In and out: Deposits and loans have been rising sharply

The domestic lending market is simultaneously shaking off the effects of the international financial crisis and gearing up for what promises to be the most active and important period in its short history, since the country transitioned from communism to capitalism when the Soviet Union collapsed. Lending rates have come down considerably, banks have learned from multiple mistakes and the regulatory environment has improved in several increments.

The sector’s story changed in 2008-09, when the impact of the global financial crisis caused two banks to fail and a slowdown in the pace of growth in the banking sector. Since then banks have been cautious in the present – asset and deposit growth grew significantly faster in 2010 than loan growth – as they raise capital for the future. This capital will be needed, as Mongolia’s burgeoning mining sector will require large amounts of it in the coming years.

LOAN EXPANSION: Trends in 2011 confirmed the expectations of rapid growth in lending. According to data from the Bank of Mongolia, the country’s central bank and regulator of the industry, the size of the aggregated loan total for the country’s lenders surged 79% between September 2010 and September 2011. Some of that represents pent-up demand, as the pace of loan growth halved in 2008 when the crisis hit, and from that level halved again in 2009.

Another reason, however, is the expected surge in economic activity to come as mining activity ramps up. Outstanding loans were at MNT4.59trn ($3.58bn) by the end of the third quarter of 2011, compared with MNT2.56trn ($1.99bn) at the same time in 2010.

The huge uptake in loans started in 2001, just after the government relaxed regulations on private real estate ownership, thereby triggering increased demand for credit for housing.

CUSTOMERS: While prior to that the country’s banks had looked to government agencies as customers, by 2010 just 1.1% of loans went to the public sector. Sector regulations since then have developed along with the market, and as of 2010 loans to any one borrower cannot exceed 20% of a bank’s total capital.

The proportion of non-performing loans (NPLs) was 51% in 1999 – an all-time high. At the end of 2009, the figure was at 17.4%, reflecting the damage done by the global financial crisis. The sectors of the Mongolian economy hardest hit were construction, agriculture and transportation, where the rate of NPLs were 30.2%, 24.6% and 24.7%, respectively, according to a report on the sector by Resource Capital, a Mongolia-focused investment bank. As of the end of the third quarter of 2011, the overall total had slid to 7.7%, according to Bank of Mongolia’s sector update.

Given that loan growth is almost assured due to the massive needs of the mining sector, combined with minimum capital thresholds scheduled to increase dramatically, banks will be looking to raise capital in the next few years. This will likely be done through foreign stock listings and debt sales, as there is currently not enough capital domestically.

DEPOSITS GROWTH: Banks have been enjoying growth in their deposit bases, recently – the aggregate total grew 63% from third-quarter 2010 to third-quarter 2011, according to the central bank. That growth is likely to continue, as the tugrik is expected to appreciate over the medium term, despite recent weakness, according to sector research by Frontier Securities, a Japanese investment firm with a local office. The rate of inflation is expected to wipe out much of the capital appreciation from interest rates paid. Foreign investors will be watching Mongolian banks’ asset quality – the ability to repay loans – in the coming years, which they will use as their principal method for measuring how well banks are handling the growth phase of their market. According to a report on Golomt Bank by Standard & Poor’s, prudent growth would require raising capital to ensure healthy solvency ratios, diversifying risks across several economic sectors and resisting the temptation to lend at too-small margins to compete with rivals.