Kazakhstan's financial system is currently undergoing a trying period coping with lack of liquidity caused by the subprime crisis in the United States. The banking system is the most developed among the CIS states, possibly even counting Russia, but massive lending sprees in international financial markets and overexposure to the (suddenly hurting) real estate sector seem to be stretching its limits.
The first sign that international investors grew wary of Kazakhstan's success story was the public offering of the GDR's of Kazakhstan third largest bank, Alliance Bank, on the London Stock Exchange. The bank tried to capitalize on global appetite for Kazakhstan's IPO’s that enabled two other large Kazakh banks to raise record amounts of money on the LSE and made Timur Kulibaev officially a billionaire. However, by the time Alliance presented its shares for sale, it was clear that investors were going to pay closer attention to what was offered. The subprime crisis was still contained to the United States, and it seemed likely that the only victims would be a few overleveraged hedge funds whose bets went wrong. But investors suddenly became wary of inherent risks not only in exotic derivative products but also in exotic emerging markets like Kazakhstan.
At the first look, Alliance Bank was a success story and a poster child of Kazakhstan’s emerging banking sector. Within less than three years it grew from being the tenth largest retail lender in Kazakhstan to being the leader in June 2007. The bank was a trailblazer in marketing strategies (some rather controversial) to attract retail and SME clients and was the fastest growing banking institution in Kazakhstan. However, the risk factors that this fast growth brought are representative of Kazakhstan’s banking sector as a whole.
The overexposure to the retail and construction sectors (in the case of Alliance retail lending represented 45 percent of its loan portfolio) has made the banks vulnerable to macroeconomic shocks. This systemic risk has not been a factor yet as Kazakhstan’s overall economy remains relatively stable and healthy. Another important risk factor, however, exposed Alliance, and other Kazakh banks, to the current crisis - its dependence on foreign credit. More than fifty percent of Kazakh banks’ borrowing is conducted abroad, and only 2006 they managed to obtain a combined $18 billion from international creditors. As long as credit was cheap, this influx of foreign money helped fuel the rapid growth of Kazakh banking sector and significantly contributed to the real estate booms in Almaty and Astana. The downside, however, was the ever increasing dependence on the willingness of foreign lenders to finance this growth. Until this summer, credit spreads were extremely low as compared to historical averages. This was thought to be due to a better ability of investors to understand and manage risk with derivative instruments. The fallacy of this view is clear now but for several years it contributed to the willingness of international lenders to overlook the inherent risks of investing in an emerging economy which depends almost entirely on the global oil prices boom. And Kazakh banks borrowed more than willingly, profiting handsomely lending at high rates to Kazakh home-buyers and retail consumers. It was an almost perfect arbitrage opportunity --- as a consequence, they experienced rapid growth and their investors reaped massive rewards from IPO’s in London.
In retrospect, it is not difficult to determine that this growth was not sustainable and its cause was mainly (temporarily) cheap credit. During the height of the Kazakhstan frenzy, however, investors, creditors and credit rating agencies largely chose to ignore the presence and possible consequences of the inherent risks. In those rare instances when the risks were brought up, they were muffled by the great showing of Kazakhstan’s overall economy and its double-digit annual growth. Kazakhstan and its banking system were held as an example of desirable and functioning banking reforms that helped distribute oil wealth among the people.
The Kazakh banks’ penetration of the retail sector is the highest among the CIS states, and Kazakh banks have been among the most active and innovative. This level of development, though, has been the reason why Kazakhstan finds itself on a verge of a banking crisis. Kazakhstan’s banks were among the few in the former Soviet states that could easily (and cheaply) raise funds on international markets. They have been the fastest in rolling out banking and mortgage products and dispersing credit among the population. But this perfect storm of the Kazakh banks’ willingness to borrow, and the eagerness of international lenders to lend to not miss out on the Kazakh miracle led to an overexposure to foreign borrowing. As mentioned above, Kazakh banks raised more than half of their funds on international markets. Russian banks, as a comparison, raised approximately 18 percent of their non-equity funding on international markets. At the point, when international lenders realized that Kazakhstan is an emerging country with a highly suspect authoritarian government and they should require an appropriate compensation for investing in such conditions, Kazakhstan’s banks were caught on the wrong end. They held $40 billion of foreign loans in foreign currencies, a significant share of which had to be refinanced at suddenly very high rates.
The continuing lending spree also led to an artificial inflation of the value of the Tenge, and the sudden drop in demand for Kazakh lending was immediately reflected in an increased volatility of the currency. This factor obviously further exacerbated the situation making the repayment of the foreign-denominated debt all the more unpredictable and difficult. The Kazakh National Bank has been pumping money into the financial markets since August and it seems that it has managed to keep the Tenge relatively stable.
Despite these systemic setbacks, it is unlikely that Kazakhstan, and its banking sector, will suffer a significant crisis. The system that first helped to jumpstart the rapid growth of the Kazakh banking sector and then was a cause of a liquidity crisis, should help the banks (at least the majority of them) to survive and thrive. The Kazakh government has already issued reassuring statements to international lenders and investors, and the consensus is that it will readily step in to bail out a major bank that would get into serious trouble. The question now may be where the line will be drawn. A run at the bank in Alliance shows that it may find itself right under the line but overall the banking sector should emerge stronger.
The credit crisis in Kazakhstan follows the predictable pattern (at least in hindsight) of boom and bust. First foreign lenders and investors did all they could to get a piece of action in the booming Kazakh market, often ignoring present warning signs. Then, when the confidence in Kazakhstan’s economic miracle finally suffered, they overreacted to warnings that should have been obvious for a long time. For Kazakhstan and its young banking system, this crisis should be an important lesson. Even before the crisis unfolded, the financial authorities were trying to pressure banks to be more conservative in their lending and borrowing policies --- recent events should leave no doubt that while the Kazakh banking system is fundamentally strong, certain restraint is necessary and in long-term interest of both the Kazakh economy and the banks’ shareholders. As for Western investors, Kazakhstan just became another hot emerging market that suddenly went cold. However, the continuing commodity boom will without a doubt provide further impetus to continuing growth of Kazakh economy and strengthening of its banking sector, and today just may be a perfect time for investors to find some great bargains among the battered banks.
