billion and the equity deficit - $ 11.66 billion. Net loss for that period equaled to $ 17.5 billion.

As stated above, in February bank was nationalized. In April BTA stopped repayments of
its liabilities, and it was followed by the downgrading, by Standard and Poor’s agency of the
ratings from ‘CC/C’ to ‘D’ – default. In June Samruk-Kazyna offered schemes for restructuring
of the debts.

ii. Alliance Bank

Alliance bank – the sixth largest in Kazakhstan. In 2006 this bank became the leaser in
terms of lending to the public. The size of loan portfolio in September, 2006 amounted to $ 1.7
billion; almost 30% of credits in Kazakhstan to the general public was made by Alliance bank.
However, this bank was also nationalized. In June, 2009 S&P downgraded bank’s long-term and
short-term credit ratings to a level of ‘D/D’ – default.
The total losses of Alliance bank increased from $ 371.6 million to $ 4.95 billion, that is
13.35 times decrease; bank’s assets decreased from $ 9.08 billion to $ 5.4 billion. The bank had
7
http://www.marketwatch.com/story/kazakhstan-takes-over-two-major-banks-amid-credit-
crunch
negative equity amounted to $ 3.65 billion; 43.95 % of loan portfolio was declared as non-
performing.
Surprisingly, Alliance bank is the first Kazakhstani bank that had successfully completed
the restructuring of its debts. In June, 2010 S&P raised its long-term credit ratings to ‘BB’, short-
term credit rating to ‘C’ According to national scale bank has ‘kzBB-’ rating.

b. Regulations

In November of 2008 the Kazakhstani government had approved “The New Plan for
Further Modernization of the Economy and Realization of the Strategy for Employment to
Ensure the Post-Crisis Development of the Country.” The government has tightened the control
over financial system. According to Ms. Yelena Bakhmutova, the head of the AFS: “The
president set goals to cut off banks from explicit or implicit affiliates and to make sure that banks
are engaged exclusively in ‘banking’ activities, and that their activities are maximally
transparent.”8
New laws suggest introducing of restrictions on shareholders’ direct or indirect
ownership of shares of the banks. Intervention of banks in operating activities of its subsidiaries
and affiliates will be limited by reducing the number of their representatives on the board of
directors of these organizations to one-third. The ownership of affiliates will only be possible if
the bank will be able to meet additional conditions of capital sufficiency. By this authorities try
to discourage banks from creation and ownership of subsidiaries and affiliates. Also AFS
suggests imposing of restrictions on the issuance of the loans by banks to individuals who have
non-transparent ownership structure and who have unstable financial situations. As concerning
the foreign borrowings, it is being considered that the financing leverage and foreign liabilities
should be limited to no more than 30% of the total obligations. Besides, banks would need to
support optimum ratio of loans to deposits at a level of no more than 1.5.9
In essence, this is innovation in the sphere of financial system and banking system. The
requirements becoming stricter, more strident, and more difficult to meet, but banks understand
that this is necessary.10 Similar complications take place in the process of borrowing money; in
addition the banks launched their own programs on working with troubled borrowers. It can be
stated, that as for financial banks, as for the general public, the time of easy money had finished.
It is also important to note that recently some experts have argued that the banking sector
may become overregulated in the future; and these arguments are not groundless. At present, the
state authorities are committed to changing the system of economic functioning and propose
various alterations to the national legislation.

V. Conclusion

During the growth period, in pre-crisis times, the banks relied upon refinancing and
financed their long-term projects by short-term liabilities. At the same time, banks did not pay
attention to the internal problems related to the quality of their loan portfolios, the factor that
become the crucial for stable operations in case of deterioration of the situation with liquidity in
the financial sector.
However, he period of stabilization is slowly coming to the Kazakhstani market. With
help of the government and restructuring of the debts national banks are trying to get rid of their
liabilities. The lending situation is also improving, even if we cannot say that public actively
taking new credits.

8
http://slon.ru/news/457246/
9
http://worldfinancereview.com/may2010/kazakhstanbankingsector.html
10
http://slon.ru/news/457246/
 The total cost of the anti-crisis measures taken by Kazakhstan in 2007-2009 amounted to
around $20 billion or 14% of GDP. Allocation of such substantial funds became possible through
the National Fund of the Republic of Kazakhstan.
The steps taken by the monetary authorities to reduce the average interest rates on
deposits, along with the anti-inflationary policy, have produced a proper effect, though the level
of effective rates of interest is considerably higher due to the existing risks in the system. On the
condition that the current trends and the implemented monetary policy remain the same, the level
of the deposit interest rates will go down; and, to a large extent, this will be determined by the
administrative measures, including the measures concerning the structure of deposit guarantees
and insurance, as well as the reserve requirements.
Finally, increased government influence because of its participation in problematic banks
can have mixed effects on the financial system. On the one hand, an increase in government
control over systemic banks can negatively affect competition; while on the other, the
government could have a positive stabilizing effect on the banking system as a whole.

http://www.marketwatch.com/story/kazakhstan-takes-over-two-major-banks-amid-credit-crunch
http://www.marketwatch.com/story/kazakhstan-devalues-currency-amid-bank-crisis
http://www.nashaagasha.org/actual/sovokupnyj-vneshnij-dolg-kazaxstana-v-dannoe-vremya-
sostavlyaet-111-mlrd-marchenko/
http://thenews.kz/2010/11/12/607379.html
http://slon.ru/news/457246/
http://www.resurs.kz/news/detail/880
http://ru.wikipedia.org/wiki/%D0%90%D0%BB%D1%8C%D1%8F%D0%BD%D1%81_
%D0%91%D0%B0%D0%BD%D0%BA
http://www.asiacentral.es/docs/Kazakhstan_Gen_Feb09.pdf
http://www.worldfinancereview.com/january2010/newbankrestructuringlawinkazakhstan.html
http://www.worldfinancereview.com/january2010/kazakhstanbankingsector.html
http://www.cacianalyst.org/?q=node/5433
http://www.worldfinancereview.com/september2009/kazakhstanbankingsystem.html
http://www.investkz.com/en/articles/1024.html
http://www.globalrating.org/kz-market-overview.php
http://www.cacianalyst.org/?q=node/4979
http://www.kisi.kz/img/docs/4592.pdf
http://kazcham.com/?p=151
http://worldfinancereview.com/may2010/kazakhstanbankingsector.html