Long-term resilience: Tighter prudential regulations have been brought in while lending growth remains healthy

Key reforms implemented in the aftermath of the 2008-09 financial crisis have created a more flexible and resilient banking sector just as the economy entered a period of slowing growth in 2012. While the sector has expanded dramatically in the past two years, banks have faced a liquidity squeeze in 2012 that has reduced the pace of growth. Over the longer term, however, Mongolia’s leading banks stand to benefit from a rebound, although they will need to mobilise fresh sources of capital to sustain expanding loan books. With total assets of MNT10.11trn ($7.1bn) in June 2012, the banking sector accounts for 95% of the financial industry. Indeed, in 2011 the assets to GDP ratio reached a new high of 86.5%. Gross outstanding loans were 51.75% of GDP by the close of 2011, according to Bank of Mongolia (BoM) data. “Mongolia’s low loans-to-GDP ratio indicates that the country is still under-banked compared to more developed economies,” Norihiko Kato, the CEO of Khan Bank, told OBG.

BOOM & BUST CYCLES: A commodity-dependent economy, Mongolia’s short commercial banking history since 1991 has been plagued by boom and bust cycles. With time and experience, however, the regulator’s powers have grown more adept at coping with volatility since the meltdown of the late 1990s. According to a July 2012 note by Michael Richmond, the US Embassy senior commercial specialist in Ulaanbaatar, the sector “has become more sophisticated and somewhat better managed”. Despite the progress at the time, 2008 brought a stark reminder of the significant challenges in regulating the small banking sector in the face of exuberant lending growth. Following a rapid expansion in banking assets from 2003 to 2009, with compound annual growth of roughly 32%, according to investment bank Resource Capital, the sector faced a serious slowdown in lending coinciding with the aftermath of the 2008 elections and the impact of the global financial crisis on commodity prices. As the quality of most assets in agriculture, manufacturing and, most spectacularly, construction deteriorated sharply from 2008, the ratio of non-performing loans (NPLs) surged from 3.3% in 2007 to 7.2% in 2008 and 17.4% in 2009, reaching a peak of 25% in November 2009, according to National Investment Bank. This caused the sector’s capital adequacy ratio (CAR) to drop to a nadir of 5% in 2009, while banks’ aggregate return-on-equity (ROE) turned negative from 21.2% in 2007 to -21.2% and -131.9% in 2008 and 2009, respectively.

TEETERING ON THE EDGE: As clients pulled their deposits and Anod Bank faced insolvency, the BoM intervened. Establishing a four-year guarantee on bank deposits in November 2008 through the Law on Deposit Guarantee, broadening it to the interbank market in March 2009, the regulator took over Anod Bank in December 2008, injecting $150m in equity to save it. Stepping in to save a second failing bank, Zoos (part-owned by the European Bank for Reconstruction and Development), in November 2009, the BoM’s foreign reserves significantly declined. In April 2009 The IMF provided an 18-month stand-by arrangement worth a total of $231.8m to stabilise the situation. A third troubled bank, Mongol Post Bank, was ceded to Savings Bank, with the merger completed in April 2010. The loss of two financial institutions has left its mark on confidence in the nascent inter-bank market, where perceived counter-party risk has soared.

BRIDGING THE GAP: The government established State Bank in November 2009 as a bridge bank, taking on the good assets of the two failed lenders. While the original intent was to privatise State Bank by 2014, this plan appeared to have been scrapped by late 2012 as the new Democratic Party-led government announced plans to use State Bank as an intermediary to disburse subsidised mortgages under the “100,000 homes” programme (see analysis).

By mid-2010 the sector had consolidated from 17 commercial banks to 13, down from 29 licensed since 1991, and one state-owned institution, while clients had overwhelmingly fled to the relative safety of the top five banks (see analysis). In particular, the market share of the top three banks grew from 53.7% in 2007 to 66% in 2009 and 71.7% by 2010 in terms of assets, according to rating agency Standard & Poor’s.

Intervention by the BoM and a series of IMF stress tests of the banks had near-immediate effects in stabilising the situation, although stress tests in the first quarter of 2011 highlighted the need for banks to shore up their capital bases. Banks’ ROE reverted to positive territory at 14.8% in 2010, while their liquidity ratio (the ratio of liquid assets to short-term liabilities) rose to 30%, according to the BoM. Excluding state and savings banks, the sector’s CAR recovered to 15.1%, while the aggregate NPL ratio dropped to 8% by the end of 2010.

ACTING COUNTER-CYCLICALLY: Beyond emergency stabilisation measures, the BoM was prodded into a more proactive reform effort to improve the ability of banks to withstand cyclical downturns linked to the commodities cycle. “The authorities have also tightened prudential regulations on asset classification and loss provisions,” the IMF noted in 2011. Central to these reforms, the Grand Khural, Mongolia’s parliament, passed a new Banking Law in January 2010. Implemented in 2011, the law replaced the last comprehensive act of 1996.

The central bank was established as the independent institution in charge of monetary policy and banking supervision following the advent of democracy in 1991. Concentration of regulatory powers within the institution had stretched its ability to cope, which handicapped enforcement of existing rules. In particular, development institutions and donors had highlighted inadequate policing of NPLs and capital requirements as concerns during the crisis.

CRACKING THE WHIP: The key revisions to the banking architecture included the ring fencing of investment and retail bank activities, opening the door to banks establishing investment operations from 2011. Higher disclosure requirements were enacted mandating the divulging of ultimate beneficiary bank shareholding information (published for the first time in September 2010), as well as tighter prudential regulations that included the limiting of crossholdings across different banks to 10% of equity and placed caps on lending by client and currency.

The cross-holding limit prompted the sale of part of the stake held by shareholders of the Trade and Development Bank (TDB) in both Capitron and Ulaanbaatar City Bank (UB City). Meanwhile, banks were restrained from exposure of over 20% of lending in a single client and 5% to related parties, a slight challenge in a domestic corporate market with only a limited number of blue-chip clients. To support the development on non-interest income, provision was also made for new sources of fee-based revenue by allowing banks to sell insurance, for instance.

The law also set the grounds for achieving longstanding goals of consolidating the sector into a smaller set of more efficient financial intermediaries. “The BoM welcomes a consolidation of the sector, which would create a more sound and competitive environment for strategic foreign investors,” L. Purevdorj, then-governor of the BoM, told local press in October 2010.

RAISING REQUIREMENTS: While refraining from granting new banking licences since the start of the millennium, the BoM has proved unsuccessful in forcing mergers and acquisitions, despite doubling capital requirements in 2004 and 2008, up to a modest MNT8bn ($5.6m). In a 2011 circular, the regulator doubled requirements once again to MNT16bn ($11.2m) effective from May 2013. Meanwhile, CARs, at 12%, were hiked to a counter-cyclical buffer of 14% from 2013 for the five largest banks that had been deemed “systemically important” by the BoM.

Reforms in the spirit of the Basel II framework have also been enacted (although the central bank is not a party to the Bank of International Settlement’s committees), with the raising of tier-1 capital to 75% of banks’ assets and the share of tier-2 maintained at 25% and the incorporation of operational risk when calculating CARs from May 2011. The central bank will also differentiate between short-term and long-term assets in its calculations of liquidity ratios from 2013, a shift towards the spirit of Basel III requirements. The 2010 law also established a more efficient model of bank resolutions for future crises, with the support of the IMF.

“Failure of a small bank would not pose any systemic risk, although it could possibly affect public perception,” H. Amar, the managing director of Tenger Financial Group, told OBG. “There are now a number of options for small bank resolutions, such as transforming a failing bank into a non-bank financial institution (NBFI), for instance.”

MINIMISING RISK: Mongolia has also made some progress in curbing money laundering by enacting a dedicated law and establishing a Financial Intelligence Unit within the central bank checking all transfers. However, the IMF warned in September 2012 that the action plan agreed upon with the Financial Action Task Force, which includes strengthening the law through act of parliament and criminalising money laundering, had yet to be fully implemented. Improvements in the BoM’s supervision have been a step in the right direction, but donors like the World Bank have highlighted continued weaknesses in the regulator’s capacity, as well as commercial banks’ internal risk management systems. Banks such as TDB have in fact announced their desire for larger banks to boost CAR levels above 15% as buffers in light of rapid lending growth, particularly given the World Bank’s finding that Mongolian banks held amongst the lowest tier-1 capital levels in East Asia in 2011. Over the medium term the BoM intends to move from a compliance-based system to a risk-based one to provide for more counter-cyclical measures such as dynamic and forward-looking provisioning and assessing the threat of contagion through the inter-bank market. This will have to overcome a significant confidence gap in the inter-market, in the view of Asian Development Bank’s (ADB) Hyung Ju Lee, a financial sector specialist at ADB’s East Asia department. “In the past two decades Mongolia had several financial crises so commercial banks are very careful in trading with each other.”

In September 2012 the IMF recommended the regulator introduce dynamic provisioning by first requiring banks to provision 1% of performing loans as a further counter-cyclical buffer. The need to focus on risk-weighted returns has become particularly evident for banks given their very rapid post-crisis growth since 2010.

EXUBERANT REBOUND: A sharp commodity-fuelled rebound of 6.4% real GDP growth in 2010 and 17.3% in 2011, the first full year since the resolution of the banking crisis, drove heady growth in deposits and loans that tested banks’ technical and financial strength. The concentration of business in the hands of five banks (or six, if one counts the sector-leading growth of UB City since 2010) spurred sharply higher competition between banks that have increasingly moved into each other’s markets as universal banks. “Strong competition in retail lending has been driving interest rates lower and tenors longer,” S. Batzaya, director of business development at Khan Bank, told OBG. “Four years ago the average loan maturities for consumers were about 12 months. They are now 20 months and we expect them to reach 24 months in 2013.”

Despite the initial damper on growth from a dzud (very harsh winter) during 2009-10, which affected construction, mining, industry, agriculture and trade, an inflow in deposits spurred a rapid recovery in lending in 2010. Aggregate deposits grew from MNT2.87trn ($2bn) in 2009 to MNT4.52trn ($3.2bn) in 2010 and MNT6.7trn ($4.7bn) in 2011, while assets increased from MNT4.35trn ($3bn) to MNT6.21trn ($4.3bn) and MNT9.22trn ($6.5bn), according to the BoM. In particular, current and savings account deposits, the cheapest yet most volatile source of funding (given depositors’ propensity to shop for the best rates), rose the fastest and accounted for 59.7% of assets in 2011. While not matching the growth in domestic deposits, foreign currency deposits increased significantly to MNT1.88trn ($1.3bn) by the end of 2011, roughly 28% of all deposits.

LENDING: While lending growth typically trails deposit inflows by three months in Mongolia, according to the World Bank, the influx in liquidity from 2010 supported an even-faster expansion in lending, particularly by the big five banks. Credit growth rose from 14.2% in 2010 to 75.4% in 2011, according to BoM data, with a turnaround in bank loans from MNT2.72trn ($1.9bn) in 2009 to MNT3.11trn ($2.2bn) in 2010 and MNT5.45trn ($3.8bn) in 2011.

The lending was widespread, with the World Bank finding that loans to households grew some 80% year-on-year (y-o-y) in 2011, while loans accounted for 59.7% of banks’ assets by year-end. The assets of the four largest banks (excluding Savings Bank) grew by 60% y-o-y in 2011 according to XacBank. Loans to private businesses totalled almost $2bn according to TDB in 2011, accounting for just over half (54%) of all lending, while that to individuals reached 45%, according to Russian investment bank Renaissance Capital. Strong growth in the retail and small and medium-sized enterprise (SME) segments in 2011 has significantly facilitated access to credit for Mongolian entities looking to expand.

CONSOLIDATION: Ranked 53rd in the World Bank’s “Ease of Doing Business 2013” report, trailing Japan (23rd) and South Korea (12th), but leading China (70th), Kazakhstan (83rd) and Russia (104th), accessing funding in Mongolia was judged easier than the average for East Asia and Pacific economies (91st). The low level of lending to government entities, at a mere 1%, has relatively insulated banks from significant government changes.

While the NPL ratio fell significantly from a 25% peak during the crisis to 11.5% in 2010, 5.8% in mid-2011 and 4.1% by August 2012, according to the World Bank, this was largely due to very rapid growth in overall loan books, alongside economic growth. Total outstanding NPLs fell by only MNT44.4bn ($31.1m) to MNT330bn ($231m) in the year to December 2011, according to the National Statistical Office. In mid-2012, however, the aggregate stock of NPLs rebounded from MNT235bn ($164.5m) in April 2012 to MNT270bn ($189m) by August.

In 2011, with credit flowing to similar sectors as in the run-up to the 2008 crisis – with industry, trade and construction accounting for 39%, 22% and 19% of private sector lending, respectively, according to Renaissance Capital – lenders and the regulator saw the potential for overheating. The first-quarter 2011 IMF stress tests called for banks to raise new capital and for the regulator to patrol new lending growth to avoid rapid deterioration in the event of a crisis.

SQUEEZING LIQUIDITY: By late 2011 it became apparent that banks were running out of funding for new loans, just as the BoM was gearing up to tighten monetary policy significantly. Indeed, banks’ loan to asset ratios grew from 51.5% in 2010 to 59.5% in 2011, while their loan to deposit ratios rose rapidly from 78% to 98% in the year to the first quarter of 2012, according to Fitch. Moody’s downgraded the country’s top four banks from Ba3 to B1 in line with the lower sovereign rating in May 2012, while Fitch highlighted the sector’s need for additional capital to support lending growth in a March 2012 note on the sector. Foreign currency deposits have stayed relatively steady, rising from 28% at the end of 2011 to 31.7% by June 2012, but overall deposit growth has slowed from 48.1% y-o-y in 2011 to 6.5% in the first half of 2012, according to BoM data. “One of the challenges for banks’ funding is that corporate deposits, which account for the lion’s share, are not sticky: companies shop around aggressively for the best rates,” Nick Cousyn, the chief operating officer of leading local brokerage BDS ec, told OBG. “This means that the velocity of money in the banking sector is higher than people assume.”

Banks have scrambled for a bigger share of deposits, especially stickier time deposits, edging MNT deposit rates up from around 10.7% in 2011 to 11% by April 2012 and dollar rates from 4.7% to 5.6%, according to the World Bank. With inflation still around the 15% mark in mid-2012, however, real interest rates have remained in negative territory.

RAISING RATES: Viewing the 75% annual bank loan growth, loose fiscal policy and double-digit inflation of 2011 as excessive, the central bank sprang to action. It raised the benchmark interest rate three times, a total of 125 basis points, to 12.25% in 2011, following up with two 50-basis-point hikes in March and April 2012 to 13.25%. This forced repo rates up to 17.25% and overnight bank rates to 22.25%, while interbank rates remained close to the benchmark. The benchmark rate remaining negative in real terms (adjusted for inflation) over the summer of 2012, prompting calls for further hikes, although slowing Chinese growth has given monetary authorities pause to consider its impact on the Mongolian economy. While benchmark rates remain a blunt instrument given Mongolia’s shallow capital markets, more effective tightening came in the form of raising of banks’ reserve requirements by 700 basis points to 12% and liquidity ratios from 18% to 25% from January 2012.

The effect on liquidity has been sharp, with BoM bills in circulation dropping from over MNT1trn ($700m) in late 2011 to around MNT400bn ($280m) in August 2012, a 60% drop, while yields on risk-free six-month BoM bills reached 17% in October 2012. The sector’s liquidity ratio reached 30% by August 2012, according to the BoM. Meanwhile, the central bank intervened in the foreign exchange market over the course of 2012 to smooth excessive volatility in the market and maintain overall stability.

“We see a certain coinciding of business and political cycles in Mongolia since spending always accelerates in the run-up to an election and you deal with the hangover afterwards,” O. Orkhon, the first deputy CEO of TDB, told OBG. “Yet we don’t expect 2012-13 to be as bad as 2008-09 since banks have become much more flexible and cautious.”

LENDING CHALLENGES: Slowing economic growth and unease about looming elections on the part of foreign depositors coupled with tighter BoM monetary policy have taken their toll on banks’ ability to lend. Annual credit growth fell from 72% to 37% in the year to August 2012, according to the IMF, with y-o-y lending growth dropping from 87% in December 2011 to 74% by February 2012 and 50% in April according to the World Bank. Lending rates shot up accordingly from around 16% in 2011 to 18.4% by the end of the first half of 2012. Credit to the property and construction sector has been the focus of much of the attention. The meteoric rise in urban housing prices caused by widespread asset price inflation has been one source of concern. Growth in the construction sector began to slow from the fourth quarter of 2011 and remained flat in 2012. In particular, concern focused on the potential for reduced government investment, lower incomes and uncertainty on demand for property.

As new projects launch, large land acquisitions and new drilling projects have dried up in 2012, banks like TDB, which holds the largest construction and mining portfolio of corporates, have scaled back since early 2012 by only lending to their most credit-worthy clients. Loan growth slowed to 30% y-o-y in August 2012, according to the BoM, still healthy by global standards although much lower than the heady heights of 2011. “Mongolian banks have been very cautious in 2012 due to the parliamentary elections and the growing nervousness of global credit markets,” Amar told OBG.

NPLS: From August 2012 banks’ NPL ratios have started to inch upwards, according to the government’s Economic Policy and Competitiveness Research Centre, rising 2.1% month-on-month. Banks such as XacBank and TDB argue that even a doubling of NPL ratios by the start of the next construction season in the second quarter of 2013 would be manageable, given the low ratios of between 1.5% and 3% recorded by the four biggest banks (excluding Savings Bank) in early 2012. “The uptick in NPLs since August 2012 is not overly concerning,” Orkhon told OBG. “The majority of bank loans are relatively fresh, having been written in 2011, with longer tenors than before, so the quality of loan portfolios is quite good as long as no one does anything foolish in 2012.”

S. Sukhbold, the CEO of Savings Bank is not concerned. “NPL ratios have been decreasing since banks became more risk-averse. Within 14 banks the average NPL ratio is now around 5%, which is still high, but we expect that number to decrease further in the near future. Banks need to focus on controlling risk while also growing rapidly,” she told OBG.

TARGETTING CORPORATES: Mongolia’s narrow corporate market presents the strongest pull on foreign lenders seeking to participate in the economy’s rapid growth over the medium term. While its economy grew to $8.56bn in 2011, according to the World Bank, domestic banks like TDB in early 2012 forecast investment totalling $68bn by 2016, focused primarily in mining, roads, housing and industry. Much of this will involve government spending, with the incoming government announcing some MNT67.2trn ($47bn) in public investment between 2013 and 2017, managed by the Single Treasury Fund. While the exposure of banks to the government remains minimal, as highlighted again in a Moody’s report in the second quarter of 2012, fiscal spending will stimulate demand for credit from both corporates and SMEs. Corporate lending has concentrated on amounts up to $1m, with a focus increasingly directed on contractors and suppliers in major sectors such as construction and mining.

New rules on risk concentration and lending to related parties since 2011 have limited the potential exposure of lenders, but have also thrown up their own challenges. In a small domestic market of some 50 larger corporates, competition is only set to grow as larger banks establish their own investment banks. The World Bank estimated in June 2012 that those 50 largest borrowers accounted for a quarter of total lending in 2011. New investment in mining stalled in 2012, while construction loans have stabilised, although a rebound is expected once the new foreign direct investment law is clarified and global commodity prices rebound.

“Businesses in need of financing in 2012 have seen the international debt and equity markets almost closed to them, so they are forced to seek MNT bank loans of around 16%, which is quite high,” Sardor Koshnazarov, the head of research at Eurasia Capital, told OBG. “Seeking to diversify away from construction and mining, banks have become much more selective in the deals they choose to finance in 2012.”

CORPORATE LENDERS: While industrial conglomerates like Bodi and Tavan Bogd have financed their operations through captive lenders, Golomt Bank and Khan Bank, respectively, the competition for local corporate businesses, such as MCS Group and Newcom, has increased tremendously, with TDB emerging as the largest corporate lender in 2011 with 25% of the segment, according to the bank. In November 2011 MCS secured a $150m three-year loan from a syndicate led by Standard Bank Group, a sign of rising competition.

Yet available capital remains limited, particularly given the lack of syndicated loans thus far. With a cap of 20% of banks’ capital per project, an average bank could only commit around $160m, according to Howard Lambert, the head of corporate and investment banking in Mongolia at ING, who says this would only cover six weeks’ operating costs at Mongolia’s largest mining project, Oyu Tolgoi. FOREIGN CURRENCY EXPOSURE: Longer-term structural issue lies in currency mismatches in an economy with such significant foreign currency deposits. Once the rise in foreign currency inflows resumes in line with economic growth, banks will be faced with a similar situation as 2011.

Under the rules passed in 2010, banks cannot hold foreign currency exposure in excess of 40% of their total asset base, with a cap of 15% per currency. While internal currency mismatches may prove manageable for banks increasingly marketing lower-interest dollar-denominated loans in the retail segment, their exposure to corporates with foreign-currency debt but MNT revenue has already been highlighted by rating agencies and the IMF since 2011. The IMF has recommended that the BoM should restrain banks from lending foreign currency to unhedged borrowers. While strengthening the foreign exchange market, this would also promote yet higher competition among banks for domestic deposits.

FOREIGN INTEREST: Foreign banks have shown growing interest in more direct involvement with larger Mongolian corporates. Beyond the traditional private placements offshore, either through bank loans or private debt, investment banks including Goldman Sachs, HSBC, JP Morgan, ING, Deutsche Bank, Standard Chartered, Sumitomo Mitsui and Mizuho have underwritten the launch of initial public offerings (IPOs) and bonds offshore on behalf of larger Mongolian corporates (see Capital Markets chapter).

Foreign-invested banks like Chinggis Khaan, held by Russian investors, and Mongolia International Capital Corporation, one of the earliest local investment banks in the country, have proven particularly aggressive in corporate deals. Growing foreign participation through convertible debt and equity stakes is now expected. Credit Suisse, for example, extended lines of convertible credit to Golomt Bank, and Goldman Sachs acquired a 4.8% stake in TDB in February 2012. While consolidation amongst midsized and smaller banks remains likely, larger lenders are considering IPOs on several markets once the new securities law is passed, which should attract keen foreign interest (see analysis). “We are seeing significant foreign interest in investing or extending funding to Mongolian banks,” O. Chuluunbat, the deputy minister of economic development, told OBG in October 2012.

A select few – ING in 2008, followed by Standard Chartered in 2011 and Bank of China in late 2012 – have established representative offices in Ulaanbaatar. ING’s office has allowed it closer access to Mongolian corporates wishing to launch Eurobond issues as well as the ability to buy government MNT bonds. Australia’s Macquarie Bank, a leader in Asian commodity finance, was granted a NBFI licence in early 2012. Japan’s Mizuho and Australia’s ANZ have both indicated their desire to the BoM to open their own representative offices. BNP Paribas, which established a semi-custodian position for a Chinese asset manager in early 2012, is likely to follow ING’s lead in establishing local representation. In June 2012 the BoM clarified rules on foreign subsidiaries, requiring minimum capital requirements of MNT65bn ($45.5m) and maintaining a representative office for one year before applying for a banking licence.

Yet many foreign banks only see the need for a more limited staff presence on the ground. “Why would foreign banks seek to establish a local subsidiary in the long run, to access the retail banking market?” Lambert said. “The market is very small, with just 2.75m people, most Mongolians are now banked and you would have to compete with the domestic banks that already service the retail banking market.”

New provisions in a draft tax code the Ministry of Finance expects to present to the Grand Khural in 2013 may increase pressure on foreign banks to incorporate locally as new rules could impose stricter taxation of profits within Mongolia.

A potential stumbling block for foreign investors in Mongolian banks came with the passing of the Strategic Foreign Investment (SFI) Law in May 2012. The inclusion of banking on the list of strategic sectors puzzled many financial regulators who spoke to OBG. Foreign state-owned entities such as Bank of China and Industrial & Commercial Bank of China, which have both expressed interest in Mongolia, could be the most affected. While compliance processes remained unclear in late 2012, the government planned to establish clear rules in the new parliamentary session. “The main objective of the SFI Law is not to restrict foreign investment, particularly in the financial services, but rather to better regulate it,” Chuluunbat told OBG.

INFRASTRUCTURE FUNDING: While commercial banks have clustered around opportunities in the corporate market, the state established the Development Bank of Mongolia (DBM) in 2010 as a means of bridging the significant gap in long-term funding on the domestic market. A team from the Korea Development Bank has managed the wholesale bank since inception under an initial three-year contract.

In March 2012 the DBM floated $580m in five-year bonds through Singapore, underwritten by Deutsche Bank, HSBC and ING, and guaranteed by the Ministry of Finance. With the yield on these bonds dropping from their initial 5.75% – the tightest yield ever for an emerging market bond debut – to 3.7% by October 2012, investor appetite for sovereign-guaranteed debt has proved to be highly encouraging.

Originally expected to fund investments in mining, transport (particularly planned railway developments) and housing, the majority of these funds remained unused in a BoM account in the last quarter of 2012.

DBM had only extended $30m in loans to State Bank to support its low-interest mortgage lending and $100m to Erdenes Tavan Tolgoi, the state-owned coal miner, within six months of raising the bond, plus to help construction of a new road. Nonetheless, the new cabinet announced plans in September 2012 to issue $5bn in new bonds by the end of 2014, with the first tranche of $1.5bn was sold in November 2012 and closed in December 2012.

CREDIT TO SMES: Funding for the overwhelming majority of businesses classed as SMEs will be crucial in developing Mongolia’s manufacturing industry and broadening the base of economic growth.

With some 89.5% of nearly 74,000 registered businesses employing fewer than 10 people in July 2012, according to the Chamber of Commerce and Industry (MNCCI), and a mere 1.8% employing more than 50, pent-up demand is significant.

The SME Agency was established in 2009 by the then Ministry of Food, Agriculture and Light Industry to frame government support for the sector. The new agency was aided by a range of donors, including the World Bank and Japan’s International Cooperation Agency, which collectively allocated some MNT285bn ($199.5m) in soft loans to 4572 SMEs and individuals by 2012, according to German development agency GiZ. In March 2012 parliament passed a new credit guarantee law to provide collateral of up to 60% of loan value for SMEs, up to a maximum of MNT20m ($14,000). With support from GiZ, the Ministry of Finance, the Mongolia Bankers Association (MBA) and MNCCI, the agency has earmarked funds of between MNT3bn ($2.1m) and MNT5bn ($3.5m), with the supported loans designed as startup capital for smaller businesses. GiZ expects some 1600 entrepreneurs to receive the fund’s support in raising loans over the next five years.

Meanwhile, the incoming administration laid out in its four-year plan published in September 2012 its intention of rolling out policies to further support access to funding for SMEs. A first policy has been a 90% tax rebate for SMEs, defined as companies with under MNT1.5bn ($1m) annual turnover, excluding firms in the mining, telecoms, oil, alcohol and cigarette segments. The aim is to create some 150,000 new jobs in sectors from manufacturing, cashmere, milk and herding to IT, tourism and other services.

Rates and maturities of loans from commercial lenders have already come down slightly, although high double-digit inflation and benchmark interest rates have kept nominal lending rates high. SMEs with good records are eligible for loans of up to MNT300m ($210,000), up from ceilings of MNT50m ($35,000) in 2007, while firms with a track record of banking with an institution are eligible for lower rates. UB City Bank, for instance, claimed in October 2012 that it was offering 16% interest on loans to loyal SME customers, compared to 18% for the public. While immoveable assets such as property and land can be used as collateral with commercial banks, a project supported by the European Bank for Reconstruction and Development (EBRD) in 2012 is now working to expand the types of assets counted as collateral to allow a wider array of firms to qualify for loans. The Secured Transaction Reform effort, backed by the EBRD, the IFC, the EU and the Swiss government, is creating a national registry of equipment, inventory, accounts receivable and other moveable assets as a real-time information platform for all claims on collateral. Operated by the MBA, the system is expected to be implemented in 2013.

LIFTING THE DEPOSIT GUARANTEE: While instrumental in stabilising the sector during the crisis, the BoM’s blanket deposit guarantee scheme expired in November 2012 and was replaced with a new insurance law scheme capped at MNT20m ($14,000). The measure had insulated the public and avoided bank runs, but the three years since have witnessed a concentration of business in the largest banks.

As banks returned to growth in 2010 the IMF characterised the scheme as “extremely generous”, given its inclusion of all accounts in the guarantee. The new BoM governor, N. Zoljargal, was confronted with the immediate question of lifting the deposit guarantee following his inauguration in September 2012. The partial guarantee is highly likely to provide a boost to the corporate bond market.

But beyond this a number of alternatives have been tabled. One is to establish a system of deposit insurance, with coverage limited to amounts of up to MNT200m ($140,000), although this has faced resistance from some banks. A more conventional system used in other countries is a deposit guarantee corporation, which is being discussed by the Ministry of Finance and the BoM. The eventual lifting of the blanket cover is likely to bring a repeat of the 2008 flight to larger lenders, but also a shift towards the credit of larger well-run corporates through public debt and equity offerings. “Once the blanket deposit guarantee is lifted we expect to see a flight to quality on the part of depositors, just as we saw in the 2008 crisis,” Amar told OBG. “Depositors are becoming more sophisticated and increasingly choosy.” OUTLOOK: While 2012 credit conditions have tightened considerably from the heady heights of previous years, still-healthy fiscal year 2012 lending growth of 30% forecast by the BoM makes Mongolia one of the more dynamic banking markets. Announcing its intention of supporting MNT liquidity and loan growth of between 20% and 40% in 2013 in its draft 2013 monetary policy presented to the Grand Khural in October, the BoM stands ready to support loan growth while limiting previous excesses.

Larger banks have secured necessary funds to keep lending at the slower pace until economic growth rebounds, although persistent inflation is likely to keep nominal lending rates prohibitively high. While foreign banks are positioning themselves in the market through loans, credit lines and equity stakes to support the corporate sector, more substantial investment is expected to come in the form of securities issuance offshore. Efforts under way to increase SMEs’ access to financing should have wider economic benefits. Meanwhile, government intervention will be necessary to increase credit flows to a majority of Mongolians unable to secure mortgages.