Fitch: Mongolian Banking Sector’s Growth Unsustainable

Fitch Ratings says Mongolia’s banking system is facing increasing challenges, due to current overheating in the economy fanned by rapid loan growth which, in turn, is pressuring capital and liquidity capacities.

“Rather than establish a government support scheme for failed banks to shore up banking system stability in times of sudden deterioration in economic and market conditions, authorities tend to not strictly enforce prudential norms, which may mask the plight of troubled banks. This serves to amplify the risks surrounding the banking system’s resilience against sharp downturns,” says Chikako Horiuchi, Director in Fitch’s Financial Institutions team.Driven by investment in mining developments, Mongolia’s economy is growing rapidly in contrast to the weakening global economy. However, Fitch believes the economy remains vulnerable to shocks, such as from slower economic growth in China, economic policy errors, or political uncertainty which could impact the flow of foreign direct investment. The country’s economy and the banking sector also remain exposed to foreign exchange risk, as evidenced in the previous crisis in 2008-2009, in part due to the economy’s reliance on commodity trade and a large share of foreign currency loans.

The Mongolian banking system experienced 40% yoy loan growth in H111. This loan balance is set to grow further given strong loan demand, particularly in the housing sector, as the country has significant development potential and is attracting sizeable foreign investment. As loan growth is mainly funded by new deposits rather than internally generated capital, competition for deposits is intensifying and driving up funding costs for the banking system.

Deposits are likely to continue growing on the back of improving household income as a result of economic growth. The government’s distribution of the country’s mining shares to all Mongolian citizens may also support an increase in deposits. However, when the existing blanket deposit insurance system expires in 2012, competition over deposit funding may intensify as the new scheme is likely to offer partial coverage only, reducing the “stickiness” of retail deposits.

Despite the Mongolian authorities’ measures to control credit growth and maintain adequate capital and liquidity, including tighter minimum paid-in capital requirement and liquidity ratio, Fitch believes such efforts could be compromised by lax implementation, at least for the smaller/weaker banks. Banks are not penalised severely if they breach prudential requirements, including in the case of breaching liquidity-related requirements. In Fitch’s opinion, this could leave banks with only a limited buffer against any unexpected adverse changes in the operating environment.

Fitch views that the lack of a framework ensuring government support for the banking sector in case of need may challenge the stability of the Mongolian banking system should the operating environment change suddenly. Strong opposition from shareholders of domestic banks has contributed to the government’s failure to obtain Parliament approval for the much-debated “Empowering the Banking Sector and Capital Support Programme”, which was planned to define government support in the case of a bank default. The government currently has no plan to create an alternative scheme.

Fitch currently rates two Mongolian banks – Khan Bank LLC (‘B’/Positive) and XacBank LLC (‘B’/Stable).

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