Key Takeaways

• Ratings on Uzbek banks remain relatively low in an international context.
• We expect that competition in the sector will intensify in 2019-2020, while rapid growth in loans will continue.
• We expect capitalization to decline in the coming two years, but still stay somewhat better than levels observed in sectors in some countries in the Commonwealth of Independent States (CIS).
• Although reported nonperforming loans are low, we expect them to gradually increase following recent high growth in commercial lending and high dollarization.
• We expect Uzbek banks to continue to mostly rely on domestic funding sources, shifting toward the soum and, striving toward lower dollarization.

Table 1

How We Derive Bank Ratings

Our criteria detail the elements that we use to determine an ICR on a bank (see "Banks: Rating Methodology And Assumptions," published Nov. 9, 2011).

We derive our bank ICRs through an analysis of the following factors:

• The macroeconomic environment in which a given bank operates;
• Bank-specific factors that inform us about a particular institution's credit profile, specifically its business position, capital and earnings, risk position, and funding and liquidity; and
• The potential for extraordinary external support.

Banking Industry Country Risk Assessment: Uzbekistan

We use our Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating (ICR). Our overall assessment of banking sector risks in Uzbekistan places it in group '8' on a scale of '1' to '10', with '1' indicating the lowest risk. Our assessment of economic risk on Uzbekistan's banking sector is '7' and industry risk is '9', both in the lower range of the spectrum. This assessment results in our anchor for a commercial bank operating only in Uzbekistan at 'b+'.

In our assessment of economic risks, we incorporate the low wealth in Uzbekistan, which is to some extent balanced by the government's solid external and fiscal balances, and limited, although improving, effectiveness of monetary policy. Overall, we note very high credit risk and relaxed underwriting standards, leading to very high growth of the sector. We see the trend of economic risk as stable because we see the risk of asset-bubble formation as rather limited, supported by low levels of household debt and low exposure to real estate and construction.

The key factors supporting our view of industry risk in Uzbekistan are still-developing regulation, the government's high involvement in decision-making at state-owned banks, leading to distorted competition in the sector with a complex competitive landscape dominated by the state-owned banks, and a selective approach to supervision. On the positive side, the banking system's funding structure, which relies on stable customer deposits and special-purpose government funds, is rather stable, although comprised mostly of short-term or on-demand deposits and longer-term government funds. We see the trend of industry risk trend as stable.

The outlooks for most of the banks we rate are stable. One positive outlook and one positive CreditWatch placement reflect specific bank factors rather than industrywide trends.

Business position of banks in Uzbekistan

The key factors when determining a bank's business position are its market share, volume and stability of the customer base, and diversity of income streams. We believe that the business position is becoming an increasingly important differentiating factor in our rating analysis, given the very tough competition in Uzbekistan's banking sector.

Of the 11 Uzbek banks we rate, the only one we view as having a strong business position is the National Bank of Uzbekistan (NBU). That reflects the bank's stronger franchise in Uzbekistan than other banks'. Its wide distribution network and diversified business model with a wide product offering compare well with domestic peers'. NBU is not only the market leader in terms of the overall loan book size (including directed lending), but also in purely market-driven commercial lending.

For the other large state-owned banks, Ipoteka Bank and Uzpromstroybank, our assessment is neutral for their rating levels, reflecting their relatively smaller size and market share in commercial business and customer deposits than NBU.

For smaller players, the business profile assessment is generally a rating weakness. We note that small and medium sized banks in Uzbekistan suffer from tough competition and their client base remains vulnerable and volatile.

For KDB Uzbekistan, its strong brand associated with with the parent Korea Development Bank is a rating strength, but one which only somewhat offsets its small size.

Chart 1

Capital and earnings.

On average, capital and earnings are positive or neutral for the ratings, although we expect some decline in capitalization ratios in 2019-2020, as banks continue to grow. We also see negative pressure on capitalization from the continued devaluation of the soum, which intensified in August 2019. That said, according to our criteria, even a weak assessment of capital and earnings has a neutral effect on ratings for banks in Uzbekistan, given that an anchor is very low at 'b+'.

Table 2

On average, Uzbek banks' better capitalization than CIS peers reflects higher regulatory capital requirements in Uzbekistan than in other countries. Another reason is lower economic risk in Uzbekistan than in some other CIS countries, and therefore, lower risk weights, which we apply for asset exposures while calculating our risk-adjusted capital ratios.

Chart 2

In our view, aggressive lending growth and shareholders' ability and willingness to provide external capital support will remain the key factors affecting Uzbek banks' capital positions.

We expect that most banks in Uzbekistan will continue rely on external capital support to underpin their lending growth. Most state-owned banks are actively developing commercial lending to increase profitability. To accomplish that they need additional capital, which they will likely continue to receive from the government over the next one to two years. We also expect that, despite growth in retail lending state-owned banks will keep a substantial portion of low margin, state-driven project lending, and consequently their profitability will remain inferior to that of private banks.

Chart 3

Risk position

We think that high recent--or expected--growth of commercial lending, and historical dollarization of the loan book, may lead to higher credit losses in the future, although problem loans are currently reported at a low 2.5%. We reflect the risks associated with high lending growth in our assessment of economic imbalances, which is embedded in our relatively low anchor for banks in Uzbekistan.

While for larger, more diversified players the risk position assessment is neutral for the rating, some small private banks demonstrate very aggressive lending growth significantly above the system average, such as Turkiston Bank, Davr-Bank, and Ravnaq-bank. For these banks, our risk position is a negative rating factor.

Chart 4

We expect that nominal lending growth will gradually slow over the medium term, but will remain high at around 40%-50% on average over the next two years, versus 51% observed in 2018. Such rapid loan growth is possible, as the ratio of household loans to GDP remains relatively low in Uzbekistan relative to peer countries.

Chart 5

Compared with previous years, retail lending and lending to non-state-owned corporates will become more important for growth drivers than financing of government-related projects. This is because of the aggressive growth targets of some state-owned banks to develop their commercial franchises. We note that for some state-owned banks, that would require significant improvements in risk-management and underwriting practices.

The reported stock of problem loans in the system remains low compared with many CIS countries, with stage 3 loans (as defined in International Financial Reporting Standard 9) of 2.5% for rated banks, versus 11.8% in Belarus and about 25% in Kazakhstan. These low levels reflect the predominance of directed lending to large government-related entities (GREs), which benefit from government support, as well as high and steady economic growth rates and strict collateral policies of most banks. Nevertheless, we note that high lending growth and relatively low transparency of reporting may mask the true picture of asset quality.

Chart 6

We expect that such a low problem loans ratio is not sustainable, given the very high growth and still developing underwriting standards. We expect that the total stock of problem loans will gradually increase to about 3% over the next two years.

We reflect a high share of loans denominated in foreign currency (56.9% as of July 1, 2019) in our anchor for Uzbek banks. The dollarization of state-related banks' balance sheets is much higher than for commercial banks (62.1% versus 36.0% on average for rated banks at mid-year 2019). Most of state-owned banks' loans denominated in foreign currency represent loans provided under special government decrees to support large GRE customers on the back of government funding provided for these purposes. Some of these large GREs are exporters and enjoy foreign currency revenue. Concentration of credit risk is also higher for state-owned banks; however, we do not reflect it negatively in our ratings on state-owned banks because the government guarantees most of such loans, which somewhat mitigates their related credit risk.

Chart 7

Funding and liquidity

The funding assessment is neutral for most of the banks we rate in Uzbekistan, except NBU (which enjoys a dominant market share in retail deposits among rated banks) and KDB Uzbekistan (which enjoys the status of a foreign-owned bank and therefore has relatively low interest expenses on customer deposits and low overall funding costs). Turkiston Bank's below average funding is driven by concentration on demand deposits and interbank funding, both of which are extremely confidence sensitive and make the bank's funding base less stable and vulnerable to shocks.

We note that nominal interest rates in Uzbekistan remain high, at the nominal level of 17%-21% in Uzbekistani soum (UZS) (compared with expected inflation for 2019 at 13%). Banks are forced to keep interest rates high amid the tough competition in the context of the population's still relatively low confidence in the local currency, driven by high inflation and history of UZS devaluation.

We note that confidence is gradually improving, however, as reflected by the declining share of deposits in foreign currency (for example, as of year-end 2017, retail foreign currency deposits were 47% of total retail deposits, compared with 38% as of April 1, 2019.)

We note that in terms of the loan-to-deposit ratio, those of large government banks are extremely high at 3.9x. We do not treat it as a rating weakness, however, as a significant part of this funding is direct, stable, matched government resources provided to fund certain strategically important projects. For privately owned banks, the ratio is a more conventional 1x, similar to that of peers in other jurisdictions.

Chart 8

In the absence of developed internal capital markets, Uzbek banks are increasingly active in attracting bilateral loans from international financial institutions, which is nevertheless rather low, accounting in total for less than 5% of total funding. We understand the largest banks plan to enter international commercial debt markets with debut Eurobonds in 2019-2020, following successful placement of sovereign Eurobonds earlier this year. Nevertheless, we don't think this funding will exceed 5% of systemwide liabilities in the next two years.

We understand that for some banks', aggressive growth in lending led to pressure on liquidity levels. We note that, generally, rated banks operate with lower liquidity buffers than two years ago. We consider such strategies as risky, specifically given the weak customer franchises of small players. If this trend continues it may start to put pressure on individual bank ratings.

Chart 9

External support

We view NBU, Uzpromstroybank, Ipoteka Bank, and Turon Bank as GREs). We think that the government fully controls the strategy of these banks through direct or indirect participation in their capital and governance bodies. We think that all of these banks (except Turon Bank) play important roles for the government by supporting a number of critically important companies in the oil and gas, transport, energy, metals, and chemistry sectors. We also think that NBU, Uzpromstroybank, and Ipoteka Bank have high systemic importance, owing to their significant market shares in lending, customer deposits, and payments, and the role they play in providing banking services for the economy and population.

We incorporate into our SACP assessments of the state-related banks ongoing government support in the form of capital, guarantees, and funding. However, according to our GRE methodology, we currently do not apply additional uplift for potential extraordinary government support in our ratings on the banks. This reflects the relatively low sovereign credit rating ('BB-') and the fact that the GRE banks' SACPs are already very close to the sovereign level.

We regard privately-owned Kapitalbank as having moderate systemic importance within Uzbekistan's banking system, since the bank is a market leader in terms of foreign currency retail deposits. Kapitalbank's market share in terms of retail deposits was about 11% on Jan. 1, 2019, which is comparable with that of the large state-owned banks. We therefore apply a one-notch uplift to our assessment of Kapitalbank's SACP for potential extraordinary government support.

We understand that Uzbekistan is contemplating privatization of some government-owned banks in the coming years. This decision currently has no bearing on our ratings, as we believe that any consequence of this action would fall beyond our rating horizon.

Appendix

Table 3

Related Research

• Turkiston Bank, Aug. 29, 2019
• Kapitalbank, Aug. 6, 2019
• Ipoteka Bank JSCM, July 11, 2019
• Uzbekistan 'BB-' Long-Term And 'B' Short-Term Ratings Affirmed; Outlook Stable, June 14, 2019
• Turon Bank, May 17, 2019
• Ravnaq-bank, March 21, 2019
• Banking Industry Country Risk Assessment: Uzbekistan, March 14, 2019
• Orient Finans Bank, Feb. 19, 2019
• KDB Bank Uzbekistan JSC, Feb. 15, 2019
• Davr-Bank, Nov. 22, 2018
• National Bank For Foreign Economic Activity Of The Republic Of Uzbekistan, Oct. 3, 2018
• Uzpromstroybank, Sept. 7, 2018
• Hamkorbank JSCB, Aug. 22, 2018