State Dominates Banking Sector

UNCLAS MINSK 000689

SIPDIS

SIPDIS

State for EB/IFD/OIA, EB/IFD/OIA, EUR/UMB

E.O. 12958: N/A
TAGS: ECON EFIN EINV KCOR BTIU PGOV AFIN BO
SUBJECT: State Dominates Banking Sector

Ref: 05 Minsk 851


1. Summary: Belarus has a poorly developed capital market, and the
financial sector almost exclusively consists of banks. The joint
stock exchange/currency exchange lists very few companies and is
mostly engaged in currency exchange for the government. The
banking sector is almost completely dominated by a few large, state-
owned banks. The government maintains tight control over the
National Bank and banking sector. The GOB uses these banks to
provide GOB-directed lending for social projects and failing state
enterprises. The state then recapitalizes these banks from the
budget. Even so, this lending causes problems for bank liquidity.
Commercial lending is also growing, driven by falling interest
rates and inflation. The National Bank has tamed inflation by
effectively pegging the Belarusian ruble to the dollar, although
the bank acknowledges that rising demand for foreign goods and
travel is threatening exchange rate stability. Foreign currency
reserves, while growing, remain low at about one month of imports.
End summary.


Largest Banks State Controlled
--------------


2. Belarus has 31 registered banks with total assets, as of
September 2005, of USD 8.2 billion. The banking sector is very
centralized, with the six largest banks controlling 88% of the
sector's total assets. Five of these six systemically important
banks are fully or majority state-owned. The GOB controls:
Belarusbank (assets USD 3.37 billion, 40.8% market share and 63% of
retail deposits),Belagroprombank (USD 1.3 billion, 15.9%),
Belpromstroibank (USD 661 million, 8%),Belinvestbank (USD 604
million, 7.3%),and Belvnesheconombank (USD 349 million, 4.2%).
The sixth, Priorbank (assets USD 937 million, 11.4% market share),
is majority owned by Austria's Raiffeisen Group and minority owned
by the GOB. No other bank has more than two percent market
share. An IMF report stated that, "Due to the lack of a level
playing field, the six largest banks are able to offer loans below
market prices and thus crowd out their competitors from the market.
The smaller banks have to find a niche to operate in the market.
The non-competitive market environment and the frequently changing
rules of the game discourage foreign investors from entering the
market."


3. The Ministry of Economics is the GOB's main player in banking,
holding capital in 10 banks and controlling 66.2% of all banking
capital. Officers of the NBB told Econoff that the GOB plans to
retain majority ownership of these large banks as the state uses
them to implement government policy. The EBRD told Econoff that
even with the state playing a strong role in banking, Belarus'
banking sector is very small for an economy of Belarus' size. No
bank is large enough to service Belarus' larger state-owned
concerns, which must then work with several banks each.


4. According to the National Bank of Belarus (NBB),26 Belarusian
banks have foreign capital, including nine which are 100% foreign
owned. Foreign capital makes up 9.3% of banking capital, despite a
2005 presidential decree ordering all Belarusian banks to have at
least 25% foreign capital (Lukashenko revoked this decree on June
15). Russia is the largest foreign investor, accounting for 3% of
banking capital, followed by Austria, Germany, Poland and the U.S.
By law branches of foreign banks are not allowed in Belarus, but
there are 12 representational offices of foreign banks in the
country. Russia's Vneshtorgbank announced in late May that it is
considering purchasing a controlling share of a Belarusian bank,
but has not yet done so. Belarusian banks have 11 representative
offices, but no branches or subsidiaries, abroad.


Lack of Independence
--------------


5. The NBB and largest state banks are not allowed to operate as
independent entities. Government officials sit on their governing
boards and influence the banks' decisions. Belarusbank also has a
seat on the NBB board. President Lukashenko can overrule or change
any NBB decision and appoints and dismisses senior NBB officials.
The NBB must coordinate its expenditures and investments with
Lukashenko, as well as the Council of Ministers and the Ministry of
Finance. An IMF report found that this coordination in fact
results in GOB and banking sector interference in the workings of
the NBB, and effectively places the NBB under permanent government
control.


6. The GOB routinely gives instructions to the NBB and banking
sector. In February the Council of Ministers ordered Belarus'
banks to attract at least USD one billion in foreign capital to
lend to domestic enterprises. The Council also ordered the banks
to increase their lending by 29%, to BYR 2.7 trillion [USD 1.26
billion]. In 2005 the GOB ordered certain Belarusian banks to open
representative offices in China.


7. The NBB is not exempt from the GOB's economic dictates. Over
the past two years the NBB has been forced to take control of 10
bankrupt collective farms and try to make them profitable. NBB
chairman Pyotr Prokopovich announced in February that all 10 farms
are now earning an average profit of 10%. [Note: This is unlikely,
as the GOB allows only limited reform of such farms. More likely,
the NBB is simply passing money to the farms to make them appear to
be profitable.]


8. This high level of state control is unlikely to end soon. On
June 15, Lukashenko publicly told his government, "It is necessary
to do everything so that the banking sector will be under the
control of the state, as this is a very important factor for the
sovereignty and independence of the country, and so that we will be
able to get the necessary funds for investment in our country." At
the same meeting Prokopovich reported to Lukashenko that 107 state-
owned companies failed to fulfill a 2005 presidential decree
ordering them to switch their bank accounts from private banks to
state-controlled banks. Prokopovich told Lukashenko the executives
at these firms "have been punished." Conversely, Lukashenko then
announced the need to create equal conditions for state and private
banks, claiming, "It is time for normal competitiveness. It is
necessary to stop supporting state banks so much. They themselves
should create favorable conditions for attracting clients."


Directed Lending
--------------


9. The NBB explained to Econoff that the GOB uses its four largest
banks to finance state social programs, such as funding housing
construction, and to provide credit at the state's direction. The
NBB added that the GOB also insists all banks provide money for
state programs, even private banks. The IMF reports these credits
are often given to support insolvent state enterprises, causing
solvency and liquidity problems at the lending banks. These four
banks provide credit on preferential terms, and the loans are often
guaranteed by the local or central government. These loans are
often made in violation of GOB lending laws and with no
consideration of risk, in which cases the GOB usually forgoes any
corrective action against the bank. GOB demands to lend money also
ignore the banks' capacity to issue such loans while maintaining
some reserve, potentially worsening the banks' financial status.
Additionally, local governments direct local bank branches to
provide loans to local enterprises or programs, often without the
bank's central headquarters being made aware of the extension of
these credits.


10. Belarusbank and Belagroprombank, Belarus' two largest banks and
both state-controlled, issue more loans than all other banks
combined. In 2005, Belarusbank accounted for 45.3% of all lending,
and Belagroprombank for 18.9%. Much of this was directed by the
government. Belarusbank gave out USD 420 million in loans for
housing, of which USD 261 million was soft loans given on order of
the GOB. Belagroprombank issued USD 172 million in easy loans for
housing. The volume of such directed loans rose 75% in 2005. In
2005 the GOB reimbursed these banks with USD 94 million from the
budget as compensation for these soft housing loans. In 2005 banks
also lent more than USD 698 million to agriculture, almost all of
which was easy loans directed by the GOB.


11. The state replenishes these banks' capital from the budget and
from the sale of government bonds. The IMF estimated the GOB
spends at least one percent of GDP (roughly USD 300 million) each
year recapitalizing its large banks. Because of this budgetary
support, the state also exempts Belarusbank from maintaining
adequate reserves (other banks must maintain 4% of deposits). The
IMF found that this practice of directed lending causes Belarus'
main banks to operate at a loss. However, their financial
reporting includes the money they receive from the budget, and so
shows these banks as being ostensibly profitable. EBRD reports
that Belarusian banks tend to have low levels of profitability,
largely because of directed lending. By law the NBB also acts as a
creditor of last resort and supports the liquidity of the banking
system.


Consumer Lending
--------------


12. In 2005 consumer lending increased 22% to USD 6.1 billion,
mainly to fund housing and consumption. The NBB attributes this
growth to decreasing inflation and dropping interest rates
(averaging 9.4% as of December 2005). Belarusian law requires 100%
collateral for any loan above USD 5,000. The law allows banks to
accept housing as collateral, but banks generally will not accept
housing as it is nearly impossible to foreclose after a loan goes
into default, especially if children live in the house. Therefore,
while there is high demand for mortgage lending, there is little
actual supply, according to the EBRD. Belarus also has no law
authorizing mortgage lending. The NBB said banks get around this
by relabeling such loans. Housing cannot be used as collateral for
a business loan. On June 15, Lukashenko signed permission for
banks to accept land as collateral for loans, which should increase
the volume of lending. The NBB claims bad loans have dropped to
1.5% of all lending.


Exchange Rate/ Low Foreign Currency Reserves
--------------


13. The NBB has stabilized the exchange rate as their main tool in
fighting inflation. Although the NBB denies it, the Belarusian
ruble is effectively pegged to the U.S. dollar, having fluctuated
less than one percent over the last two years. The NBB claims
instead the Belarusian ruble is loosely tied to the Russian ruble,
although the Belarusian ruble strengthened 3% against the Russian
ruble over the past year. The NBB admitted to Econoff that the
exchange rate is artificially high and is hurting exporters.
However, they said that rationalizing the rate is a political
decision that needs to be made at the highest level.


14. In April, NBB chairman Prokopovich told the press that
Belarusians' spending habits are making it more difficult to
stabilize the exchange rate. Prokopovich stated, "Unfortunately,
the production of quality goods and services is not developed
enough in this country and lags behind the increase in real incomes
of the population. The money that could remain in Belarus and work
here, USD 400 to 500 million annually, is spent to support
producers in other countries." He also complained that Belarusians
buy foreign currency to vacation and buy cars abroad (the main
demand for foreign currency). According to NBB statistics,
Belarusians purchased 26% more foreign currency in the first two
months of the year than a year prior, while they sold 11% more
foreign currency.


15. Because of this strong domestic demand for foreign currency,
the NBB has not been successful in increasing foreign currency
reserves. The GOB has been trying to increase its volume of its
reserves for some time, but with little success. The NBB's foreign
currency reserves in January were USD 1.384 billion, or about one
month of imports. Foreign currency reserves in commercial banks
were even worse, at USD negative 323.3 million.


Money Supply
--------------


16. Buoyed by a stable exchange rate, dropping inflation and GOB-
mandated salary increases, ruble deposits increased over the year
ending in May by 80% to BYR 6.2 trillion [USD 2.9 billion]. USD
deposits are shrinking, and 70% of all deposits are now in rubles,
up from 50% in January 2004. Prokopovich claimed the NBB has not
been successful in further decreasing foreign currency deposits
because, "Belarusians trust neither the NBB nor the parliament."
The share of long-term deposits is still low, at 20%. The overall
supply of rubles in the economy grew 59.5% on the year to BYR 8.6
trillion [USD 4 billion]. In December alone, ruble money supply
grew 13.8% after Lukashenko ordered the government to spend the
entire budget surplus. The NBB therefore ransferred BYR 982
billion [USD 457 million] to he Finance Ministry, and provided
additional funs to the main state banks as recapitalization. The
IMF told Econoff they predicted this massive increase in money to
be inflationary, but the Finance Ministry and NBB acted quickly in
the new year to remove some of this excess money from circulation.
In January Belarus' ruble supply fell 2.8%.


Credit Rating
--------------


17. Belarus does not have a sovereign credit rating. Lukashenko
ordered his government to apply for one in early 2005, but soon
changed his mind after announcing the USG would ensure Belarus
received a low rating. In June 2006, Lukashenko again started
discussing the possibility of applying for a national credit
rating. The NBB told Econoff that they expect Belarus to receive a
BB+ or B-, although Prokopovich has since told the press Belarus
should expect a low rating that would only improve with time.


18. The NBB told Econoff that only four Belarusian banks have
international credit ratings. GOB-owned Belarusbank,
Belagroprombank, and Belpromstroibank all have a CCC+. Private
Belgazprombank is rated B-.


Banking Supervision
--------------


19. The NBB is charged by law with regulating and supervising the
banking sector. However, the NBB does not have the ability to
fully implement this oversight. By law, banks only need to
disclose any owners who have invested more than 10% of the bank's
capital. There is no legislation allowing the NBB to investigate
whether minority shareholders, each possessing 9.9% or less, are
working cooperatively, and legislation does not allow the NBB to
investigate past the first level of registration to determine who
might be the ultimate owners of banks operating in Belarus.


20. Belarusian banks have not adopted international financial
reporting standards, and do not employ appraisal of assets and
liabilities based on fair market value. The IMF found that many
banks do not properly measure liquidity risk.


Comment
--------------


21. International financial institutions present in Belarus told
Econoff that Belarus' financial sector is small and undeveloped for
an economy of this size. The IFIs claim that talented and
knowledgeable people work at the mid-level in Belarus' banks and
government. However, interference from the top and the state's use
of banking for political ends means that the sector is not growing
and will likely remain distorted. The frequent use of directed
loans, with no regard to risk, makes the banking sector vulnerable
to internal and external shocks. These mid-level professionals
have succeeded so far in limiting the worst of the damage caused by
Lukashenko's economic meddling. Belarus' banking and financial
sector, though, cannot mature as long as Lukashenko uses them as a
tool to keep himself in power.

KROL