Extended Annual Review Report

Project Number: 40908 Loan No: 7235/LN2235 - KAZ November 2011

Kazakhstan: Term Loan Facility JSC Alliance Bank

In accordance with ADB’s Public Communications Policy 2011, this redacted version of the extended annual review report excludes information that is subject to exceptions to disclosure set forth in paragraph 97.

CURRENCY EQUIVALENTS

Currency Unit – tenge (T)

At Appraisal At Project Evaluation 1 March 2006 17 Oct 2011 T1.00 – $0.0075 $0.00675 $1.00 – T134.00 T147.94

ABBREVIATIONS

ADB – Asian Development Bank ALB – JSC Alliance Bank DPR – diversified payment right EMS – environmental management system FSA – Financial Supervision Agency JSC – joint stock company NBK – National Bank of Kazakhstan NPL – nonperforming loan ORM – Office of Risk Management PSOD – Private Sector Operations Department RRP – report and recommendation of the President SMEs – small and medium-sized enterprises

NOTE

In this report, "$" refers to US dollars.

Vice-President L. Venkatachalam, Private Sector and Cofinancing Operations Director General P. Erquiaga, Private Sector Operations Department (PSOD) Director R. van Zwieten, Capital Markets and Financial Sectors Division, PSOD

Team leader C. Teo, Principal Investment Specialist, PSOD Team member A. K. Gaza, Investment Officer, PSOD

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

I. THE PROJECT 1 A. Project Background 1 B. Key Project Features 1 C. Progress Highlights 1 II. EVALUATION 2 A. Overview 2 B. Project Rationale and Objectives 2 C. Development Outcomes and Impact 3 D. ADB Investment Profitability 10 E. ADB Work Quality 11 F. ADB Additionality 13 G. Overall Evaluation 13 III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS 14 A. Issues and Lessons 14 B. Recommended Follow-up Actions 14

APPENDIXES

1. Overview of the Banking Sector in Kazakhstan 15 2. Private Sector Development Indicators and Ratings 20 3. Project-Related Data 23 4. Organizational Chart 28 5. Restructuring Package and Terms 30 6. Comparative Financial Statements 32 7. List of Lenders 37 8. Supporting Computations 38

BASIC DATA Alliance Bank (40908/7235/LN2235 – KAZ)

As per ADB Loan Actual Key Project Data Documents ($ million) ($ million) Total project cost 50.00 50.00 ADB investment: Loan Committed 50.00 50.00 Disbursed 50.00 50.00

Key Dates Expected Actual Concept clearance approval 2006 March 2006

Board approval 2006 May 2006

Facility agreement 2006 15 June 2006

Disbursement 2006 23 June 2006

Financial and Economic Return on Appraisal XARR Invested Capital (%) (%) Financial return on invested capital None Negative Economic return on invested capital None Negative

Project Administration and Monitoring No. of Missions No. of Person-Days Fact finding Several April and November 2005

Appraisal (including due diligence) Several Not recorded

Project administration and risk assessment 1 6 person-days

Extended annual review 1 2 persons, 18–26 July 2011

Others (including exit, final repayment, 2 2 persons, 24 March– workout transfer) – joint mission 5 April 2009 and 16–18 April 2009

ADB = Asian Development Bank, Source: ADB

EXECUTIVE SUMMARY

In May 2006, the Asian Development Bank (ADB) approved a $50 million, 5-year term facility to JSC Alliance Bank (ALB). The facility was part of an assistance package provided to private banks in Kazakhstan. The main objectives of the facility were to help ALB grow its portfolio of loans to small and medium-sized enterprises (SMEs) and to assist it in better matching its assets and liabilities.

On 15 June 2006, ALB and ADB executed the facility agreement and on 23 June 2006, the loan of $50 million was fully disbursed.

In November 2006, ADB provided a $100 million guarantee facility to ALB to support its $200 million diversified payment right (DPR) securitization program. KfW joined this facility as a risk participant for up to $50 million of the guaranteed amount. A separate extended annual review report on this guarantee facility will be prepared.

On 30 June and 31 December 2008, ALB made two principal repayments of 16.7% each, representing $16.7 million in total. However, the principal repayment due on 30 June 2009 was not honored, as by then ALB had declared a moratorium on payments to all its creditors. The outstanding principal amount stood at $33.3 million as at the date of default.

Two years after the loan was made, ALB suffered a series of setbacks. The global financial crisis that started in 2008 as a result of Lehman’s bankruptcy hit Kazakhstan's economy harshly. The collapse of the property sector, the deleveraging of the banking sector, and the global economic slowdown resulted in poor asset quality. A $1.1 billion internal fraud involving United States Treasury securities brought ALB to the brink of bankruptcy. Subsequently, ALB defaulted on its debt and, with the support of both its commercial creditors and the Government of Kazakhstan, underwent a restructuring.

The Government of Kazakhstan, through its sovereign wealth fund Samruk-Kazyna, injected T24 billion into ALB and was made the largest shareholder with a 67% stake. Samruk- Kazyna also converted the debt owed by ALB of T105 billion into convertible preference shares. The other ALB creditors were allotted the balance of 33% of ALB shares.

Pursuant to the debt restructuring, ADB converted its loans into various debt instruments and equity in ALB. These instruments and their terms and conditions are listed in Appendix 5, Tables A5.1 and A5.2. ADB’s $100 million guarantee facility to ALB’s DPR bond issue was not part of the restructuring and was fully repaid from DPRs in September 2011.

The project was evaluated using criteria established in ADB’s Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations (2007) and the related project administration instructions (July 2008). These criteria are: (i) development impact, (ii) ADB investment profitability, (iii) ADB work quality, and (iv) ADB additionality. Overall the project is rated unsuccessful.

The development impact of ADB's investment in ALB is rated partly satisfactory when evaluated against four criteria: (i) private sector development, (ii) business success, (iii) economic development, and (iv) environmental and social performance.

The project’s private sector development is rated satisfactory based on (i) direct company impact and (ii) beyond company impact. ALB was successful in growing its SME portfolio. This can be seen from the growth in amounts, number of borrowers, and number of loans made. Loans to SMEs increased from T8.525 billion in 2005 to T96.433 billion in 2010. The number of SMEs grew from 700 in 2005 to 8,957 in 2010, and the number of borrowers rose from 674 in 2005 to 4,714 in 2010.

ADB’s 5-year loan assisted ALB in improving its liquidity gap and in matching assets and liabilities in the category of 1–5 year tenors. For the period ending 31 December 2005, ALB had a negative liquidity gap of T38,557 million in the 1–5 year category. However, the liquidity gap improved to a positive T2,105 for the period ending 31 December 2006.

ADB’s financial intermediary loan to ALB sent a strong signal to the financial community of the support given to the Kazakhstani finance sector and of the vote of confidence for the Government of Kazakhstan in trying to promote economic growth in the private sector.

One of the objectives of this project was to help the government expand the SME sector and move away from its over-reliance on oil and other natural resources. The share of SME output increased from 19% in 2006 to 32% in the first half of 2011. The number of people employed in the SME sector as a percentage of the total workforce also increased over the years, from 26% in 2006 to 30% in first-half 2011.

During the financial crisis that occurred in 2008, ADB contributed to the stability of Kazakhstan's finance sector. ADB did so by staying in the market and by participating actively in ALB’s restructuring negotiations. Through its representation on the creditors' steering committee, ADB showed support for the efforts of the Government of Kazakhstan to restructure and bail out ailing banks.

In November 2006, ADB provided a guarantee to a $100 million bond issued by ALB and in August 2007, ADB issued a T6 billion-denominated bond. These two instruments deepened and broadened the Kazakhstani capital market and assisted in reaching out to a new class of investors.

The project's business success is rated unsatisfactory, as the weighted average cost of capital is 5.24%, and the return on invested capital is negative due to ALB’s negative net worth.

Expected return on invested capital as the measure for the contribution to economic development as per ADB’s guidelines is negative, leading to a rating of unsatisfactory. However, there are additional economic benefits from this project that cannot be precisely measured or directly attributed. These benefits include the value created in output and employment by the dozens of companies to which ALB had granted loan facilities by tapping ADB’s loans. Another economic benefit is that by ADB’s participation in ALB’s debt restructuring and the support given to it after restructuring, ALB was able to survive the crisis and rebuild its business.

In the evaluation of the project’s compliance with environmental and social safeguard issues, the rating is partly satisfactory. Before restructuring, under the terms of the facility agreement, ALB had undertaken to maintain and implement the environmental management system (EMS). ALB confirmed compliance with the terms of the facility agreement related to safeguard and environmental issues. However, it is not evident that ALB rigorously enforced the screening and classification of loans under the EMS.

After restructuring, no formal EMS exists at ALB. However, ALB confirmed compliance of its subborrowers with the national environmental law under the Environmental Code of the Republic of Kazakhstan No. 212 of 9 January 2007. This project is thus rated partly satisfactory on environmental, social, health, and safety performance.

ADB wrote off part of the loan and exchanged the balance owed to it for a package of debt instruments and equity. On ADB investment profitability, the rating is unsatisfactory, as ADB will not be able to fully recover the loan extended to ALB.

ADB work quality is rated satisfactory using the following criteria: (i) screening, appraisal, and structuring of the project; (ii) monitoring and supervision; and (iii) ADB's role and contribution. Screening, appraisal, and structuring is rated partly satisfactory, as the risks were correctly appraised but the structuring of the loan was not sufficiently strong to overcome a payment moratorium and subsequent debt restructuring by ALB. On monitoring and supervision, the rating is satisfactory based on ADB’s standard of ongoing monitoring during the transaction and its valuable contribution and active participation in the creditors’ steering committee. ADB’s role and contribution is rated satisfactory based on the support for ALB in its debt restructuring.

ADB additionality is rated satisfactory. After ADB’s loan assistance in June 2006, many international lenders provided financing to ALB. Appendix 7, Table A7.1 contains a list of ALB’s lenders. ADB’s catalytic role in attracting the international lenders is difficult to measure. However, it is safe to say that ADB as a lender to ALB would have provided some comfort to other lenders contemplating new financing to ALB. ADB is also rated on the support provided in ALB’s restructuring negotiations and positive contributions as a member of the creditors’ steering committee.

Virtually all the transaction and country risks that ultimately affected the transaction were recognized in the report and recommendation of the President or discussed in the credit committee and found to be acceptable. This is true also for the amount of due diligence and safeguards contained in the transaction documentation. The perceived quality of ALB as a leading Kazakhstani bank was established.

In retrospect and with the benefit of hindsight, some of the recognized risks should have been given more weight and followed through in the legal documentation. The Office of Risk Management has prepared an analysis of lessons learned from this transaction and the Private Sector Operations Department concurs with most of the conclusions drawn.

ADB also had too much confidence in Kazakhstan's regulatory capacity to supervise and monitor the banking sector. In the early 2000s, the National Bank of Kazakhstan did not have the resources and tools for prudent regulatory control of the banking sector. For example, an internal fraud at ALB was left undetected by the central bank and the auditors of ALB. It was only uncovered when Samruk-Kazyna took control of ALB. The central bank also failed to rein in the external borrowings of all the banks and new regulations on foreign borrowings were imposed only after the crisis.

ADB will need to closely monitor the financial performance of ALB and make an assessment of ALB's success in rebuilding its business. To preserve ADB’s investment in this project, a decision on an exit in the near future will be considered prudent.

I. THE PROJECT

A. Project Background

1. In May 2006, the Asian Development Bank (ADB), through its private sector operations, approved a $50 million, 5-year term facility to JSC Alliance Bank (ALB).1 The facility was part of an assistance package provided to two private banks in Kazakhstan—ALB and JSC Bank TuranAlem (now BTA Bank).

2. Prior to this facility, in 2001, ADB had rendered technical assistance2 to the Government of Kazakhstan through a grant of $600,000 for the preparation of the Urban Small Business Development Project.3 The evaluation of the project preparatory technical assistance is included in this report.

3. The objectives of the facility were to help ALB grow its portfolio of loans to small and medium-sized enterprises (SMEs). It was anticipated that by doing so, ADB would help the Government of Kazakhstan achieve a more balanced economic growth premised on SME-led growth and away from heavy dependence on oil and other natural resources. It was also anticipated that the long loan maturity of 5 years would assist ALB in better matching its assets and liabilities. At the time of the loan agreement, it was difficult for Kazakhstani banks to access loans with maturity longer than 3 years.

B. Key Project Features

4. On 15 June 2006, ALB and ADB executed the facility agreement4 and on 23 June 2006, the loan of $50 million was fully disbursed. The unsecured senior loan had a maturity of 5 years with a grace period of 2 years and was to be repaid semiannually in six equal installments of $8.35 million each. Interest on the loan was calculated at a margin of 2.5% over the London interbank offered rate with built-in margin adjustments based on ALB’s credit rating.

5. In the facility agreement, it was stated that the loan was to be applied toward the financing of eligible subloans.5

C. Progress Highlights

6. On 30 June and 31 December 2008, ALB made principal repayments of 16.7% each (i.e., $8.35 million each) as part of the loan obligations. However, the principal repayment due

1 ADB. 2006. Report and Recommendation of the President to the Board of Directors: Proposed Assistance to Private Banks in Kazakhstan. Manila. 2 The technical assistance (TA) was financed from the Japan Special Fund. 3 The objective of the TA was to support economic growth by promoting development of the urban SME sector. The TA was to (i) review the status of SME development in Kazakhstan and its policy, legal, and regulatory framework; and (ii) identify and evaluate suitable financial institutions that could act as intermediaries in the delivery of finance to SMEs. The results of the TA formed the basis for formulating an assistance program, the approaches and modalities for financing to SMEs. The TA findings were to be integrated in the Urban Small Business Development Project. However, negotiations on the provision of a guarantee from the Government of Kazakhstan were not successful and the Urban Small Business Development Project did not take off. The financing to SMEs was later replaced by the Proposed Assistance to Private Banks in Kazakhstan. 4 ADB Term Facility Agreement dated 15 June 2006 between JSC Alliance Bank and the Asian Development Bank. 5 Eligible subloans mean the provision by ALB of loan facilities to small and medium-sized customers incorporated and doing business in Kazakhstan. 2 on 30 June 2009 was not honored, as by then ALB had declared a moratorium on payments to all its creditors. The outstanding principal amount stood at $33.3 million as at the date of default.

7. In November 2006, ALB issued a $200 million bond6 with guarantee of up to $100 million provided by ADB under the Diversified Payment Rights Securitization Program. 7 The bond carried a fixed interest rate of 5.10% per annum, a tenor of 7 years, a guarantee margin of 1.10% per annum, and was placed out to international institutional investors. It provided ALB with a stable source of funding to build its loan portfolio and expand its market share.

8. After the default mentioned above, ALB entered into debt restructuring negotiations with all its creditors. With their support and that of the Government of Kazakhstan, the restructuring plan was concluded and became effective upon approval by the Kazakh Specialized Financial Court on 28 April 2010.

9. ADB participated actively in ALB’s restructuring negotiations and was a member of the creditors' steering committee.

10. On the closing of the restructuring, the government, through its sovereign wealth fund Samruk-Kazyna, injected T24 billion to become the largest shareholder with a 67% stake. Samruk-Kazyna also converted the debt owed by ALB of T105 billion into convertible preference shares. The other ALB creditors were allotted the balance of 33% of ALB shares.

11. Pursuant to the debt restructuring, ADB converted its loans into various debt instruments and equity in ALB. Appendix 5, Tables A5.1 and A5.2 list the debt instruments and equity allotted to ADB under the terms of the restructuring.

II. EVALUATION

A. Overview

12. The project is evaluated using the criteria defined in ADB's Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations. 8 The project rationale and objectives are presented to provide the objectives envisaged during the approval of the project. The investment is appraised according to (i) development impact and outcomes; (ii) ADB investment profitability, (iii) ADB work quality, and (iv) ADB additionality. An overall evaluation of the project performance is then presented.

B. Project Rationale and Objectives

13. The main objective of ADB’s assistance to ALB was to help it build up its SME loan portfolio. ADB anticipated that its loan to ALB would provide the much-needed funding for ALB to broaden and deepen its outreach to SMEs throughout the country via its broad network of branches, and especially to the rural areas.

6 The $200 million bond consisted of two series: (i) the $100 million 2006A Series Fixed Rate Note guaranteed by ADB and (ii) the $100 million 2006B Series Floating Rate Note. Both series have a 7-year tenor. 7 ALB’s bond issuance was not part of the debt restructuring, as it was secured and repaid by diversified payment rights (DPRs) that were deposited outside Kazakhstan. A separate extended annual review report on ALB’s DPR facility is currently being prepared. 8 ADB. 2007. Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations. Manila.

3

14. It was anticipated that if the main objective could be fulfilled, it would contribute to the government's efforts to build up the SME sector and hence create an environment for better- balanced economic growth away from over-reliance on oil and other natural resources. To build a more vibrant SME sector, the first step was to make credit more easily available.

15. As stated in the report and recommendation of the President (RRP), SMEs had very little access to capital. A survey conducted by the United Nations Development Programme in 2000 found that only 7% of SMEs had access to bank credit when starting a new business. The issue was compounded by the negative image of and lack of confidence in the banking sector during the Soviet era. Banks were viewed as an unreliable funding source and SMEs relied on their own savings and those of family and friends, as well as on moneylenders for seed money, to start or fund their businesses. This trend in the public perception of the banking sector was slowly changing. ADB as an international bank providing assistance to ALB was anticipated to engender a positive image of the banking sector in Kazakhstan.

16. The loan tenor of 5 years was intended to assist ALB in a better maturity match and to close the gap in its funding periods. Kazakhstan's banks had very little access to funding on longer terms than 3 years.

C. Development Outcomes and Impact

1. Overview

17. The overall development outcome and impact is rated partly satisfactory based on component ratings of satisfactory in private sector development, unsatisfactory in business success, unsatisfactory for contribution to economic development, and partly satisfactory in environmental, social, health, and safety performance.

2. Private Sector Development

18. The private sector development is appraised under two categories, “direct company impacts” and “beyond company impacts”. The private sector impacts of the project are rated satisfactory. More details are in Appendix 2.

a. Direct Company Impacts

19. ALB was successful in growing its SME portfolio. This can be seen from the growth in amounts, number of borrowers, and number of loans made. Table 1 illustrates the growth trend.

Table 1: Alliance Bank – Portfolio of Loans to Small and Medium-Sized Enterprises

Items/Years 2005 2006 2007 2008 2009 2010 Loans to SMEs (T billion) 8.525 45.567 80.121 62.266 86.110 96.433

Number of SME Loans 700 4,539 7,358 5,139 7,147 8,957

Number of SME Borrowers 674 3,978 7,268 4,216 3,851 4,714

SMEs = small and medium-sized enterprises, T = tenge, Kazakhstan's currency. Source: Alliance Bank

4

20. Loans to SMEs increased from T8.525 billion in 2005 to T96.433 billion in 2010. The number of SMEs grew from 700 in 2005 to 8,957 in 2010, and the number of borrowers rose from 674 in 2005 to 4,714 in 2010.

21. ADB’s 5-year loan had helped ALB improve its liquidity gap and assisted it in matching assets and liabilities in the category of 1–5 year tenors.9 For the period ending 31 December 2005, ALB had a negative liquidity gap of T38,557 million in the 1–5 year category. However, the liquidity gap improved to a positive T2,105 for the period ending 31 December 2006.

b. Beyond Company Impact

22. The project's beyond-company impacts are discussed under the following stated objectives: (i) contribution to an expanded SME sector; (ii) contribution to the growth of a more stable finance sector; and (iii) contribution to bond market development in Kazakhstan.

i. Contribution to an expanded small business sector

23. One of the objectives of this project was to help the government expand the SME sector and to move away from heavy reliance on the oil and extraction sector.

24. Private enterprises in Kazakhstan are defined by size as shown in Table 2.

Table 2: Criteria for Defining Enterprises by Size

Private enterprises Number of employees Average annual assets ($ million) Small Not more than 50 Not more than 0.5 Medium Not more than 250 Not more than 3 Large Above 250 Above 3 Source: Kazakhstan’s Law (on private entrepreneurship), Kazakhstan’s Agency of Statistics (www.stat.kz)

25. The structure of currently active SMEs is shown in Table 3.

Table 3: Structure of Active Small and Medium-Sized Enterprises

SME Type Number (in thousands) Enterprise 73 Sole Proprietor 431 Farm 171 SMEs = small and medium-sized enterprises. Source: Kazakhstan’s Law (on private entrepreneurship), Kazakhstan’s Agency of Statistics (www.stat.kz)-status as at first half of 2011.

26. SME output as a percentage of gross domestic product increased over the years and so has the number of employees in the SME sector (Tables 4.1 and 4.2).

9 Source: ALB’s audited financial statements. FY2005, page 67, FY2006, page 66 and FY2007 page 65.

5

Table 4.1: Contribution of Small and Medium-Sized Enterprises to Gross Domestic Product

200,0 32% 31% 32% 180,0 160,0 19% 20% 148,4 15% 140,0 115,7 120,0 109,2 100,0 87,4 80,0 69,5 68,8 60,0 46,6 36,5 40,0 17,2 16,5 22,1 20,0 13,1 0,0 2006 г.2007 г.2008 г. 2009 г. 2010 г.1 пг. 2011 г.

GDP SME Output Share of SME output

Source: Kazakhstan’s Agency of statistics (www.stat.kz) Unit: $ billion, according to current exchange rate GDP= Gross Domestic Product SME= Small and Medium Enterprises r=year, nr= half year

27. The share of SME output increased from 19% in 2006 to 32% in the first half of 2011. During the financial crisis year of 2008, it dipped to 15%. The share of SME output has since been around 30%.

Table 4.2: Employment in SMEs

12 000 31% 30% 28% 29% 26% 25% 10 000 8 114 8 204 7 631 7 857 7 903 8 000 7 404

6 000

4 000 2 522 2 487 1 952 2 121 1 995 2 297 2 000

0 2006 г. 2007 г. 2008 г. 2009 г. 2010 г.1 пг. 2011 г.

Employed population Employed in SME Share of SME

Source: Kazakhstan’s Agency of Statistics (www.stat.kz) Unit: In thousands SME= Small and Medium Enterprises r=year, nr= half year

6

28. The number of people employed by SMEs as a percentage of the total workforce increased over the years from 26% in 2006 to 30% in first-half 2011. This upward trend demonstrates the sector's expanded role in job creation.

ii. Contribution to the growth of a more stable finance sector

29. In September 2002, Kazakhstan became the first country in the former Soviet Union to receive an investment-grade credit rating from a major international credit rating agency. Local banks were successful in tapping the international capital markets. The estimated level of foreign debt was $43.40 billion in 2005 and $73.46 billion in 2006.

30. Kazakhstan's economy was also booming after many years of consistent growth—gross domestic product grew by 10.7% in 2006, 9.7% in 2005, 9.6% in 2004, 9.2% in 2003, and 9.5% in 2002.

31. However, starting in 2006, Kazakhstan had begun to experience a lack of liquidity that was caused by the subprime crisis in the United States. There was growing skepticism among international investors about the banking system and the health of the banks. Under these circumstances, ADB's support was important for the banking system and for ALB in particular.

32. ADB’s financial intermediary loans sent a strong signal to the financial community of the firm support given to Kazakhstan's finance sector and the vote of confidence for the government in trying to promote economic growth in the private sector.

33. When the financial crisis occurred in 2008, ADB’s participation in ALB’s restructuring contributed to some form of stability in the country's finance sector.

iii. Contribution to the bond market development in Kazakhstan

34. In the RRP, a tenge-denominated bond issue was contemplated and this was done in August 2007. 10 The proceeds, however, were not lent to ALB but to another bank in Kazakhstan.11

35. The T6 billion bond had a maturity of 5 years priced at 100%, with a coupon of 6.8% per annum. The issue was settled in US dollars and converted into tenge at the reference rate at the time of pricing. Proceeds of the bond were used for ADB’s private sector operations.

36. The bond represented many firsts in the tenge market: first issue by a supranational institution, first issue rated AAA, and first tenge issue in the international capital markets, listed on the Luxembourg Stock Exchange. JPMorgan was the sole lead manager and bookrunner, and it placed the bonds solely to overseas institutional investors.

10 www.beta.adb.org – press release – ADB Issuing 6 billion Kazakhstan Tenge Bonds 11 Proceeds of bonds were onlent to Bank CenterCredit.

7

37. In November 2006, ADB provided a $100 million guarantee to a $200 million bond issued by ALB.12 At the time of the issuance, the bond market in Kazakhstan was still in its nascent stage and only two such issues existed.13

38. ADB’s tenge and US dollar bonds, as described in the paragraphs above, helped broaden and deepen Kazakhstan's bond market.

3. Business Success

39. The project’s contribution to business success is measured primarily by the return on invested capital and then compared with the weighted average cost of capital. See Appendix 8 for the calculation.

40. ALB’s weighted average cost of capital as calculated is 5.24%. The return on invested capital is negative due to ALB’s negative net worth.

41. The project’s business success is thus rated unsatisfactory.

42. The key financial highlights of ALB are presented below.

Table 5: Key Financial Highlights (T million)

2005 2006 2007 2008 2009 2010 Balance Sheet Total Assets 332,758.00 920,750.00 1,160,931.00 748,308.00 419,094.00 427,584.00 Total Liabilities 304,726.00 822,351.00 995,071.00 968,868.00 944,865.00 470,344.00 Total Equity 28,032.00 80,038.00 158,975.00 (227,180.00) (525,771.00) (105,035.00) Total Deposits 138,083.00 245,261.00 241,817.00 189,044.00 153,776.00 208,798.00 Total Loans 180,097.00 619,800.00 819,194.00 433,475.00 243,707.00 251,827.00

Income Statement Net Interest 6,254.00 39,843.00 88,879.00 65,409.00 3,641.00 4,391.00 Income Net Fee and 2,502.00 2,629.00 2,121.00 (11,767.00) 6,934.00 4,122.00 Commission Income Operating (9,109.00) (25,333.00) (47,246.00) (263,396.00) (186,810.00) (14,440.00) Expenses Operating 1,379.00 19,968.00 49,180.00 (225,355.00) (293,458.00) 11,398.00 Profit Net Profit 1,596.00 14,010.00 42,683.00 (386,210.00) (298,440.00) 334,434.00

2005 2006 2007 2008 2009 2010

12 ADB. 2006. Report and Recommendation of the President to the Board of Directors: Proposed Guarantee for the Diversified Payment Rights Securitization by Alliance Bank JSC. Manila.. ALB issued $200 million in bonds, but only $100 million was covered by ADB’s guarantee. $50 million out of the $100 million was risk participated to KfW. 13 They were a $100 million bond issue by Halyk Savings Bank in October 2003 and a $200 million bond issue by JSC Kazkommertsbank in December 2005.

8

2005 2006 2007 2008 2009 2010

Selected Ratios Return on 6% 26% 36% 1132% 79% (106%) Equity Return on 0.5% 2.2% 4.1% (40.5%) (51.1%) 79.0% Assets Cost–Income 87% 56% 49% 692% (175%) 56% Ratio Total Equity to 8.4% 8.7% 13.7% (30.4%) (125.5%) (24.6%) Total Assets Total Liabilities 91.6% 89.3% 85.7% 129.5% 225.5% 110.0% to Total Assets Total Deposits 45% 30% 24% 20% 16% 44% to Total Liabilities Total Loans to 130% 253% 339% 229% 158% 121% Total Deposits Capital 14.00% 16.00% 19.20% (17.00%) (104.10%) 13.90% Adequacy Ratio

Growth Rates Asset Growth 176.70% 26.09% (35.54%) (43.99%) 2.03% Deposit 77.62% (1.40%) (21.82%) (18.66%) 35.78% Growth Loan Growth 244.15% 32.17% (47.09%) (43.78%) 3.33% Net Profit 777.82% 204.66% (1004.83%) (22.73%) (212.06%) Growth Operating 1348.01% 146.29% (558.22%) 30.22% (103.88%) Profit Growth Operating 178.11% 86.50% 457.50% (29.08%) (92.27%) Expenses Growth ( ) = negative. Source: Alliance Bank’s audited financial statements.

43. Between 2005 and 2010, ALB went through three different stages of growth: (i) from 2005 to 2007—drastic expansion; (ii) from 2008 to 2009—deceleration and debt restructuring; and (iii) from 2010 onward—rebuilding business.

44. Both assets and liabilities ballooned in the 2005–2007 expansion. Total assets increased from T332 billion (in 2005) to T1.16 trillion (2007). The increase in assets was due mainly to an increase in loans from T180 billion (2005) to T819 billion (2007). The loan growth rate for 2006 was 244%. The expansion of ALB's loan portfolio came at the expense of its quality, which only became obvious in the following years. In 2006 and 2007, the recorded nonperforming loan (NPL) ratios were only modest at 1.2% and 3.8%. The increase in total liabilities was drastic— from T304 billion (2005) to T995 billion (2007). Total deposits increased by about 75%, but total loans grew more than 200% during this period. The expanded liability base was funding expanded loans. Equity injections rose from T24.90 billion (2005) to T97.60 billion (2007), which was small compared with the huge increase in loans. With the capital injections, ALB’s capital adequacy ratio was healthy at 14% (2005), 16% (2006), and 19.2% (2007). No dividend was paid from 2005 to 2007.

9

45. From 2008 to 2009, there was a drastic deceleration in the asset-building process, as ALB suffered heavily from the poor quality of its assets. The weaknesses in corporate governance and poor credit control led to an increase in NPLs. Over-concentration of loans to the construction and real estate sectors, which collapsed during the financial crisis, and related- party loans that cannot be recovered were the main reasons for the poor asset quality. In addition, a $1.1 billion internal fraud, which was discovered in 2009, aggravated the situation. The NPL ratios were 30.5% in 2008, 66.65% in 2009, and 75.25% in 2010. Debt restructuring starting in April 2009 had put most of ALB's businesses on hold as management was focused on trying to solve the NPL and funding problems, and to salvage the bank. Depositors’ confidence dropped during this period, as can be seen from the reduction in total deposits from T189,044 billion (in 2008) to T153,776 billion (in 2009).

46. Since the completion in March 2010 of its debt restructuring, ALB has started to rebuild its business. Its efforts are starting to pay off as both loans and deposits have increased. In September 2011, ALB announced the sale of a portfolio of nonperforming retail loans. The successful conclusion of this transaction is one further step taken by ALB to clean up its bad loans.

47. ALB’s capital adequacy ratios fluctuated from 14% in 2005 to –104% (2009) to 13.9% (2010). In 2010, the positive ratio was due to the capital injection of T24 billion and the subscription of preference shares for T105 billion by Samruk-Kazyna.

4. Economic Development

48. The economic rate of return on ADB's loan to ALB is calculated as per ADB’s guidelines.14 Accordingly, the economic return on invested capital is used as a proxy for the economic internal rate of return, because loan funding for this project was not targeted to specific capital investment projects.

49. In 2010, ALB has negative capital of -T105 billion. This will result in a negative economic return on invested capital, thus the contribution to economic development of the project is rated unsatisfactory.

50. However, there are additional economic benefits from ADB’s loan to ALB that cannot be measured precisely or directly attributed. These benefits include the value created in output and employment by the dozens of companies to which ALB had granted loan facilities by tapping ADB funds.

51. ADB’s participation in ALB’s debt restructuring and the support given by staying with ALB after restructuring have enabled ALB to survive the crisis and to rebuild its business.

5. Environmental, Social, Health, and Safety Performance

52. This project is rated F1 in the environmental category and C in the indigenous peoples and resettlement category. Under the terms of the executed facility agreement, ALB had undertaken to maintain and implement the environmental management system (EMS) and to submit on a yearly basis an environmental performance report evaluating the environmental,

14 ADB. 2007. Guidelines for Project Performance Evaluation Reports on Nonsovereign Operations. Manila.

10 health, safety, and social performance of ALB.15 ALB delivered such a report in 2007, confirming compliance with the terms as set out in the facility agreement. However, it is not evident that ALB has rigorously enforced the screening and classification of loans under the EMS.

53. Because ADB, among all other creditors, was a minor participant in ALB’s global restructuring, it was not able to impose ADB social and environmental safeguard standards and have them included in the restructuring terms. Such clauses are not standard in bond documentation and it is not customary to include them in bond instruments.

54. Currently, there is no formal EMS at ALB.16 However, ALB confirmed compliance of its subborrowers with the environmental law of Kazakhstan under the Environmental Code of the Republic of Kazakhstan No. 212 of 9 January 2007. This project is thus rated partly satisfactory for environmental, social, health, and safety performance.

D. ADB Investment Profitability

55. ADB’s loan to ALB was partially repaid ($16.7 million of $50 million) by the end of 2008. However, ALB defaulted on the next principal repayment due on 30 June 2009. ADB’s remaining loan exposure was restructured into a package of cash, debt, and equity instruments in ALB’s debt restructuring exercise.

56. ADB had made a full provision on ALB’s defaulted loan amount and upon closing of ALB’s restructuring exercise, ADB wrote off approximately $19.6 million, representing 39.2% of the total loan of $50 million. The package received by ADB in exchange for its loan balance was valued at $13.68 million. Part of the package consists of recovery bonds that allow ADB to participate in future recoveries of ALB’s NPL portfolio. ADB still holds this package.

57. Table 6 offers a snapshot of the performance of ADB’s loan to date, which is –8.77%.

15 Clauses 17.15, 17.20, 20.8, and Schedule 8 Clause (e) of ADB's term facility agreement of 15 June 2006. 16 On 30 September 2011, ADB disbursed T22.2 billion to Damu Entrepreneurship Fund, with a guarantee provided by the Government of Kazakhstan. The 5-year loan is part of a $500 million multitranche facility under the SME Investment Program. Funds under tranche 1 are onlent to ALB, Bank CenterCredit, and Kazkommertsbank. As part of the implementation of the tranche 1 loan, Central West Public Management, Financial Sector and Trade Divison (CWPF) and Central West Office of Director-Portfolio Results, Safeguards and Social Sector Unit (CWOD-PSS) will be working with these banks to implement environmental and social screening procedures to ensure that the SME subprojects to be financed under Tranche 1 have minimal or no adverse environmental or social risks. In addition, CWOD-PSS intends to offer technical assistance to these banks to establish or implement a formal environmental and social management system.

11

Table 6 – Internal Rate of Return as at 31 August 2011 Year Investment Interest Principal Value of Value of Debt Total Cash ($) Payments Payments Equity Securities Flow 2006 (50,000,000) 2,127,913 (47,872,088) 2007 4,010,524 4,010,524 2008 3,023,903 16,700,000 19,723,903 2009 721,937 721,937 2010 1,186,382 3,894,16917 5,080,551 2011 386,317 66,816 147,253 6,662,664 7,263,050 Total (50,000,000.00) 11,456,976 20,660,984 147,253 6,662,664 (11,072,123) IRR (8.77%) ( ) = negative, IRR = internal rate of return. Sources: Controller's Department report (value of equity as at 31 July 2011); for value of debt securities, valuation is based on prices traded as at 31 August 2011.

58. On ADB investment profitability, the rating is unsatisfactory, as ADB will not be able to fully recover the loan extended to ALB.

E. ADB Work Quality

59. ADB work quality is rated satisfactory based on (i) screening, appraisal, and structuring of the project; (ii) monitoring and supervision; and (iii) its role and contribution. Though the structuring of the project was somewhat lacking in proper monitoring of its purpose, the project was a unique attempt on the part of ADB to intermediate in a young and growing finance sector and provide funding to the underdeveloped SME market.

1. Screening, Appraisal, and Structuring

60. In 2005, ADB’s Private Sector Operations Department (PSOD) conducted missions to Kazakhstan and singled out the finance sector for potential cooperation. Previously, ADB's Board of Directors had visited the Central Asia region and argued for ADB private sector operations in that market.

61. To create a sustainable footprint in the Central Asia region, ADB chose Azerbaijan18 and Kazakhstan within the Commonwealth of Independent States for its first moves. In addition, ADB took a portfolio approach to the selection of individual banks in Kazakhstan by limiting itself to lending only to the banks in the top of their tier—Bank TuranAlem (now BTA Bank) and Kazkommertsbank as market leaders, and ALB and Bank CenterCredit in the mid-to-lower level of the top tier. It was anticipated that this portfolio approach would allow ADB to maximize development impact across Kazakhstan's banking sector.

62. The portfolio approach was also intended to spread the risk while permitting ADB to access higher yield.

63. The rationale behind a portfolio approach was appropriate but could not prevent loss when the economic downturn in Kazakhstan in 2008 and 2009 badly affected ALB and Bank

17 Payments on recovery notes were considered as principal repayments. 18 ADB. 2006. Report and Recommendation of the President to the Board of Directors on a Proposed Assistance to the Republic of Azerbaijan for Private Banks and Leasing Companies in Azerbaijan. Manila (AZE: 39930).

12

TuranAlem, a situation compounded by weak internal credit risk management systems and lack of good corporate governance.

64. As for appraisal before approval, the individual risks of the selected banks and those facing Kazakhstan as a whole had been correctly identified. However, the mitigating factors were not sufficient to overcome a moratorium on payments by ALB and Bank TuranAlem and for ADB to avoid involvement in the banks’ restructuring after the global financial crisis and Kazakhstan’s economic slowdown.

65. As for structuring, the project’s main objective was for ALB to onlend ADB’s funds to companies in the SME sector. The facility agreement did not contain a definition of what constitutes SMEs and ADB relied on ALB’s definition and classification. This made it difficult to ensure that the proceeds from ADB’s assistance were accurately applied and disbursed to borrowers in the SME sector.

66. Thus, appraisal and structuring are rated partly satisfactory.

2. Monitoring and Supervision

67. After the loan was made to ALB, the project administration unit in the Capital Markets and Financial Sectors Division of PSOD was responsible for administering the loan.

68. The account manager made desktop reviews through quarterly Private Sector Investment Management Notes, and ALB submitted its audited financial statements on a regular basis until April 2009 when it went into debt restructuring with its creditors.

69. From April 2009 to December 2009, a workout team consisting of members from the Office of Risk Management (ORM), PSOD, Office of the General Counsel, and Kazakhstan Resident Mission dealt with the debt restructuring of Kazakhstani banks, including that of ALB.

70. ADB was a member of the creditors' steering committee of ALB and participated actively in the restructuring negotiations to protect the interests of all classes of creditors. ADB’s valuable inputs assisted in a successful closing of the restructuring in March 2010.

71. Since restructuring, the account has been monitored closely via quarterly reports to the ORM.

72. ADB’s monitoring and supervision is rated satisfactory.

3. ADB's Role and Contribution

73. By participating in ALB’s debt restructuring and supporting ALB in its rebuilding efforts, ADB contributed to the stability in Kazakhstan's finance sector. By agreeing to the terms of the debt restructuring, ADB, along with the other ALB creditors, had given a new lease of life to ALB and a chance to rebuild its business. The restructuring came at a heavy price to ALB’s creditors (including ADB). All had to take a hefty discount and suffered huge losses on their loans. ADB’s role and contribution is thus rated satisfactory.

13

4. Overall ADB Work Quality

74. As discussed earlier, screening, appraisal, and structuring of this project is rated partly satisfactory, monitoring and supervision is rated satisfactory, and ADB's role and contribution is rated satisfactory. Overall work quality is rated satisfactory.

F. ADB Additionality

75. Evaluation of ADB additionality is based on whether (i) ADB finance was a necessary condition for the timely realization of the project, either directly or indirectly by providing sufficient comfort to attract private financiers; and (ii) ADB contribution to the project design and function improved the development impact.

76. After ADB’s loan assistance in June 2006, many international lenders provided financing to ALB (Appendix 7, Table A7.1), but it is difficult to measure ADB’s catalytic role in attracting these lenders. It is safe to say, however, that ADB's intervention would have given lenders some comfort in contemplating new financing to ALB.

77. ADB’s participation in ALB’s debt restructuring provided the support to a successful closing of the restructuring.

78. ADB’s additionality is thus rated satisfactory.

G. Overall Evaluation

79. Overall the project is rated unsuccessful. Table 7 summarizes the individual ratings.

Table 7: Summary Evaluation of the Project

Partly Indicators/Ratings Unsatisfactory Satisfactory Excellent Satisfactory

Development Impact √ Private Sector Development √ Business Success √ ) Economic Development √ Environmental Social, Health, √ and Safety Performance ADB Investment Profitability √ ADB Work Quality √ ADB Additionality √ Partly Highly Unsuccessful Successful Successful Successful Overall Rating √ ADB = Asian Development Bank.

14

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS

A. Issues and Lessons

80. Virtually all the transaction and country risks19 that ultimately affected the loan had been recognized in the RRP or discussed in the credit committee meeting and found to be acceptable. This is also true for the amount of due diligence and safeguards as contained in the transaction documentation. The perceived quality of ALB as one of the leading Kazakhstani banks was established.

81. In retrospect and with the benefit of hindsight, some of the perceived risks should have been given more weight and followed through in the legal documentation. For example, the risk management system could have been scrutinized more closely to ensure that good credit policies were in place and risks properly assessed and monitored. Asset quality could have been monitored more closely by sampling ALB’s loans and requiring ALB to submit aging reports and better scrutiny on related-party transactions. ADB’s due diligence of ALB’s corporate governance was limited to a survey of ALB’s governance institutions. In effect, significant de-facto weaknesses existed. It is questionable whether more intensive due diligence would have brought significant findings. ALB’s auditors, the banking supervisors, and a number of renowned commercial lenders conducted regular due diligence of ALB’s operations without significant findings.

82. ADB also had too much confidence in Kazakhstan's regulatory capacity to supervise and monitor the banking sector. In the early 2000s, the National Bank of Kazakhstan (NBK) did not have the resources and tools for prudent regulatory control of the banking sector. For example, a fraud20 at ALB was left undetected by the central bank and the auditors of ALB. It was only uncovered when Samruk-Kazyna took control of ALB. NBK also failed to rein in the external borrowings of all of the banks, and new regulations on foreign borrowings were imposed only after the crisis.

83. For a detailed analysis of lessons learned, please refer to ORM’s memorandum.21 PSOD concurs with most of the findings contained in the memorandum.

B. Recommended Follow-up Actions

84. ADB will need to monitor closely ALB's financial performance and assess the bank's success in rebuilding its business. Samruk-Kazyna is not likely to sell it to any private investor(s) until ALB restores its capital to positive territory and there is more visibility on the rebuilding effort.

85. At some point, to preserve its investment in this project and as part of prudent portfolio management, ADB will have to decide on a possible exit.

19 ALB’s asset quality, need for additional capital, concentration of lending and deposit base, liquidity risk, and risk management system were recognized as possible transaction risks. Country risks were identified as fast-growing banking market, regulatory and macroeconomic risks, foreign currency risk, and exposure to the state treasury and National Bank of Kazakhstan. 20 This involved the pledge of US Treasury securities amounting to $1.1 billion to offshore banks which issued guarantees to companies related to a former shareholder. These transactions were neither recorded in ALB’s books, nor approved by the board of directors. 21 ORM's memorandum dated 13 October 2011 covers lessons learned from ADB's experience with ALB and Bank TuranAlem (now BTA Bank).

Appendix 1 15

OVERVIEW OF THE BANKING SECTOR IN KAZAKHSTAN

1. The key components of the financial system in Kazakhstan are the banking sector, the insurance sector, the securities market, the pension system, and a number of organizations engaged in specific types of banking operations, such as the financial subsidiaries of National Agricultural Holding, sovereign wealth fund Samruk-Kazyna,1 several mortgage organizations, Kazpost, the Central Securities Depository, the Kazakhstan Stock Exchange, and the interbank settlement center of the National Bank of Kazakhstan (NBK).

2. Kazakhstan has a two-tier banking system. The first tier is represented by NBK, which is responsible for the monetary and foreign exchange policies and is the lender of last resort. All other banks belong to the second tier—with the exception of the Development Bank of Kazakhstan,2 which is a government-controlled “policy” bank, has a special status, and belongs to neither tier.

3. There were 39 second-tier banks in January 2011, compared with 38 at the beginning of 2010. 3 Second-tier banks are primarily privately owned commercial banks. However, the financial crisis that started in 2008 forced the state to bail out three banks and make substantial equity investments in others through Samruk-Kazyna. As a result, Samruk-Kazyna holds controlling stakes in BTA Bank (81.5%)4, Temirbank (79.9%)5 and Alliance Bank (ALB, 67.0%)6 since their restructuring, and also owns 21.3% of Kazkommertsbank and 20.9% of Halyk Bank.

4. The Kazakhstani banking system is characterized by a high degree of concentration. As at the end of 2010, the three leading banks accounted for 53.6% of total assets— Kazkommertsbank (20.2%), Halyk Bank (16.8%), and BTA Bank (16.6%). The top five banks (the above institutions as well as Bank CenterCredit and ATF Bank) accounted for 71.8% of total assets, 74.8% of total loans, and 69.8% of total deposits.7

5. Second-tier bank assets totaled $81.6 billion as at end of 2010, 4.1% more than a year earlier.8 Total asset growth suffered a major slowdown—from 96.6% in 2006 to 31.7% in 2007, 1.8% in 2008, and –2.8% in 2009, indicating the vulnerability of the foreign borrowing-based growth model of the banking sector.

1 Samruk-Kazyna plays an important role in the country’s economy, controlling several national development institutions, national companies, and other legal entities, including holding majority stakes in three bailed-out banks. As of June 2010, the assets of Samruk-Kazyna accounted for 71.2% of 2009 gross domestic product. 2 The Development Bank of Kazakhstan is a specialized government institution that finances underdeveloped priority sectors of the economy not connected with natural resources. 3 Agency of the Republic of Kazakhstan for Regulation and Supervision of the Financial Market and Financial Organizations (FSA), 2011: List of Second-Tier Banks as of February 1, 2011. http://www.FSA.kz/attachments/35/245/publish245-1007975381.doc 4 Silk Road Intelligencer (2010). “BTA completes debt restructuring.” http://silkroadintelligencer.com/2010/09/03/bta- bank-completes-debt-restructuring/ 5 Fitch Ratings (2010). “Fitch upgraded rating of Temirbank to level «B-» after restructuring.“ http://www.fitchratings.ru/financial/banks/news/newsrelease/news.wbp?article-id=0478C4A8-E6F3-4C65-9F78- 9B93B05E0FCA 6 Bloomberg (2010). “Kazakh Alliance Bank Completes Debt Restructuring (Update1).” http://www.businessweek.com/news/2010-03-30/kazakh-alliance-bank-completes-debt-restructuring-update1-.html 7 Calculated based on data from FSA, 2011: Two tier banks' financial indicators on 01.01.2011. http://www.FSA.kz/attachments/143/267/publish267-1768299547..xls 8 Calculated based on data from FSA, 2011: Two tier banks' financial indicators on 01.01.2011. http://www.FSA.kz/attachments/143/267/publish267-1768299547..xls

16 Appendix 1

6. Domestic credit began collapsing in the second half of 2007 as the combined result of a bursting real estate bubble, the forced and substantial deleveraging of the banking sector when the international capital markets became closed to Kazakhstani banks, and the global economic slowdown. Annual growth of total gross loans plummeted from 95.7% in pre-crisis 2006 to 48.0% in 2007, 4.2% in 2008, and 4.3% in 2009. In 2010, they decreased by 5.9% after write- offs of 10.6% of the average gross loans.9 Despite strong liquidity inflows from government support programs and other sources, banks remain reluctant to expand lending to the real sector. Total loans accounted for 75.4% of total assets as at the end of 2010, a significant decrease from 83.4% a year earlier.

7. Islamic banking is present in the Kazakhstani banking sector since March 2010, when Al-Hilal Islamic Bank was set up as a 100% subsidiary of the Abu Dhabi government-owned Al- Hilal Bank. The Malaysian government-owned trustee company Amanah Raya Bhd is planning to establish the second Islamic bank in the country in 2011–2012, as a joint venture with the Development Bank of Kazakhstan and the local brokerage company Fattah Finance.10

8. Loan portfolio structure and quality. As of the end of 2010, 72.1% of total loans were to legal entities and 27.9% to individuals; 57.7% were in national currency and 42.3% in foreign currency; 16.4% were short-term and 83.6% long-term. The exposure per sector was largest to trade at 24.0%, followed by construction at 18.1% and industry at 9.4%.11 The exposure to the troubled construction sector represents a significant concentration risk.

9. The substantial concentration of the banks’ loan portfolios by customer and among related parties considerably increases the credit risk.

10. The severe loan portfolio deterioration caused by the global financial crisis has not been reversed yet. As at the end of 2010, the sector-wide nonperforming loan (NPL) ratio12 stood at 32.6%, which is lower than the 36.5% in 2009; however, in absolute terms NPLs increased by 12.3% if the massive write-offs are included in the calculation. At the end of 2009 and 2008, the NPL ratio had been at 8.1% and 1.3% respectively. As at the end of 2010, the NPL ratios of the large banks that underwent restructuring were even higher—66.1% for BTA Bank (down from 78.7% a year earlier mainly as a result of the massive write-offs) and 63.5% for ALB.13

11. International rating agencies believe that the officially reported NPL indicator does not fully reflect the scope of the problem, given the insufficient transparency of the banks' reporting and their inclination to restructure bad loans rather than writing them off or selling them. Fitch estimates that bad loans, including restructured ones, accounted for over 50% of total loans at

9 Calculated based on data from FSA: Information about owned capital, liabilities and assets of financial institutions in the Republic of Kazakhstan]: http://www.FSA.kz/ru/information-for-entities-of-financial-market/banks- sektor/2009-11-09-11-41-37/2009-11-12-05-55-10/2009-11-12-06-04-15 . BTA Bank alone accounts for 79.4% of total write-offs. 10 Kamarul Yunus (2011): “AmanahRaya plans to set up Islamic bank in Kazakhstan.“ http://www.btimes.com.my/articles/amazakh/Article/ 11 Calculated based on data from the National Bank of Kazakhstan: Loans of banks by economy branches for January 1, 2011 http://www.nationalbank.kz/cont/publish734494_6520.pdf 12 FSA defines nonperforming loans as “loans classified as doubtful 5th category plus loss loans plus the actual provisions for homogenous loans.” 13 http://www.afn.kz/en/information-for-entities-of-financial-market/banks-sektor/2009-11-09-11-41-37/2009-11-12-05- 55-10/2009-11-12-06-14-08

Appendix 1 17

YE2010. 14 According to Standard & Poor’s, publicly underreported single-name, economic sector, and related-party exposure concentration implies a higher level of impaired loans.15

12. Deposits and liquidity. Customer deposits reached $46.3 billion as at the end of 2010, 56.7% of total banking sector assets. They increased by 13.7% in 2010, after growing by 30.8% in 2009 in tenge terms—boosted by the February devaluation—and by 17.8% in 2008. Large deposits from Samruk-Kazyna and state-owned enterprises, which continued to have access to the international capital markets, substantially contributed to the improvement of the liquidity position of some major banks during the global financial crisis.

13. As at the end of 2010, deposits from legal entities accounted for 67% of total deposits, while deposits from individuals stood at 33%, approximately the same level as at the end of 2009 and 2008. The majority of deposits (57.3%) were denominated in tenge16. As a result of the very limited credit growth since the second half of 2007, the loan to deposit has significantly dropped from 2.3x as at the end of 2007 to 1.3x as at the end of 2010.

14. Despite the increase in customer deposits, total liabilities decreased by 14.5% in 2010, due mainly to the restructuring of the debt of the defaulted banks.

15. Liquid assets to total assets were at 21.2% as at the end of 2010, having increased by 2% in 2010 and by 7.6% over 2 years. The liquidity ratios exceeded their required minimums by 3–5 times.17 Liquid assets to deposits were at 37.4% compared with 37.0% in 2010 and 35.3% in 2009, reflecting the cautious policy of the banks toward issuing new loans.

16. Capital adequacy. Total equity of the banking sector stood at $8.9 billion as at the end of 2010, 10.9% of total assets, after registering a negative value of $6.6 billion as at the end of 2009 mainly as a result of the vast losses of the three defaulted banks (ALB,BTA Bank, and Temirbank).

17. Overall capital adequacy indicators are compliant with the required minimum as at the end, after the restructuring of the three banks: tier 1 capital to total assets (k1-1) was 11.6% (required minimum: 6%), tier 1 capital to risk-weighted assets (k1-2) was 13.5% (6% required) and total capital to risk-weighted assets (k2) was 17.9% (12% required). As at the end of 2009, the capital adequacy ratios of the banking sector excluding the two defaulted banks also complied with the regulatory requirements, standing at 10.6% (k1-1), 12.6% (k1-2), and 16.7% (k2).18

18. However, the reported levels of capital adequacy are possibly overstated by the large amount of accrued interest in the banks’ balance sheets.19

14 Astana.kz (December 21, 2010): Fitch changed its outlook on Kazakhstan's "positive". http://www.astana.kz/en/node/21201 and Fitch Ratings (June 28, 2010). Kazakh Banks: Return to Health Lags Stronger Macroeconomy. Kazakhstan Special Report. 15 Standard & Poor’s (April 19, 2010). Banking industry country risk assessment: Kazakhstan 16 Calculated based on National Bank of Kazakhstan. 2011. Deposits in banks (by regions) for January 1, 2011. http://www.nationalbank.kz/cont/publish818404_6487.pdf 17 FSA. 2011. Current conditions of the banking sector of the Republic of Kazakhstan in tables and graphs as of January 1, 2011. http://www.FSA.kz/attachments/105/267/publish267-1142014511..pdf 18 FSA. 2011. Current conditions of the banking sector of the Republic of Kazakhstan in tables and graphs as of January 1, 2011. http://www.FSA.kz/attachments/105/261/publish261-821382963..pdf 19 Fitch Ratings (June 28, 2010). Kazakh Banks: Return to Health Lags Stronger Macroeconomy. Kazakhstan Special Report.

18 Appendix 1

19. Profitability. Net income remained under pressure from high provisioning expenses and decreasing interest income from loans as a result of the fall in interest rates and the increase in non-accrual loans. In 2010, the sector demonstrated positive net income of $9.6 billion compared with net losses of $19.2 billion in 2009. However, excluding the three restructured banks that benefited from a vast extraordinary restructuring income, the banking sector suffered net losses of $0.8 billion in 2010, almost the same level as the previous year when excluding the three banks.

20. Excluding the three restructured banks, return on assets and return on equity before income tax were –1.2% and –10.6% in 2010, slightly less negative than –1.4% and –12.6% in 2009. In 2007, these indicators had been 1.4% and 10.9%.

21. Ratings. In 2010, the international rating agencies started revising their views on Kazakhstani banks, acknowledging improvements in the macroeconomic environment, liquidity, and capitalization as well as the successful restructuring of the three defaulted banks. However, all the rated banks remain in the highly speculative B category, except for the foreign-owned ATF (BBB), Sberbank (BBB-) and VTB Bank (BBB-), and there is very limited potential for significant further rating upgrades in the short term. 22.

Last Available Issuer Outlook Issuer Default Rating Alliance Bank B- Stable ATF BBB Positive BCC B Stable BTA Bank B- Stable Eurasian Bank B- Stable Halyk Bank B+ Stable Kaspi Bank B- Stable Kazkommertsbank B- Stable Sberbank BBB- Stable Temirbank B- Stable VTB Bank (Kazakhstan) BBB- Stable Source: Fitch Ratings, Silk Road Intelligencer, Bank websites.

23. Regulatory update. The Deposit Insurance Fund currently guarantees deposits by natural persons of up to circa $33,800. From 1 January 2012, this amount will be reduced to circa $6,800. 20 The Deposit Insurance Fund issues recommendations on the interest rates offered by banks on deposits to natural persons. In April 2010 the recommended rates were reduced from 11.5% to 10.0% for deposits in national currency and from 8.0% to 7.0% for deposits in foreign currency.21

24. Regulations for the development of Islamic banking in Kazakhstan were adopted in 2009.

20 Anna Melnikova. 2010. The state reduces compensation for guaranteed deposits. http://profinance.kz/2010/05/19/iyolbyoe-yosbn-epinshhnsn-ibbsebx-lnpse.html 21 Kazakhstan Deposit Insurance Fund. Recommended deposit interest rates. http://kdif.kz/ru/recommended_rates

Appendix 1 19

25. On 2 September 2010, FSA proposed to introduce the following new requirements for banks: (i) limiting share ownership by individuals and legal entities to 25% of a bank’s capital except for shares owned through banking holdings; (ii) limiting a bank's investment in shares of financial organizations to 10%; (iii) restricting a bank's investment in shares of nonfinancial organizations except for those providing banking-related services (such as encashment, securitization, etc.); (iv) limiting a bank's investment in the parent bank’s shares; (v) limiting the number of representatives of the parent bank on the boards of directors of its subsidiaries to one-third; (vi) restricting lending to related parties except for those who are participants in the banking conglomerate. The limitations on investments will be effective from 1 January 201322.

26. To facilitate the write-off of NPLs, the government intends to amend the tax code that exempts provision income from taxation. Other rules that make it challenging to manage NPLs are: (i) Kazakhstani laws do not allow banks to establish special-purpose vehicles to manage NPLs efficiently and (ii) banks are prohibited from taking an equity position in nonbanks, which makes it impossible for them to convert their NPLs into equity.

27. FSA plans to introduce several new requirements for banks in line with the Basel III global standard from 2013: (i) “core capital” will include issued common shares and reserves; (ii) perpetual financial instruments and preference shares will be excluded from tier 1 capital; (iii) the limitation that tier 2 capital cannot exceed tier 1 capital will be removed; (iv) tier 2 capital will include dynamic reserves of up to 1.25% of risk-weighted assets, perpetual financial instruments, preference shares, and subordinated debt; and (v) tier 3 capital will disappear.23

28. Effective 12 April 2011 by a decree of the President of the Republic of Kazakhstan, the powers and functions of FSA and of the Agency for Regulation of Activities of the Regional Financial Center for Almaty were transferred to the central bank. Pursuant to the decree, NBK is now responsible for functions previously performed by FSA, such as licensing and regulation of financial organizations (banks, insurance companies, pension funds, etc.), oversight of joint stock companies, and regulation of the securities market. NBK will also be responsible for the development and regulation of the Regional Financial Center of Almaty. In addition, NBK continues to be the country’s central bank.

29. Industry outlook. The banking sector is expected to gradually continue its recovery from the crisis, though more slowly than the real economy.24 NBK does not expect growth in lending before 2012. According to NBK, new loans issued in 2011 will be offset by current loan repayments and write-offs. In 2012–2013, loans are expected to grow by 10% per annum. In the medium term, profitability is expected to be constrained by higher interest expenses, operating costs, and provisions compared with pre-crisis levels. NBK expects overall deposits to increase by 19.5% in 2011, 13.1% in 2012 and 11.9% in 2013. The official refinancing rate will probably increase from 7% in 2010 to 8% in 2011–2013.

22 Kazkommertsbank. Kazakhstan Financial Review, August 2010. http://en.kkb.kz/attach/KazakhstanInBrief/Kaz_Fin_Review_Aug_2010.pdf 23 Kazkommertsbank. Kazakhstan Financial Review, December 2010. http://en.kkb.kz/attach/KazakhstanInBrief/Kaz_Fin_Review_Dec_10.pdf 24 Standard & Poor’s (April 19, 2010). Banking Industry Country Risk Assessment: Kazakhstan.

20 Appendix 2

PRIVATE SECTOR DEVELOPMENT INDICATORS AND RATINGS: FINANCIAL INTERMEDIARIES

Indicator Rating Justification 1. Beyond Intermediary and Subborrower Impacts 1.1 Private sector expansion and Satisfactory As a result of the deleveraging of the institutional impact economy, the banking sector has shrunk. ALB’s total assets have 1.1.1. Contributes to an increased private decreased from its height in 2007 of sector share and role in the economy, T1,160 billion to T427 billion in 2010 and to sustainable jobs and total loans decreased from KZT819 billion in 2007 to KZT251 billion in 2010. However, ALB is on track to reach its target growth rates. Under its strategic goals, it aims to achieve the following by 2013: (i) market share of 11.2% in retail lending and 10.7% in SME lending; (ii) market share of 9.3% in retail deposits and 4% in corporate deposits; and (iii) return on assets of 4%, return on equity of 19%, net interest margin of 7%, and a cost– income ratio of 41%.

1.1.2. Contributes to expanded SME Loans made to SMEs have increased lending from T25 billion in 2009 to T30 billion in 2010. The target of SME sector financing for 2011 is T52 billion.

Through its network of branches, ATMs, 1.1.3. Contributes to institutional change and cash offices, ALB is able to deliver by improving supply and access generally its services across Kazakhstan. to formal credit and banking service to SMEs ADB’s participation and support in 1.1.4 Contribution to the growth of viable ALB’s debt restructuring brought some financial institutions and financial market measure of stability to the fragile development finance sector during 2008–2009.

1.2. Competition. Contributes to new Satisfactory ALB’s development strategy is to grow competition for SME business among its market share of SME business to local banks (including new product and 10.7% in 2013. As at April 2011, ALB service offerings, local currency products) had an 8% market share with a portfolio size of T108 billion. ALB is currently ranked No. 5 in financing for the SME sector; the top four are Kazkommertsbank, AFT Bank, BTA Bank, and Bank CenterCredit. 1.3. Innovation. Contributes to new ways Satisfactory The products offered to SMEs are of offering effective banking services to overdrafts, working capital, and short- SMEs (including new products, services, term loans. To increase its market and technologies) in ways that are share, ALB has reduced the interest replicated by other banks and in the rates on these products and increased financial system the size of the overdraft and/or loan.

Appendix 2 21

Indicator Rating Justification In addition, ALB participates in government programs to boost economic activities and growth. So far, ALB has participated in Damu I, II, and III Tranches, Damu Ondyrys, and Damu Regions II. Damu I, II, and III are targeted solely at companies in the SME sector. 1.4. Links. Contributes to local savings Satisfactory Depositors’ confidence in ALB has and deposits mobilization via network of returned since restructuring. Customer branches and contribution to notable deposits, which suffered a dip in 2008– upstream or downstream link effects to 2009, have increased. At the end of subborrowers’ businesses in their 2010, customer deposits stood at T208 industries or the economy billion, an increase of 36% on 2009 figures. 1.5. Catalytic element. Contributes to Satisfactory ADB’s loan assistance to ALB had a mobilization of other local or international certain catalytic effect on bringing in financing to SMEs, and to positive more financing opportunities for ALB. demonstration to market providers of debt However, it is not clear if the funds and risk capital to SMEs provided by ALB’s lenders were targeted at the SME sector. 1.6. Affected laws, frameworks, Satisfactory ALB is in constant dialogue with NBK regulation. Contributes to improved laws, and provides feedback and opinions on regulation, and inspection affecting formal laws and regulations to be introduced or SME banks and banking services to promulgated by NBK. For example, SMEs in the local financial system ALB has given positive feedback to NBK and other government agencies on improving the tax regime and changing laws to allow a more efficient management of nonperforming loans. 1.7. Wider demonstration of new Partly satisfactory After restructuring, ALB has taken standards. Contributes to raised positive steps to overhaul its corporate standards in corporate governance, governance standards to make it more transparency, and stakeholder relations transparent, and raised accountability standards among the board of directors and the management board. 2. Direct Participant Bank And Subborrower Impacts with Wider Potential 2.1. Skills with wider impact potential. Partly satisfactory After restructuring, ALB made major changes to its risk management system Contributes (i) to improved SME credit to be in line with international practices. approach at all stages in the participant A system of checks and balances is bank(s) in ways that will be replicated by now in place at all levels. other providers of SME finance and banking service; and (ii) via the participating bank(s) to improved subborrower skills in operation of their businesses, e.g., via good appraisal and monitoring by the bank(s)

2.2. Demonstration and new Partly satisfactory After restructuring, major improvements standards-setting potential in corporate governance and stakeholder relations were made with Demonstrates potential through improved the installation of a new management

22 Appendix 2

Indicator Rating Justification and achieved standards in corporate team. Currently,there is no governance and transparency, environmental management system in stakeholder relations, and ESHS spheres place. However, ALB confirmed compliance of its sub-borrowers with the local Kazakhstani environmental law.

Overall Private Sector Development Satisfactory Rating ALB = JSC Alliance Bank, ATM = automated teller machine, ESHS = environmental, social, health, and safety, NBK = National Bank of Kazakhstan, SMEs = small and medium-sized enterprises.

Rating scale: Excellent, satisfactory, partly unsatisfactory, and unsatisfactory. The rating is not an arithmetic mean of the individual indicator ratings, and these have no fixed weights. It considers already manifest actual impact (positive or negative) and the potential for impact as well as risk to its realization.

Appendix 3 23

PROJECT-RELATED DATA

A. Introduction

1. Alliance Bank (ALB) was established in 1993 as IrtyshBusinessBank. It was a regional commercial bank in Pavlodar, Northern Kazakhstan. In 1999 it merged with Semipalatinsk Municipal Joint Stock Bank. In 2001, Seimar Investment Group purchased a 37% stake in the bank and the bank was renamed Alliance Bank.

2. Under Seimar’s leadership ALB experienced impressive growth and in 2007 became the fourth-largest bank in Kazakhstan by total assets. Its assets stood at $9.7 billion in 2007. In July 2007, ALB conducted an initial public offering and listed its shares both in Kazakhstan and on the London Stock Exchange.

3. In April 2009, ALB entered into debt restructuring negotiations with its creditors after failure to fulfill its loans repayment obligations. Many factors contributed to the payment default, chief among them the poor asset quality and fraudulent transactions involving US Treasury bonds.1 The poor asset quality was due to the lack of good credit policy and assessment. The majority of corporate loans were made to parties related to shareholders, and there was overconcentration in lending to the real estate and construction sectors. These sectors collapsed during the global economic crisis that began in late 2008. Many of the loans were also made to speculative projects. Hence, nonperforming loans (NPLs) ballooned to 54% in 2009.

4. In March 2010, ALB concluded its debt restructuring with the support and assistance of the Government of Kazakhstan and all its creditors. Samruk-Kazyna, the sovereign wealth fund, became the largest shareholder after injecting T24 billion for 67% of the common shares and T105 billion for 67% of the preference shares. ALB's external debt was reduced by 77.8% from $4.5 billion to $1.08 billion, and financing terms were extended from 7 to 20 years. ALB's capital adequacy ratio is now within Kazakhstani regulatory requirements. Samruk-Kazyna has committed to continue to support ALB until a strategic investor is found.

B. Business Strategy and Operations after Restructuring

5. ALB provides products and services of a commercial bank, including loans, deposits, settlement, guarantees, and foreign currency exchange to corporate and retail customers. Its services are delivered through a network of branches, cash offices, and ATMs across 53 cities in Kazakhstan. Since restructuring, the network has been optimized to deliver better service at less cost. The number of branches was reduced from 21 to 19, cash offices from 176 to 108, and ATMs from 1,125 to 929. The number of employees has been trimmed from 5,536 in 2008 to 3,553 (as at 1 July 2011) as part of ALB’s overall operational efficiency exercise. The bank has two 100%-owned subsidiaries, one in the Netherlands, the other in the Russian Federation, both with the sole objective of raising funds for ALB in capital markets internationally and in Russia.

6. In March 2010, the board of ALB approved the bank's development strategy for 2010– 2013, which clearly defines the business goals. These include development in three core areas: (i) sustainable assets and deposit growth; (ii) improvement and strengthening of risk management and corporate governance; and (iii) efficient management of NPLs.

1 ALB pledged United States Treasury securities for guarantees issued to companies related to a former shareholder. These guarantees were provided by offshore banks. These transactions which amounted to $1.1 billion were neither recorded in ALB’s books nor authorized by the board of directors.

24 Appendix 3

7. ALB aims to achieve a well-balanced and profitable loan portfolio of 51% retail, 28% SME, and 20% corporate loans, and to become a leading lender in the retail and SME sectors.

8. Under the bank’s development plan, the major strategic goals to be achieved by 2013 are: (i) market share of 11.2% in retail lending and 10.7% in SME lending; (ii) market share of 9.3% in retail deposits and 4% in corporate deposits; (iii) return on assets of 4%, return on equity of 19%, 7% net interest margin, and 41% cost–income ratio.

9. ALB is trying to regain market share and has stepped up its marketing efforts to attract customers, both in loan lending and deposit taking. It has launched seven secured and two unsecured loan products to meet the demands of retail customers. In the SME sector, ALB is participating in government programs targeted at SME customers. Boosted by the confidence of Samruk-Kazyna as a major shareholder, customer deposits have increased since restructuring. In the first quarter of 2010, customer deposits totaled $509 million, which has risen by 82% to $929 million in the second quarter of 2011.

10. Efficient management of NPLs is also one of the strategic goals of ALB. The loan portfolio is segregated into “Good Bank” and “Bad Bank”. As of 1 July 2011, the “Bad Bank” loan portfolio was 64% of the total portfolio and had a 96% provision level. The “Bad Bank” is managed by a workout team comprising 113 dedicated specialists in the corporate department and 260 dedicated specialists in the retail department.

11. In terms of risk management and corporate governance, the system was substantially overhauled after lessons learned from the restructuring. The changes are explained in detail in the following paragraphs.

C. Ownership and Shareholding Structure

12. Until February 2009, the major shareholder in ALB was Seimar Alliance Financial Corporation, which owned 76%. On 30 December 2009, the FSA forced the transfer of all outstanding shares of ALB to Samruk-Kazyna, which became a 100% shareholder. On 30 March 2010, Samruk-Kazyna converted T105 billion of the debt owed to it by ALB into convertible preference shares and recapitalized ALB by subscribing to additional common shares with a T24 billion cash injection. At the close of the restructuring, Samruk-Kazyna had become a 67% shareholder and creditors received the remaining 33% of shares.

D. Organizational Structure

13. Please refer to Appendix 4, Table A4.1 for ALB’s organizational structure. The structure has undergone substantial changes since Samruk-Kazyna became the major shareholder.

14. The board of directors comprises 6 directors, of which 3 are appointees from Samruk- Kazyna, 2 are independent, and 1 represents the bank. The board is responsible for issues relating to strategy, risk management and control, funding, staffing, and internal audit. The board meets every month, and three specialized committees report directly to it: audit, risk and debt committee; strategic planning and corporate governance committee; and personnel and remuneration committee. The committees meet monthly.

15. The management board performs the executive functions of the bank and reports to the board of directors. It is headed by the chairman, who is also a member of the board of directors and is assisted by three deputy chairmen, a chief financial officer, two vice-presidents, three managing directors, and two advisors, each in charge of an ALB department.

Appendix 3 25

E. Corporate Governance

16. In March 2010, ALB adopted a new corporate governance code that set out the role and responsibilities of the board of directors, the establishment of committees, the principles of risks and control, the system of internal control and risk management, the requirement for financial reporting and capital management, the quality of the management information system, and rules on providing information and reporting to shareholders.

17. Based on the corporate governance code, ALB undertook a major overhaul of its internal systems to ensure transparency with built-in checks and balances in all aspects of operations.

F. Risk Management

18. The risk management system in ALB has been substantially overhauled since Samruk- Kazyna became the major shareholder and also draws on the experience and lessons learned when going through the debt restructuring.

19. The major risks for ALB relate to market risk, credit risk, and liquidity risk.

20. Risk management policies and procedures. The risk management policies aim to recognize, analyze, and manage the risks for ALB by setting adequate risk limits and controls. These are constantly monitored to ensure adherence and compliance.

21. The board of directors has overall responsibility for the oversight of the risk management framework, supervising the management of key risks and reviewing risk management policies and procedures as well as approving significant exposures.

22. The management board is responsible for monitoring and implementing risk mitigation measures and making sure that ALB operates within the established risk parameters. The head of risk service (Risk Department and Collateral Department) is responsible for the overall risk management and compliance functions, ensuring the implementation of common principles and methods of identifying, measuring, managing, and reporting both financial and nonfinancial risks. He or she reports directly to the chairman of the management board and indirectly to the board of directors.

23. Credit, market, and liquidity risks at portfolio and transactional levels are managed and controlled through a system of credit committees and an asset and liability management committee (ALCO). To engender efficient decision making, ALB established a hierarchy of credit committees depending on the type and amount of the exposure.

24. Both external and internal risk factors are determined and managed throughout the organization. Particular attention is given to developing risk maps that are used to define the full range of risk factors and serve as a basis for determining the level of assurance over the current risk mitigation procedures. Apart from the standard credit and market risk analysis, the Risk Department monitors other financial and operational risks by holding regular meetings with operational units to obtain expert judgments in their areas of expertise.

25. Market risk. Market risk refers to the risk where movements in market prices (which include foreign exchange rates, interest rates, credit spreads, and equity prices) will have an effect on the income or value of portfolios. Market risk comprises currency risk, interest rate risk, and other price risks. Market risk arises from open positions in interest rate, currency, and equity financial instruments. These open positions are subjected and exposed to general and specific market movements and changes in market prices.

26 Appendix 3

26. The objective of market risk management is to manage and control market risk exposure within acceptable parameters while optimizing the return on risk.

27. Overall authority on market risk is vested in ALCO, which is chaired by the Chief Financial Officer. Market risk limits are approved by ALCO based on recommendations of the Risk Department (Market Risk Management Division) and subsequently agreed by the board of directors.

28. ALB manages its market risk by setting open position limits in relation to financial instruments, interest rate maturity, and currency positions and stop-loss limits. These are monitored on a regular basis and reviewed and approved by the two boards.

29. In addition, ALB uses a wide range of stress tests to model the financial impact of a variety of exceptional market scenarios on individual trading portfolios and the overall position.

30. Credit risk. The risk of a financial loss to the bank if a customer or counterparty to a financial instrument fails to meet its contractual obligations is classified as credit risk. ALB has policies and procedures for the management of credit exposures, including guidelines to limit portfolio concentration. The responsible credit committee actively monitors the credit risk.

31. The bank’s credit policy is reviewed and approved by the Board of Directors and establishes (i) procedures for review and approval of loan credit applications, (ii) methodology for credit assessment of both individual and corporate borrowers, (iii) methodology for credit assessment of counterparties, issuers, and insurance companies, (iv) methodology for the evaluation of collateral, (v) credit documentation requirements, and (vi) procedures for the ongoing monitoring of loans and other credit exposures.

32. Corporate loan credit applications are originated by the relevant client managers and are then passed on to the Department of Corporate Business. Analysis reports are based on structured analysis focusing on the customer’s business and financial performance. The loan credit application and the report are then independently reviewed by the Risk Department (Credit Risk Management Division) and a second opinion is given accompanied by a check that credit policy requirements are met. The credit committee reviews the loan credit application based on submissions by the loan and the risk departments, the legal opinion, the conclusion of the Security Department., the Collateral Department’s evaluation, collateral report and independent assessment of the company / credit applicant.. Individual transactions are also reviewed by the legal, accounting, and tax departments depending on the specific risks.

33. ALB continuously monitors the loan portfolio by conducting credit reviews of the borrowers and updating the value of the collaterals through appraisal done by independent companies or internal specialists. In the event of a drop in market prices, the borrower is usually requested to come up with additional security.

34. The Retail Lending Division reviews the retail loan credit applications via scoring models and application data-verification procedures developed with the Risk Department.

35. Liquidity risk. Liquidity risks refer to the risk for the bank in the event of not being able to raise funds to meet its commitments and exist when the maturities of assets and liabilities do not match.

36. ALB aims to ensure that funds will be available at all times to honor all cash-flow obligations as they become due. The management board reviews and approves the liquidity policy.

Appendix 3 27

37. ALB seeks to support a diversified and stable funding base comprising debt securities in issue, long-term and short-term loans from banks, core corporate and retail customer deposits, and a diversified portfolio of highly liquid assets so as to respond quickly and smoothly to unforeseen liquidity requirements.

38. The Treasury Department receives information from the business units on the liquidity profile of their financial assets and liabilities, and details of projected cash flows arising from the projected future business. Based on this information, the Treasury Department will ensure that sufficient liquidity is maintained at all times.

39. The Risk Management Department monitors the daily liquidity position and performs regular liquidity stress tests. Under normal market conditions, liquidity reports are presented to senior management on a weekly basis. Decisions on liquidity management are made by ALCO and implemented by the Treasury Department.

40. ALB also calculates mandatory liquidity ratios on a daily basis in accordance with the requirement of the central bank. It was in compliance with these ratios as at 31 December 2010.

G. Anti-Money-Laundering Policies

41. ALB has a manual on combating money laundering and the financing of terrorism. These policies and procedures are applied across all branches and subsidiaries. Essentially, the manual covers (i) customer identification, i.e., Know Your Customer rules; (ii) prevention, detection, and reporting of suspicious transactions; and (iii) record keeping and the relationship with politically exposed persons.

42. Reports on cash deposits and withdrawals exceeding $40,000 and offshore transfers above $13,000 are automatically generated and submitted to the Financial Monitoring Committee of the Ministry of Finance. In addition, suspicious transactions are reported within 24 hours. Specialized anti-money-laundering software has been integrated in the Athena core banking system. Customers are cross-checked against blacklists received on a regular basis from Dow Jones and the central bank. The compliance controller reports directly to the board of directors.

43. Since the anti-money-laundering law came into force in March 2010, all staff concerned have had requisite training and new staff receive an introduction to anti-money-laundering rules and the combating of terrorist financing. No money-laundering cases have been detected so far.

28 Appendix 4

Table A4.1: Organizational Structure of JSC Alliance Bank

Appendix 4 29 Appendix 429

Source: ALB

30 Appendix 5

Table A5.1: Restructuring Package Due to ADB ($)

Recognized Value in ADB's Nominal Amount books in April 2010 Cash 4,218,086.00 4,218,086.00 Dollar Discount Notes 7,358,423.00 7,358,423.00

Recovery Notes 11,577,000.00 1,273,470.00 GDRs for Preferred Shares 324,720.00 GDRs for Common Shares 180,236.00 1,580,512.28 Total Amount recognized in ADB's books 14,430,491.28

Amount of Original Debt Written Off 19,618,064.97 Total 34,048,556.25

Principal outstanding of Outstanding Amount of Debt as of Default Date $34,048,556.25 $33.3 million and accrued interest of $748,556.25 Amount of Outstanding Debt Restructured into $14,430,491.28 42.38% New Instruments Amount of Outstanding Debt Written Off $19,618,064.97 57.62%

100.00% ADB = Asian Development Bank, GDR = global depository receipt. Source: ADB

Table A5.2: Key Terms and Conditions of the Financial Instruments

Dollar Discount Security/Instrument Recovery Notes GDRs for Preferred Shares GDRs for Common Shares Notes ISIN ISIN XS 0495755562 ISIN XS 0495755729 ISIN US 0185316082 ISIN US 0185315092 Luxembourg Stock Luxembourg Stock Listed at Luxembourg Stock Exchange Luxembourg Stock Exchange Exchange Exchange Listing on 25-Jun-10 25-Jun-10 02-Sep-10 02-Sep-10 Currency USD USD USD USD Nominal Amount 7,358,423 11,577,000 324,720 180,236 Tenor 7 years n/a Grace Period on Principal 4 years n/a Principal Repayments 3 years n/a Interest Rate / Dividend Rate 10.50% 4% of Subscription Value n/a Subject to a 4% per annum

Interest Payment Semiannual payments cumulative dividend n/a Interest Payment Calculation basis of a 360-day n/a n/a Details year, 30-day month 6 equal semiannual Principal Repayments n/a n/a installments

1 GDR is equal to 1/40th of a 1 GDR is equal to 1/4 of a common Conversion of GDRs into Shares preference share or 40 GDRs equal share or 4 GDRs equal to 1 common 1 preference share share

Preference shares may be converted If the recovery notes have not into common shares on a 1:1 basis

Other Conditions been paid within 7 years, the at any time on 10-business-day May be paid ahead of payments will stop and the notice to the bank. schedule (prepaid) residual will be valued. The depending on payments of residual value will be evenly A

recovery notes split and paid in 3 equal Drag-along/tag-along rights with Samruk-Kazyna (SK): Prior to any proposed ppendix 531 installments payable on the sale of its shares, SK shall procure that any third-party purchaser interested 12th, 24th, and 36th month. in buying SK's shares also make an offer to buy the pro-rata amount of common shares and/or preference shares of all bank creditors. Source: ADB GDR = global depository receipt. n/a= not applicable

32 Appendix 6

Table A6.1: Comparative Financial Statements

Balance Sheet Name of Bank: Joint Stock Company Alliance Bank

Year ended: December 31 2010 2009 2008 2007 2006 2005 (T million) Loans

Customer loans 622,238.00 697,882.00 703,265.00 862,721.00 640,913.00 187,652.00

(Loan loss reserves) (370,411.00) (454,175.00) (269,790.00) (43,527.00) (21,113.00) (7,555.00)

Customer Loans, Net 251,827.00 243,707.00 433,475.00 819,194.00 619,800.00 180,097.00 Other Earning Assets

Deposits with the central bank 56,663.00 20,563.00

Interest-bearing deposits & placements with other banks 700.00 2,702.00 6,450.00 37,079.00 14,984.00 24,104.00

Government securities 100,880.00 67,276.00

Trading securities 10,368.00 11,247.00 3,658.00 155,620.00 48,748.00 16,045.00

Investment securities 57,208.00 97,131.00 1,422.00 3,057.00 5,219.00 8,896.00

Derivative financial instruments - 32,272.00 22,487.00 2,216.00 Investment in unconsolidated subs and affiliates

Pledged assets (earning assets) 56,339.00 5,648.00 167,362.00 1,513.00 2,676.00 Other earning assets

TOTAL EARNING ASSETS 376,442.00 360,435.00 644,639.00 1,038,950.00 848,510.00 319,657.00

Fixed assets, net 21,912.00 23,750.00 32,665.00 29,613.00 12,520.00 1,999.00 Other Non-Earning Assets

Cash and non-interest bearing deposits 10,874.00 9,160.00 52,571.00 20,698.00 48,546.00 7,842.00

Pledged assets (non-earning assets) - Foreclosed properties

Year ended: December 31 2010 2009 2008 2007 2006 2005 (T million) - 264.00 225.00 3,539.00

Intangible assets, net 1,188.00 1,262.00 1,532.00 1,436.00 262.00 182.00

Deferred income tax assets 468.00

Other assets 17,168.00 24,487.00 16,637.00 70,009.00 7,373.00 2,610.00

TOTAL ASSETS 427,584.00 419,094.00 748,308.00 1,160,931.00 920,750.00 332,758.00 Deposits & Money Market Funding

Local currency customer deposits 189,545.00 135,794.00 140,353.00 197,397.00 194,312.00 138,083.00

Foreign currency customer deposits 19,253.00 17,982.00 48,691.00 44,420.00 50,949.00

Due to banks 32,770.00 10,807.00 Other money market funds

TOTAL DEPOSITS & MONEY MARKET FUNDING 208,798.00 153,776.00 189,044.00 241,817.00 278,031.00 148,890.00 Other Liabilities

Derivative financial instruments 332.00 19.00 50,168.00 6,280.00 18.00 -

Deferred income tax liabilities 1,554.00 1,100.00 -

Non-interest bearing payables 8,239.00 13,017.00 143,934.00 5,167.00 4,766.00 889.00 Other Money-Market Funding

Domestic short-term borrowings 67,660.00 155,610.00 102,574.00 88,767.00 23,102.00 6,291.00

Foreign short-term borrowings 551,636.00 448,008.00 154,634.00 28,575.00 957.00

Long-Term borrowings: A ppendix 633 Bank borrowings 17,357.00 22,613.00 - 163,293.00 308,356.00 88,862.00

Debt issues / bonds 145,806.00 - 305,646.00 164,150.00 53,488.00

Other borrowings (sub-debt, hybrid capital) 22,152.00 48,194.00 35,140.00 27,913.00 14,253.00 5,349.00 TOTAL LIABILITIES

34 Appendix 6

Year ended: December 31 2010 2009 2008 2007 2006 2005 (T million) 470,344.00 944,865.00 968,868.00 995,071.00 822,351.00 304,726.00

Subordinated debt 62,275.00 - 6,620.00 6,885.00 18,361.00 -

Hybrid capital ------

Common stock (including capital surplus) 121,597.00 97,602.00 97,602.00 97,602.00 61,235.00 24,904.00

Perpetual non-cumulative preferred stock 152,715.00

Retained earnings (290,570.00) (625,099.00) (326,776.00) 59,297.00 16,468.00 2,433.00 Less: Treasury shares Reserves

Disclosed reserves (84,955.00)

Revaluation reserves (3,822.00) 1,726.00 1,994.00 2,076.00 2,335.00 695.00 Minority interest Others

TOTAL EQUITY (105,035.00) (525,771.00) (227,180.00) 158,975.00 80,038.00 28,032.00

TOTAL LIABILITIES and CAPITAL 427,584.00 419,094.00 748,308.00 1,160,931.00 920,750.00 332,758.00

Exchange Rate 147.43 148.38 120.79 120.30 127.00 133.77 Source: ALB

Income Statement Name of Bank: Joint Stock Company Alliance Bank

Year ended: December 31 2010 2009 2008 2007 2006 2005 (T million)

Interest income 44,381.00 85,189.00 166,086.00 181,768.00 80,193.00 17,858.00

Interest expense (39,990.00) (81,548.00) (100,677.00) (92,889.00) (40,350.00) (11,604.00)

Net Interest Income 4,391.00 3,641.00 65,409.00 88,879.00 39,843.00 6,254.00

Fee and commission income 4,531.00 7,452.00 12,817.00 12,629.00 6,019.00 2,942.00

Fee and commission expense (409.00) (518.00) (24,584.00) (10,508.00) (3,390.00) (440.00)

Net Fee And Commission Income 4,122.00 6,934.00 (11,767.00) 2,121.00 2,629.00 2,502.00

Foreign exchange income, net 16,202.00 (52,417.00) 13,989.00 (10,748.00) (1,138.00) (36.00)

Trading income, net 2,460.00 (63,779.00) (31,307.00) 16,066.00 3,114.00 922.00 Dividend income

Other operating income (1,337.00) (1,027.00) 1,717.00 108.00 853.00 846.00

TOTAL OPERATING INCOME 25,838.00 (106,648.00) 38,041.00 96,426.00 45,301.00 10,488.00 Less Operating Expenses:

General and administrative expenses (9,011.00) (8,658.00) (8,035.00) (10,185.00) (5,403.00) (2,063.00)

Personnel expenses (7,724.00) (8,438.00) (10,055.00) (9,252.00) (4,443.00) (1,581.00)

A Depreciation (2,678.00) (3,253.00) (3,033.00) (2,238.00) (696.00) (271.00) ppendix 635

Other operating expenses (759.00) (273.00)

PRE-PROVISION INCOME 6,425.00 (126,997.00) 16,918.00 74,751.00 34,000.00 6,300.00

Loan loss provision 4,973.00 (166,461.00) (242,273.00) (25,571.00) (14,032.00) (4,921.00)

36 Appendix 6

Year ended: December 31 2010 2009 2008 2007 2006 2005 (T million)

INCOME AFTER LOAN LOSS PROVISIONS 11,398.00 (293,458.00) (225,355.00) 49,180.00 19,968.00 1,379.00

Other provisions (496.00) (8,381.00) (164,147.00) 79.00 (356.00) (139.00)

Other nonoperating income 326,842.00 3,967.00 3,712.00 8,056.00 - -

Share of earnings of associate

Other nonoperating expense (3,310.00) (543.00) (766.00) (726.00)

PRETAX INCOME 334,434.00 (298,415.00) (386,556.00) 56,589.00 19,612.00 1,240.00

Taxes (25.00) 346.00 (13,906.00) (5,602.00) 356.00 Extraordinary items, net Minority interest

NET INCOME 334,434.00 (298,440.00) (386,210.00) 42,683.00 14,010.00 1,596.00 Income Distribution Adjustments Cash Dividends:

Common shares (declared) - - -

Preferred shares 1,280.00 49.00

To retained earnings 334,434.00 (298,440.00) (386,210.00) 42,683.00 12,730.00 1,547.00

Additional capital reconciliation items

Exchange Rate 147.43 148.38 120.79 120.30 127.00 133.77 Source: ALB

Appendix 7 37

Table A7.1: List of Lenders

Issuance Original Debt outstanding Lenders to JSC Alliance Bank Date Amount at 8 October 2009 Bilateral Loans European Bank for Reconstruction and Development—Kazakhstan Small Business 26 Jan 2006 $5,000,000 $2,000,000 Programme

European Bank for Reconstruction and 09 Mar 2006 $10,000,000 $6,666,667 Development—Small and Medium Enterprises Morgan Stanley 25 Apr 2006 T13,500,000,000 T13,500,000,000

Wachovia Bank, National Association 11 May 2006 $16,000,000 $8,000,000

Asian Development Bank 15 Jun 2006 $50,000,000 $33,300,000

JP Morgan Chase Bank N.A. 21 Aug 2006 T8,567,400,000 T8,567,400,000 DEG – Deutsche Investitions- und 24 May 2007 $22,500,000 $22,500,000 Entwicklungsgesellschaft—subordinated loan

DEG – Deutsche Investitions- und 22 Jun 2007 $22,500,000 $22,500,000 Entwicklungsgesellschaft—senior loan Morgan Stanley & Co International 27 Jun 2007 ¥18,375,000,000 ¥18,375,000,000

National City 31 Oct 2007 $30,000,000 $30,000,000

Syndicated Loans

Standard Bank 01 Nov 2006 $300,000,000 $20,583,333

Calyon Bank 19 Mar 2007 $150,000,000 $65,000,000

Sumitomo Mitsui Banking Corporation Europe 13 Jun 2007 $400,000,000 $223,500,000

Source: ALB

38 Appendix 8

SUPPORTING COMPUTATIONS Table A8.1: Weighted Average Cost of Capital Computation

Market value of equity (T million) 251 Market value of debt (T million) 261,546 Cost of equity, as indicated in ORM's 18 August 2010 16.50% memo on "Cost of Equity" Cost of debt 5.23% Effective tax rate 0.00% WACC 5.24%

Cost of Debt Computation (in T million) Interest expense: 2010 Debt securities issued 16,123 Subordinated debt 6,259 Loans from banks 2,443 Loans from Government of Kazakhstan 1,550 Amounts payable under repurchase agreements 1,154 Total Interest Expense 27,529 Average Debt 526,318 Cost of Debt 5.23%

Market Value of Debt Computation: 2010 Due to banks and other financial institutions - Derivative fin liab 332 Deferred income tax liabilities - Non-interest bearing payables 8,239 Domestic short-term borrowing 67,660 Foreign short-term borrowing - Bank borrowings 17,357 Debt issues/bond 145,806 Other borrowings 22,152 Total Debt without Customer Deposits 261,546

Effective Tax Rate Computation: 2010 Income tax for the year - Profit before income tax 334,434 Effective tax rate 0.00%

Assumed Terminal Value of Alliance Bank Preference Common Total Issued or outstanding number of shares, 2010 Audited FS, 261962600.00 Note 9, p. 30 1363756300.00 Price per share as converted from GDR price as at 0.25 0.125 31 August 2011 Value of issued shares in actual US$ 654906.50 1704695.375 1,711,244 Exchange rate US$ to tenge 147 Value of shares in T 251,039,559

FS = financial statement, GDR = global depository receipt, ORM = Office of Risk Management, WACC = weighted average cost of capital. Source(s): ADB