The Kazakh banking system has returned to solvency. A comparison of the macro-situation of October 2008 with that two years later shows that the national inflation rate has fallen from 18.2 percent to 6.7 percent, banks’ liquidity as a percentage of all their assets has risen from 14.1 percent to 22.6 percent, the volume of banks’ assets placed in the National Bank has risen from US$ 9.1 to US$ 10.5 billion, and the gross external debt of the national banking system has decreased from US$ 41.6 billion to US$ 17 billion. Although the national economy grew by only 0.3 percent in 2009, most Eurasian countries experienced GDP contractions that year.
BACKGROUND: According to Kazakh government assessments, tightening conditions in international financial markets beginning around August 2007 made it more difficult for local banks to raise external financing. The resulting bank liquidity deficit negatively affected Kazakhstan’s construction sector and real estate market, which had been fueled by generous loans. In October 2008, the Lehman Brothers bankruptcy engendered a second phase of the crisis, as Kazakhstan’s banks suffered like others from turmoil on the world’s major stock and financial markets and the resulting surge in the risk premiums. Kazakhstan’s economic growth declined considerably due to the substantial drop in capital inflows and the sharp fall in world commodity prices. The lending activity of Kazak banks fell precipitously since Kazakh businesses stopped asking for credit.
The bank restructuring process began in earnest in October 2008, when the government promulgated its financial stabilization law aimed at strengthening its capacity to manage the crises. From November 2008 through February 2009, the government developed and implemented its anti-crisis plan for the banking sector. In February 2009, the Sovereign Wealth Fund Samruk-Kazyna injected capital into troubled banks in return for additional shares. The government also implemented further rescue measures. These steps included replacing the senior management of many banks and appointing independent advisors to develop and implement banking sector restructuring plans. Over time, assets were recovered and distributed while debts were restructured. In July 2009, the government adopted a new restructuring law to provide an adequate legislative framework for bank restructurings.
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. Unfortunately, several banks experienced severe external over-indebtedness and lacked adequate domestic private funding sources. Various Kazakh banks also suffered from other problems, including the lack of liquidity in the domestic financial markets, worsening asset quality, illegal practices such as money laundering, inadequate collateral, fictitious capitalization, non-transparent sources of capital, affiliated and connected lending, non-opaque decision making, and a general lack of economic and professional foresight.
In considering their response, the Kazakh authorities assessed but rejected two possible extreme options, both of which were supported by certain officials. On the one hand, if the government had simply declared bankruptcy, as Russia did in 1998, they anticipated that this decision would have resulted in a complete loss of confidence in the entire national banking system. This collapse would in turn have led to a large-scale bank-run by their depositors, which would have been replicated by the flight of foreign investors and enduring speculative pressure on the national currency. On the other hand, if Kazakhstan had chosen the bail-out option, the country would have faced an enormous moral hazard problem. The bailouts would have encouraged further reckless behavior since bankers would plausibly expect the government to again step in and cover any major losses. A bailout would also have imposed a significant burden on state finances and possibly led the banks to become addicted to government support. Finally, it could have reduced the international competitiveness of Kazakh banks since they would not have undergone effective restructuring.
In the end, the authorities restructured US$16 billion of bank debt. Approximately US$11 billion were written off; some loans were converted into equity, with the common shares distributed among claimants; while other claims were cancelled in exchange for cash and new bank notes. Furthermore, the maximum maturity of some financial debt was extended, in some cases more than twice its original date. Negotiations occurred between creditor steering committees and the banks. These negotiations were difficult in that the major creditors often appealed to their economic and political contacts, which included national ministers of important European countries. Despite occasional contentious moments, more than 90 percent of the creditors eventually approved the outcome. The recovery rate has averaged almost 50 cents for each dollar loaned by the restructured Kazakh banks.
IMPLICATIONS: Kazakh officials attribute their country’s successful financial restructuring to a novel asset recovery technique that they believe could be applied to other Eurasian countries in economic distress. This unique “burden-sharing” approach brought together the National Trust Fund Samruk-Kazyna and other partners to collectively address the problem with a representative Creditors Steering Committee for each troubled bank. The members for each of the restructured banks included official sector creditors, Eurobonds holders, commercial banks, and private trade finance creditors. The banks and the committees then undertook due diligence assessments of each bank’s loan portfolio.
This review and negotiations focused on addressing four key issues: how to secure additional funds to sustain bank operations; how to preserve Kazakhstan’s strong fiscal profile; how to limit the risk of moral hazard and discourage future irresponsible behavior; and how to improve the bank’s management and governance. The banks, the steering committees and Samruk-Kazyna signed a memorandum of understanding on the terms of each financial institution’s restructuring plan. All the creditors would then vote on the proposed restructuring and recapitalization blueprint. If they approved it, the plan was then submitted to Kazakh national bank regulators for further scrutiny and possible approval.
The restructured banks have strongly committed to implement aggressive recovery strategies to retrieve the maximum value from their old loans, including suing the former bank owners in British courts. The committees hired independent accounting firms to confirm that fraud had occurred, as well as legal and financial advisers for each of the banks. In addition to cash and new debt instruments, the restructuring packages offered equity and recovery units to the different categories of creditors.
The Samruk-Kazyna National Welfare Fund, created in October 2008 as a state-owned joint stock holding group to implement a coordinated strategy among strategic national industries representing almost half of Kazakhstan’s GDP, played an essential role in stabilizing the national financial system. The Fund increased its majority shareholding positions in some banks, especially the most troubled ones, by exchanging debt for shares. Although all the creditors incurred initial financial losses by writing off bad loans, Samruk-Kazyna allowed each bank and their creditors to split any assets they recovered 50-50 by waiving its own recovery claims. And the fund urged banks to implement good corporate governance practices according to the highest international standards.
In addition, the National Bank of Kazakhstan (NBK) took other measures to further the banking system’s recovery. The National Bank reduced its policy interest rate and reserve requirements to record low levels; provided refinancing loans to banks to ensure short-term liquidity; and expanded the list of instruments it accepted as collateral. The reappointment of Grigory Marchenko, a well-respected economic reformer, as NBK chairman in January 2009 helped restore international confidence in Kazakhstan’s battered financial sector. As NBK head from 1999-2004, Marchenko managed to limit the fallout from Russia’s 1998 default on Kazakhstan by introducing key financial reforms aimed at promoting transparency and good governance.
CONCLUSIONS: The Kazakh authorities believe their burden-sharing approach to bank recovery yielded considerable benefits. First, it eschewed the extremes of bailing out troubled banks or allowing them to go bankrupt. Second, the approach enabled Kazakh bankers and regulators to show foreign partners that they had nothing to hide. Third, the steering committees helped improve corporate governance by drafting the most stringent corporate charters for each of their banks ever seen in Kazakhstan. To avert future banking crises, Kazak authorities are now strengthening their national banking regulations by imposing more restrictions on intra-group transactions, additional transparency obligations on large banking clients, and further requirements on the structure and management on banking conglomerates.
AUTHOR’S BIO: Richard Weitz is Senior Fellow and Director of the Center for Political-Military Analysis at Hudson Institute. He is the author, among other works, of Kazakhstan and the New International Politics of Eurasia (Central Asia-Caucasus Institute, 2008).