Banking infrastructure in Uzbekistan

The banking sector suffers from its weak role in Soviet times, when it was largely an adjunct of the 5-year plans, though many people had savings accounts in the Savings Bank. What personal savings people had were wiped out in 1991 due to hyperinflation. Continued inflation since then has resulted in a large transfer of wealth from creditors to debtors, further shaking confidence in the sector. The level of financial intermediation is thus very low and has fallen further since independence. All personal incomes and outlays are transacted in cash and very few individuals maintain savings accounts. The National Bank of Uzbekistan (NBU) tried unsuccessfully to introduce a VISA card in the local soum currency last year.

On the whole, the banking system is still marked by lack of openness, relatively high degrees of concentration, segmentation and cross-ownership, and substantial non-performing loans. The Economist places Uzbekistan with China at the bottom of its Emerging Market Access Index, a measure of market openness based on trade and investment barriers. On the other hand, there have been positive steps to reform the sector since independence: the legal foundation has largely been developed and banking supervision strengthened, an electronic payments system introduced and internationally-accepted accounting standards for banks adopted. Underway now are a WB-financed financial institution building project and plans to privatize the largest banks.

At present foreign banks can open offices only in the form of subsidiary banks or as JVs. Minimum capital requirements are $30m for the parent bank and $5m for the subsidiary bank. The only foreign bank with fully established operations here is ABN Amro, although the Turkish Ut Bank and the Korean Daewoo Bank operate, servicing primarily their own nationals involved in JVs and trade operations in Uzbekistan.

Concentration, government control and segmentation

The financial sector is dominated by the Central Bank of Uzbekistan (CBU) and 33 commercial banks. The CBU has 14 branches: one in each of Uzbekistan`s 13 regions and in the city of Tashkent. Of the 33 commercial banks, two are fully state-owned, four are joint ventures, eight are fully private, and 19 are joint stock companies with direct and/or indirect state participation. The largest 5 banks - the fully state-owned National Bank of Uzbekistan (NBU), Asakabank, Pahtabank, Uzpromstroybank and Narodny Bank (formerly the Savings Bank) - account for almost 90% of banking assets (versus 60% in Kazakhstan), with the NBU accounting for the bulk of banking assets and 60% of net income.

Specialized banks, a legacy from planning days, continued in the first years of independence, and are intended to support the development of specific sectors. Their importance fell as the CBU started to issue licenses to new universal banks and encouraged existing specialized banks to diversify their loan portfolio. However, segmentation remains a major weakness, since many of the formerly specialized banks are small and have sector-concentrated loan portfolios, while foreign trade transactions and household savings are still dominated by the NBU and Narodny Bank. The NBU (its full title is the National Bank of Uzbekistan for Foreign Economic Activity) was recently involved in an embarrassing court case brought by the Danish importer Jahn International which lost $865,000 when new, stricter exchange laws were made retroactive on a foreign exchange transaction that had been completed and signed before the law came into effect. The Supreme Court upheld the NBU.

At present, many commercial banks are owned by other banks and/or their clients. This of course creates conflict of interests and entails a serious risk for the banking sector as a whole. For instance, more than half of the assets of Promstroy Bank (Industrial construction) come from the large airplane factory in Tashkent and the energy sector. Their outstanding loans, with little hope of repayment in the near future, remain on its books, limiting its ability to diversify its portfolio.

Addressing this problem, the Cabinet of Ministers issued resolution No. 24 in January 1999 limiting the share of any one share-holder in the charter capital by 2002 to 7 %, excepting the state and commercial banks with participation of foreign capital and private banks. It also prohibits existing banks from contributing to newly registered banks` charter capital after January 1, 2001.

Problems with loans

Inter-industry debts and government-guaranteed loans to ailing state-owned enterprises are problems for commercial bank loan portfolios, both from the point of view of system stability and potential strategic investor interest. Banks risk collapse if the guarantees are not honored or if companies declare bankruptcy, and potential investors are at risk from the non-transparency of enterprise balance sheets. The Government is aware of the problem and has announced its intention to restructure relevant bank loans.

The reserve requirement in Uzbekistan continues to be onerous for commercial banks, the minimum requirement being 20% of bank clearing and deposit account balances, which does not bear interest. This is costly to the banks, increasing the spread between borrowing and lending rates.

Interest rate regime

Nominal interest rates have been steadily falling for the last several years, reflecting the decline in inflation. The CBU`s refinance rate declined from 5% in 1996 to 3% in 1999. However, the yield on 91-day T-bills remains negative in real terms, and interest rate spreads are high. The lack of competition in the banking sector and the high reserve requirement are the primary causes.

Nonbank financial sector

This consists of the Tashkent Republican Stock Exchange, the National Depositary, the secondary stock market, more than 80 insurance companies (of which 3 are state-owned), and about 70 Privatization Investment Funds (PIFs). Because of the underdevelopment and closed nature of the capital market, the trade volumes at the Tashkent Stock Exchange are far from robust. Shares worth $36m were sold in 1998, a modest increase over 1997 ($34m). Secondary stock market transactions, where PIFs play a dominant role, are somewhat larger.

Nonbanking duties

The banking system currently plays an anomalous role in collecting and enforcing taxes. Not only do they make tax payments at their client`s request, but they are obliged to help tax authorities enforce tax legislation. In particular, they must block an enterprise`s settlement account, monitor their client`s accounts receivable, and inform the law enforcement agencies about contracts not paid on time. Until this year, in order for the tax authorities to keep track of enterprises, enterprises were allowed to maintain only one settlement account.

While it is believed that this helped prevent the collapse of tax revenue collection which has afflicted many of the FSU (former Soviet Union) countries, particularly Russia, it undermines trust in the confidentiality and reliability of the banking system, which in turn, contributes to the low level of financial intermediation, low levels and efficiency of investment, and lower rates of economic growth. So far the Government has not responded to this criticism. Lifting the single account restriction was possible because of the adoption of the electronic payments system.

Another restriction which has hindered banking reform is the distinction between cash and non-cash transactions for enterprises. Cash withdrawals by enterprises are permitted only for purposes of payments of wages, pensions and travel expenses, meaning that almost all inter-enterprise transactions must be conducted in non-cash through the banks (as oppose to all personal transactions, which are in cash).

The rationale has been to contain monetary growth and reduce inflation, reduce tax avoidance, dampen currency speculation, and check corruption and money laundering. However, it imposes time and transaction costs for both banks and customers, fosters illegal arbitrage between the cash and non-cash `markets`, encourages informal financing and barter, causes cash/non-cash price distortions for goods, and encourages the dollarization of the Uzbek economy.

While the objectives are noble in both the above cases, alternative policy instruments without the harmful side-effects are well known and are being encouraged by the WB and other financial advisers. Inflation requires the adoption of consistent and tight fiscal and monetary policies; tax avoidance is curbed through the strengthening of the administration of taxes and surveillance measures requiring commercial banks to report to the tax authorities all currency transactions above a certain limit; currency speculation requires a sensible exchange rate regime. The Government continues, at its own pace, to work on all these elements of a sensible fiscal and monetary policy, but so far does not feel confident enough to relieve the banks of their nonbank duties.

New reform push

In response to criticisms, the Government has made concerted efforts to adopt international standards and address the underlying weaknesses in the sector. These include:

-Revised accounting standards and external auditing requirements for banks. Last year 16 banks underwent an audit by international auditing firms, and 17 - by domestic auditing companies.

-Timely and reliable credit information on borrowers. This is provided by the National Information Base of Bank Depositors under the aegis of the Central Bank. There is now a clearly defined exit policy and bankruptcy law to deal with an insolvent commercial bank. The regulations have already been applied in the case of Legkombank, which merged with Savdogarbank in 1998.

-A computerized payments system which has substantially reduced interbank clearing and settlement times, allowing banks to make timely monetary payments and manage their liquidity better. So far, it only processes credit orders, not debit orders, such as utility bills, tax payments, etc. The CBU intends to enhance inter-bank clearing and settlement network, canceling the processing by the CBU of transactions internal to one bank.

-The above-mentioned decisions to discourage bank sector segmentation, to gradually reduce an individual bank`s share-ownership by a single investor to 7% by January 1, 2002, and to cancel of the single account restriction. These moves ease banking procedures for enterprises and increases the competitiveness of the banking sector.

-The recent partial liberalization of foreign currency trading. While this represents an easing of the NBU monopoly on all foreign currency transaction (Uzpromstroybank, Asakabank, Uzzhilsberbank [Uzbek housing and savings bank] are authorized to deal in foreign currency), its seriousness as a step towards convertibility is questionable. Already, the `suggested` negotiated rate for banks to purchase dollars - 675 - is already out of line with the black market rate, which is presently 780 soums to the dollar, and the selling of dollars is still tightly restricted.

-Bank restructuring and privatization. A series of Presidential decrees and Cabinet of Ministers` Resolutions from 1997 onwards has resulted in an asset restructuring agency and a bank privatization bureau being set up within the Ministry of Finance. Decrees promoting the establishment of private commercial banks, reducing the state`s share in joint-stock commercial banks to not more than 50%, and promoting the participation of foreign capital in privatization of banks have been issued.

Financial institution building project

This summer the Government confirmed its intention to carry through its long-planned reforms by selecting a consortium of ABN Amro and Arthur Andersen to implement a financial institution building project, for which the WB approved a $25m loan.

The project involves: technical assistance to selected commercial banks (at first limited to Uzpromstroybank, Uzzhilsberbank, Asakabank, Andijan Bank, Ipak Yuli Bank); sector-wide technical assistance/ IAS audits of commercial banks; upgrading of interbank and intrabank payment systems; assistance in bank privatization and restructuring. The main goals are to strengthen the operations of the selected commercial banks, and to improve commercial services, especially lending to the private sector, and to prepare the banks slated for privatization.

According to Paul Jansen, a consultant with Uzzhilsberbank on the project, a significant improvement can be made in organizing the bank`s day-to-day work. "The banks operate more like government agencies or department. One of my goals is to streamline the internal operations to make Uzzhilsberbank function like a real bank."

The five banks that the project is focusing on all have their specific problems. Uzzhilsberbank, with a mandate of housing construction, is hampered by the lack of private property, which is necessary as collateral to allow financing of construction to develop normally. Uzpromstroybank is saddled with a mandate of providing `strategic` airplane factory and energy loans. Andijan Bank is the only truly private bank of the lot, and it suffers discrimination on the part of the Government as a result. The smallest, Ipak Yuli Bank has a mandate of supporting small and medium business, but it is so small it can do very little, and is trying to merge with other banks to bring its charter capital up to a reasonable level.

Privatization

In May, Uzbekistan Finance Minister Rustam Azimov announced to the EBRD annual meeting in Riga that the sell-off of a 40% stake in the country`s largest bank, the NBU, would start at the beginning of 2001, part of a 3-year plan to sell stakes in the country`s four largest banks - the NBU, Asaka (Automotive sector), Promstroy (Industrial construction) and Pahtabank (Cotton). (see table below) "We expect this process to take place for the four largest banks in 2001 and 2002. At the same time we have a plan for privatization of the smaller banks which will start at the end of 2000," Mr. Azimov said.

A bank privatization bureau has been operating unofficially at the Ministry of Finance since January. They are organizing tenders for a foreign general adviser and four investment bank consultants for marketing and sale of each of the banks to be privatized. The Government wants a strategic investor who is well represented in London, Frankfurt, NY and Tokyo.

International experts are not jejune about the prospects of privatization until the economy is more securely opened up, currency convertibility is instituted, and the Government truly begins to relax its hold on the economy. Other large-scale privatization projects to encourage foreign investment in major sectors of the economy, such as the Almalyk Mining and Metallurgical Complex or the telecommunications sector, have failed in the past year. Time will tell whether or not the Government has learned its lesson.

Privatization Contact: Bakhtier Abdulaev (World Bank) 998-71-133-2185, 998-71-139-4988

Adil Juraev (Ministry of Finance) 998-71-133-6349, 998-71-139-1438