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. Last Updated: 07/27/2016

Kazakhs Offer Lessons in the Art of Banking

Awash in petrodollars, the Russian economy is moving full steam ahead. Yet while the oil sector has established its role as the driver of economic growth, many other sectors, including banking, seem to have taken a back seat.

Thousands of kilometers away, Russia's biggest Central Asian neighbor, Kazakhstan, has also been enjoying a windfall from oil revenues -- oil comprises more than half of Kazakhstan's total exports. But unlike Russia, the Central Asian nation has succeeded in creating one of the strongest banking sectors in the former Soviet Union, proving that a petrodollar shower does not necessarily condemn other industries to underdevelopment.

Strong personalities, progressive policies and timely privatization -- all that the Russian financial sector seems to lack -- have accounted for Kazakhstan's exemplary banking reform, analysts said.

Banks have become the pillar of Kazakh economic development, said Richard Hainsworth, CEO of RusRating. "The banking sector is facilitating growth," pushing the whole economy forward, he said.

The Kazakh powers that be began reforming their banking system long before Russia did, said Rostislav Musiyenko, a banking analyst at BrokerCreditService. While International Financial Reporting Standards and a deposit insurance scheme -- fundamental elements to restructuring a banking sector -- have been in place in Kazakhstan since the late 1990s, Russia is only beginning to implement these reforms, he said.

The weaknesses of Russia's banking system were highlighted by a mini-banking crisis last summer, when panic ensued after the Central Bank revoked licenses of several second-tier banks. A run on deposits by jittery consumers caused a brief liquidity crisis in the banking sector.

Thanks mainly to the competent stewardship of Kazakhstan's reformist Central Bank Governor Grigory Marchenko until 2004, Kazakhstan managed to avoid major financial crises. As a result, its banks now enjoy greater public trust than in Russia, Hainsworth said.

Kazakhstan's banking reform "was mainly a matter of government policy and commitment," said Irina Penkina, a banking sector analyst with Standard and Poor's rating agency.

Only a decade ago, the only discernible difference between Russia and Kazakhstan's infant banking sectors lay in the number of banks in each country.

Since then, however, Kazakhstan has taken proactive steps to level the playing field for financial lenders, encouraging them to consolidate, while Russia's financial sector remains fragmented, with hundreds of small banks unable to challenge state-run Sberbank.

Moscow-based Sberbank, heir to the Soviet Union's only retail bank, manages 60.3 percent of Russia's total individual deposits, according to the Central Bank's January 2005 figures. It controls assets worth more than 1,920 billion rubles ($67.80 billion), making it the largest bank in Eastern and Central Europe.

"Kazakhstan is also far from perfect, but there is no monopoly there," Musiyenko said. Instead, "there is an oligopoly of three banks -- Kazkommertsbank, TuranAlem and Halyk."

Successful and timely privatization has been key to financial sector development in Kazakhstan, analysts said. A more low-key state presence encourages competition and reduces the barriers of entry for private banks, Penkina said.

"The share of government participation in Kazakhstan's banking sector is about 0.1 percent, whereas in Russia this figure exceeds 50 percent," Musiyenko said. Moreover, Sberbank's privatization does not seem to be a priority for the Russian government, he said.

Kazakhstan's largest bank, Kazkommertsbank, which had assets totaling $5.416 billion at the end of 2004, has been privately run since its establishment in 1990. Meanwhile, TuranAlem, the nation's No. 2 bank, which emerged from Promstoibank's Soviet-era Kazakh branch, was fully privatized in 1997.

Strict regulation, including the enforcement of high minimal capital requirements, has encouraged Kazkakh lenders to consolidate, Andrew Keeley, a banking analyst at Renaissance Capital, said.

Kazakhstan's three largest banks account for more than 60 percent of total assets in the sector, said James Watson, director of financial institutions at Fitch Ratings. In Russia, meanwhile, "you must include a few dozen banks before you can cover 80 percent of [Russia's financial] market."

While the economic prerequisites for consolidation exist in Russia, there are significant procedural problems, said Hainsworth.

The Central Bank took important steps last year to simplify legislation on mergers and acquisitions of banks.

For example, the regulator no longer requires all shareholders of both companies to vote on proposed mergers, Hainsworth said. Since a quorum of 100 percent was nearly impossible to achieve, this and other similar rules used to stall mergers, he said.

"Many other small changes are taking place, but they are not on the radar of individuals working outside the sector," said Sergei Donskoi, a banking analyst at Troika Dialog.

The merger of five Russian banks -- including NIKoil, Avtobank-NIKoil, and UralSib -- slated for completion later this month, will serve as a test for the Central Bank's new rules, Hainsworth said.

Among other recent developments are the introduction of mandatory deposit insurance for banks that accept deposits from individuals and the legalization of credit history collection.

"Half of Moscow banks and 15 percent of regional banks were excluded from the deposit insurance system," Hainsworth said.

Limiting admittance to the insurance system is one of the many ways to put pressure on banks to consolidate. The banks left out from the scheme are likely to have a stronger incentive to merge or look for opportunities to be bought by larger peers.

At the moment, Kazakhstan is developing at break-neck speed. Its volume of consumer deposits and loans increased 65 percent over the course of last year -- 20 percent higher than in Russia, according to S&P.

However, when it comes to long-term development, "Kazakh banks recognize future limitations, given a small pool of consumers and corporate clients," Penkina said.

With the country's population base of more than 140 million people, Russia will hardly face a similar dilemma. As more consumers and businesses come to rely on the banking system, it will become an increasingly important engine for growth.

So far in Russia, the lack of a strong banking sector has hardly hindered growth, which has been driven by big natural resource companies. But as the economy diversifies, strong financial institutions will increasingly be important, Keeley said.