Mongolia's banking sector on the rise after a downturn in recent years

While early 2014 was a time of considerable uncertainty for the banking sector in Mongolia, the year turned out to be much better than expected. No banks failed or faced runs, and the institution that generated the greatest concern – Golomt Bank – fared well in the end. As the sector’s third-largest player by assets, a collapse at Golomt Bank would have caused serious issues for the sector. However, problems at the bank were not nearly as bad as originally thought and reported, although sector challenges remain. Questions about asset quality persist, and corporate governance may not yet be where it should be. However, with Golomt Bank looking increasingly sound, sentiment has turned hopeful.

Back from the Brink

Towards the end of 2013 and into early 2014, the situation looked dire. In July 2013 Savings Bank, the country's number five lender, collapsed and, around the same time, questions began to emerge about the health of Golomt Bank. It had failed to publish its 2012 audited financial report and hold a shareholders meeting in a timely manner. Due to the lack of transparency, international ratings agencies Standard & Poor’s (S&P) and Moody’s withdrew their rating. Matters got worse early the following year when a number of news reports claimed that the institution had issues related to the letters of credit guarantee and the dispute with Stanhope Investments. Other acquisitions by Golomt Bank included Credit Suisse loan litigation, and the accusations, in part, seemed to be without merit as the bank had reported that it had resolved a letter of credit dispute in 2012 while there was no litigation with Credit Suisse over their loan to the bank. The bank commented in a press release that the case with Stanhope Investments was a matter of differing interpretations over the terms of the contract.

The company also brought itself up to date with its financial statements and published two annual reports, for 2012, which was delayed, and 2013. G. Ganbold, CEO at the time, told local media that all outstanding issues had been resolved and that the case against the bank, lodged in London by Stanhope Investments in early 2014, was resolved amicably by April of that year. In July 2014 the bank saw its S&P rating – B – restated, and its Moody’s rating is expected to be assigned in the coming years.

Hindsight

The period of troubles may in retrospect have been helpful for the bank. Due to the expansion of its loan book being slowed during its time of uncertainty, asset quality may now be better than average. With its major troubles behind it, Golomt Bank is focused on making sure its operations and reputation are solid as it starts to build its business again. Corporate governance and transparency appear to be at the top of the list. The bank will be taking on a “Big Four” accountant to audit its 2014 financials (in 2013, accountants from top global firms were unavailable due to their high volume of work that year).

In May 2014, Golomt became the first bank in the country to become compliant with the US Foreign Account Tax Compliance Act when it registered with the US Internal Revenue Agency as a participating foreign financial institution. As of July 2014, S&P began rating the bank again and in late 2014 Golomt announced it may seek a Moody’s rating again now that it is back on schedule with its reporting and most of its outstanding issues have been addressed.

Developing Golmot

In terms of building it business, the bank received its custody licence from the Financial Regulatory Commission in August 2014 – the first such licence issued in the country – and is working to attract the best talent to its bank. Golomt Securities started offering an online trading system that the bank describes as being of international standard, allowing for people in Mongolia and overseas to directly trade on the Mongolian stock exchange. More broadly, the company has greatly altered its structure to reflect its desire to grow as a diversified institution. In 2014, the Golomt Financial Group was created, with the bank as a subsidiary (83.66% owned by the group). The same year, the group acquired a significant stake in Mandal Insurance, a company that had been part of Mongolia Growth Group.

“A slowdown in the economy is always a good time to look into new areas of growth and efficiency,” L. Bolormaa, chief investment officer and executive vice-president at Golomt Bank, told OBG.

Other Players

With Golomt looking more transparent and sound, the banking sector as a whole is now on much firmer footing. In early 2014, the situation was very different. While the three strongest banks in the country – Khan Bank, Trade and Development Bank (TDB) and XacBank – were seen as solid, Golomt was a big question mark and the smaller banks were under a cloud following the collapse of Savings Bank; a good half of the market was potentially shaky. Now that Golomt has dealt with many of the concerns about it, the Mongolian banking sector is now more than three-quarters in reasonably good shape, while institutions that make up the rest of the market are small enough to be supported by the central bank should they become troubled.

Sector Indicators

At the end of 2014, total sector assets reached MNT22.6trn ($13.6bn), up 8.1% from MNT20.9trn ($12.5bn) the previous year. For 2013, the most recent year for which individual bank data is available, Mongolia’s four largest banks accounted for 74% of sector assets, with TDB holding 24.5%, Khan Bank (23%), Golomt Bank (17.7%) and XacBank (8.7%). Aggregate lending reached MNT12.4trn ($7.4bn) in 2014, an increase of 16.1% over the previous year, while total public deposits rose 14.2% to MNT10.1trn ($6.06bn) over the same period.

SME Lending

While no major moves have been taken by the banks since the collapse of Savings Bank, some efforts have been made by the major players to strengthen lines of business and expand into new areas. A particular focus has been on small- and medium-sized enterprise (SME) financing. In late 2013, TDB signed an agreement with the Mongolia Credit Guarantee Fund to provide loans to smaller companies. The fund was established in 2011 and provides up to 60% of the collateral for loans up to MNT20m ($12,000). Meanwhile, in late 2013, XacBank received a $30m loan from the Asian Development Bank (ADB) for SME lending, and in September 2014 it received an additional $20m from the OPEC Fund for International Development (OFID) for the same purpose. The ADB also lent $40m to Khan Bank in July 2014 for SMEs, saying that only about 10% of SMEs in the country were able to raise financing regularly, with additional funding coming from OFID and the European Bank of Reconstruction and Development.

Strain

Despite the newfound stability and the improvements being made by the banks, overall the system is under strain and will likely be for some time. The immediate crisis has been avoided, but serious unresolved issues continue to hang over the sector. In early 2014, Moody’s revised its outlook for the banks it rates (Khan Bank, TDB and XacBank) to negative from stable. In August 2014, the ratings agency downgraded the banks. The local currency long-term deposit rating for all three dropped from B2 to B1 while the foreign currency long-term senior unsecured debt rating for TDB fell to B3 from B1.

The update followed the downgrade of Mongolia's foreign currency government bonds to B2 from B1. The banks themselves argue that their downgrade was due to the sovereign downgrade – Moody’s really had no choice but to adjust the ratings – however Moody's found a good deal to be concerned about in the banking sector as well and appeared to indicate that the move was more than simply a technical one.

Challenging Environment

The banks remain well capitalised. Overall, the capital adequacy ratio was 17.7% at the end of 2014, up considerably from the 5.5% seen in 2009 and still well above the central bank’s minimum of 14%. However, there remain concerns about the quality of the assets, the growth of the assets and the inconsistent application of corporate governance best practices.

For example, Moody's noted that TDB’s loans to its top 20 borrowers total more than three times capital and that many of these borrowers are in high-risk industries, such as mining. It is also difficult for the banks to raise new capital given the weak demand for emerging markets paper. In 2014, TDB was forced to cancel the sale of a 5-year dollar bond. NPLs: The rating agency said that the overall operating environment was deteriorating as a result of falling resource prices and a slowing economy. Moody’s also noted that non-performing loans (NPLs) were beginning to tick up and that this key ratio was likely to rise further as credit growth slows and companies have increasing difficulty keeping up with payments.

According to the World Bank, growth in NPLs and past due loans was negative from July 2010 through September 2012. However, year-on-year growth then spiked, with the value of problematic loans doubling in the year to May 2014.

Even if NPLs held by banks in liquidation are excluded, the total value of NPLs has nearly doubled over this period, indicating that the issue is not confined to institutions at risk. According to the Bank of Mongolia, in April 2015 the number of outstanding loans to individuals and firms reached MNT12trn ($7.2bn), which was an increase of MNT1trn ($600m) over the same period in 2014. The bank also said 5% of all loans at commercial banks are delinquent, which led to a decision to cut back on lending.

The standards used for classifying and reporting troubled assets may vary between institutions, and the true NPL picture might not be as good as suggested by the headline figure. While International Financial Reporting Standards are technically required in Mongolia, the local version is not as strict as the international standard and allows for more flexibility in terms of provisioning against problematic loans. For example, some banks and financial institutions only report NPLs when they are past due. However, international standards require that provisioning be done throughout the life of the loan to account for the chance of default, even if it is being paid in a timely manner.

In November 2013, the growth rate for all loans hit a recent year-on-year (y-o-y) peak of 57.6% (it had gone as high as 74.7% in 2011), but the rate has since begun to subside. Loan growth has been particularly high in construction, mining, real estate and wholesale, with the rate of increase spiking in all four sectors in the middle of 2013. Much of the growth has come as a result of the Price Stabilisation Programme (PSP), which was initiated in late 2012 by the Central Bank of Mongolia. Under the PSP, funds are loaned to banks at discounted rates so that low interest loans can then be made to targeted industries (such as petroleum import, and meat and flour distribution) in hopes that this will minimise inflation. According to an IMF report released in March 2015, by the end of August 2013 banks had received about MNT600bn ($360m), with banks charged 0.5-4% and corporate customers in turn subject to rates of up to 7%.

Housing Loans

The 8% mortgage programme also contributed to the rise in outstanding loans. Under the terms of the initiative, which is formally known as the Housing Mortgage Programme (HMP) and was started in June 2013, applicants are able to get 7% to 9%, 20-year loans for apartments that are less than 80 sq metres. Borrowers must have a regular income and come up with a down payment of at least 30%.

Furthermore, banks are required to sell loans issued under this programme to the Mongolia Mortgage Corporation (MMC), which uses them to issue asset-back securities. The Bank of Mongolia subsequently purchases 90% of these, while the banks are required to purchase and hold 10% of the mortgage-backed notes. So far, two-thirds of these loans have been sold to the MMC, with the balance planned to be sold in the near term. This strategy has led to a decrease in the level of mortgage loans since mid-2014.

The efforts with respect to improve access to mortgages have resulted in a spike in outstanding housing loans. Mortgage growth increased from 25% in 2012 to more than 145% y-o-y by early 2013, with around 80% of housing loans falling under the HMP by the end of 2014. As a result, total mortgages almost quintupled in less than three years.

While bankers say that credit departments are being careful and that the borrowers tend to be in good shape – coming in with sizeable down payments and paying down quickly – asset quality does appear to be deteriorating. In 2014, mortgages “past due in arrears” jumped from less than 0.5% to 2.2%, while actual NPLs were creeping up to 0.5%.

Concerns

The two programmes, in addition to liquidity injections by the central bank into local lenders, are creating some concerns. International institutions have warned that interventions of this sort have the potential to do serious damage in Mongolia. They could exacerbate inflation, lead to bubbles, crowd out more productive investment and cause the currency to weaken. The IMF advised in its 2013 Article IV Consultation report, and the World Bank concurred in a June 2014 report, that the PSP needs to be phased out. Bankers concede that the rapid increase in PSP and mortgage loans outstanding could lead to some deterioration in asset quality, but those involved in the sector are not overly concerned. Executives also say that despite the flood of money into the targeted businesses and into housing, prudent lending rules were nevertheless maintained and the institutions have not systematically loosened their standards. It is not a sub-prime situation, the bankers argue.

As banks work to keep their balance sheets in shape, they are also facing challenges on the deposit side of the business. In late October 2014, the Mongolian Stock Exchange started to sell government bonds in the primary market. The move may help the exchange, which still suffers from low volumes, but the new offering is seen as a direct competitor to deposit products provided by banks, as it is largely tailored to retail investors. The bonds have short maturities, are free of tax, are government guaranteed and are being offered in MNT100,000 ($60) units. The concern is that this product will appeal to the average Mongolian, who is seeking to invest but who may be concerned about the stability of the country’s banks. In March 2015 Parliament approved a measure allowing the State Bank of Mongolia to issue a $300m international bond.

Deposit Insurance

The country has a deposit insurance scheme currently in place, but it does not offer the same level of security as government bonds. The Deposit Insurance Corporation is an independent entity which gets its funding from an annual levy on deposits (no more than 0.5%), an initial premium from the banks (1% of capital), paid in capital from the government, the sale of assets in the course of the liquidation of banks and the sale of bonds. The maximum payout is also limited to MNT20m ($10,500). While the programme is properly structured, it does not provide an outright sovereign guarantee and offers far less support than the programme it replaced. Under the 2008 Deposit Guarantee Law, the payouts were unlimited and directly funded by the state.

With the challenges that face the sector and the economy in general, a consolidation is the logical next step. The small population is not seen justifying the 13 institutions in existence now, and because some of the smaller institutions have been competing intensely for deposits by offering dangerously high rates, the larger banks would appreciate a market of only the larger, more disciplined challengers.

The presence of foreign banks is also putting the sector under pressure and could lead to consolidation. The Bank of China is expected to receive an operating licence. While this may help lower current bank lending rates to a more affordable level for SMEs and individuals, it would ay also mean stiff competition for local banks. The Bank of Tokyo Mitsubishi and Japan’s Sumitomo Mitsui Banking Corporation (SMBC) were approved to open representative offices in Mongolia in late 2013. Mizuho Financial Group, meanwhile, has signed a memorandum of understanding (MoU) with TDB, while SMBC has signed an MoU with Khan Bank. Standard Chartered and ING have also had representative offices in Mongolia for some time (since 2011 and 2008, respectively). It is not clear what the newer entrants have planned. Some bankers say they are preparing to get full branch status while others say that they will be lending to local banks. Whatever the case, competition could increase.

Outlook

The banking sector in Mongolia is facing many challenges and the environment will continue to be difficult for the near future. However, it has weathered the storm so far. The fortunes of the sector will greatly depend on how the assets brought onto the books in recent years perform, and that will depend on whether the quality of credit analysis and standards of governance were maintained as 8% mortgages and PSP loans were written. Despite these challenges, however, the sector continues to have good longterm potential. While increasing competition and economic uncertainty will raise concerns in the short term, Mongolia’s considerable natural resources and stability promise to continue attracting international investor interest as soon as commodity prices recover. Recent efforts to resolve delays at the Oyu Tolgoi mine project are also set to spur economic activity.