Policy Studies Series [PS/01/2018] Banking Sector Monitoring Georgia 2018 Ricardo Giucci, Alexander Lehmann, Giorgi Mzhavanadze, Anne Mdinaradze German Economic Team Georgia in cooperation with Berlin/Tbilisi, March 2018 © German Economic Team Georgia / Berlin Economics I. Banking sector and financial markets in Georgia 1. Banking sector vs capital markets in Georgia 2. Regional comparison © German Economic Team Georgia / Berlin Economics 2 1. Banking sector vs capital markets in Georgia Market capitalisation and banking sector assets Banking sector • Good progress in deepening % of GDP Market capitalisation* Banking sector assets 100 88.9 intermediation 90 79.4 80 • 89% bank assets to GDP relatively 70.7 70 64.3 high for an economy at this stage 60 of development 50 40 Capital markets 30 • Relative stagnation may be due to 20 some structural obstacles 6.7 7.0 10 3.7 5.3 0 2013 2014 2015 2016 Uneven development of banking Source: National Bank of Georgia; eop * Due to data limitations, market capitalisation before 2016 is calculated by sector and capital markets assuming the same structure of the capital market as in 2016 Georgia’s financial sector almost entirely dependent on banks © German Economic Team Georgia / Berlin Economics 3 2. Regional comparison Banking sector assets, 2016 120 Banking sector % of GDP 100 • Georgia ranks highly in terms of 80 overall banking sector ‘depth’ 60 • There are still some problems with 40 access to credit 20 0 Romania Ukraine Moldova Armenia Georgia Turkey Latvia Capital market remains Source: National Banks, eop underdeveloped Market capitalisation, 2015 • Equity market highly illiquid % of GDP 93.8 • Liquid sovereign bonds but private 100 86.0 80 bond issuance limited 56.3 60 49.9 40 20 6.7 IMF index of financial 0 Georgia Russian Turkey Poland Slovenia development suggests Federation considerable growth benefits Source: Bank for International Settlements, World Bank, IMF and capital market development strategy from the Ministry of Economy of Georgia and National Bank of from further financial deepening Georgia; eop © German Economic Team Georgia / Berlin Economics 4 II. Market structure, profitability and governance 3. Number of banks 4. Market structure 5. Bank profits 6. Corporate governance and foreign listings © German Economic Team Georgia / Berlin Economics 5 3. Number of banks 25 21 2014-2017 20 19 16 16 • Numbers of active banks went down from 15 21 to 16 10 • Six small banks no longer active, TBC and 5 Bank of Georgia acquired smaller 0 2014 2015 2016 2017 institutions Source: NBG, eop • But: One microfinance institution received a banking license Jan2015: Merger of TBC and Bank Constanta May2015: Merger of BOG and Privatbank • A dynamic process of entry and exit 2016: Progress Bank cancelled its banking license to Drivers of the consolidation process become a non-bank institution Sep2016: NBG revoked license of Caucasus Dev Bank; • NBG regulation and supervision, e.g. bankruptcy of mother company in AZE higher minimum capital requirements in Nov2016: Closure of Capital Bank due to breach of NBG regulations (money laundering) effect from 2018 Mar2017: Banking license for Credo (microfinance) • But also market forces; search for May2017: Merger of TBC and Bank Republic economies of scale / efficiency © German Economic Team Georgia / Berlin Economics 6 4. Market structure Banking sector assets, Dec 2017 Cartu Bank Other banks Top 3 banks currently account for 77% of 3% 11% ProCredit assets; high concentration Bank TBC Bank 4% 37% • VTB Bank- TBC Bank: 37% of assets Georgia • Bank of Georgia: 35% of assets 5% Liberty Bank 5% Strong presence of foreign capital • 15 of the 16 banks with foreign-capital Bank of Georgia Source: NBG participation 35% • 80% of assets under foreign ownership Share of top 3 banks - regional comparison, 2015 (though by portfolio, not strategic, 80 % 70 investors) 60 Unusual, no state-owned bank 50 40 International experience suggests that 30 even highly concentrated banking 20 10 systems can be efficient and provide 0 good access to credit for firms Georgia Moldova Romania Armenia Latvia Turkey Ukraine Source: Global Financial Development Indicators (World Bank) © German Economic Team Georgia / Berlin Economics 7 5. Bank profits Banking sector profit Return on equity (ROE) 1000 GEL m in % 30 800 25 • Increase to 24.6% in 2017 likely due 20 600 to special factors 15 400 10 • Positive for financial stability 200 5 • Relatively high in regional context but 0 0 partly explained by good operating 2013 2014 2015 2016 2017 Profits ROE efficiency and low impairment Source: NBG charges Return on equity: regional comparison, 2016 20 % Policy will need to 15 • Ensure open entry into the sector 10 • Safeguard against abuse of market dominance and facilitate 5 information sharing 0 • Tackle the ‘too-big-to-fail’ Armenia Romania Moldova Latvia Turkey Georgia problem Source: IMF Financial Soundness Indicators © German Economic Team Georgia / Berlin Economics 8 6. Corporate governance and foreign listings • Weak Georgian legislative framework for corporate governance EBRD assessment of the Georgian Corporate • TBC and BoG both listed on premium Governance Code London Stock Exchange segment (BoG Structure and Functioning in the FTSE250) of the Board • As such they comply with the UK corporate governance code and a high Stakeholders and institutions Transparency level of transparency and Disclosure • This defines an expanded investor base, and likely reduces costs of funding within Georgia, however at Rights of Internal Control the expense of liquidity in Georgian Stakeholders securities markets Source: EBRD Introduces high corporate governance standards within Georgia, which has a weak local framework © German Economic Team Georgia / Berlin Economics 9 III. Bank soundness 7. Liquidity 8. Capital 9. Asset quality and non-performing loans © German Economic Team Georgia / Berlin Economics 10 7. Liquidity Bank deposits • 8 6 Deposit funding stable, and steady GEL bn USD bn 5 growth since 2014, despite major 6 4 regional turbulences and GEL 4 3 depreciation GEL deposits, left hand scale 2 • Limited wholesale funding, in part from 2 FX deposits, right hand scale 1 IFIs 0 0 • High share of liquid assets • Loan to deposit ratios around 100% at Source: NBG, own calculations, excl. interbank deposits all key banks Structure of deposits Depositors appear to trust the banks Current Term and the supervisor; absence until now of a deposit insurance scheme has not 58.2% 41.8% been a problem GEL FX Banks adopt conservative funding models 33.8% 66.2% Source: NBG, own calculations © German Economic Team Georgia / Berlin Economics 11 8. Capital Capital adequacy ratio 20 Capital adequacy ratio (CAR) % 15 Total minimum CAR (10.5%*) Basel III • Regulatory minimum for each bank: 10 10.5% total CAR (including minimum 5 capital requirement and capital Basel I Basel III 0 conservation buffer) comfortably met by all banks Source: NBG; *including minimum capital requirement of 8% and capital conservation buffer of • System-wide ratio about 16% 2.5% • Demanding risk weights for FX loans CAR as % of risk-weighted assets of individual banks • BoG and TBC as systemic banks also 35 % 30 have substantial additional buffers 25 20 The system is well-capitalized 15 10 5 Capital buffers should be 0 maintained, given the external risks, and other vulnerabilities Source: NBG, Note: Data for 4Q2017 (after regulatory changes by NBG) © German Economic Team Georgia / Berlin Economics 12 9. Asset quality and non-performing loans Non-performing loans (NPLs) • Long-term decline of NPLs, according NPLs as a share of total gross loans to the NBG‘s definition from 9.5% 12 in % by IMF's methodology by NBG's methodology (Q1-2013) to 5.9% (Q4-2017) 10 • Good provisioning policies by the 8 banks 6 • Active restructuring efforts of over- 4 indebted companies and a new 2 bankruptcy law should also help 0 • No major spike in NPLs following the 2013Q3 2017Q2 2013Q2 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 2016Q4 2017Q1 2017Q3 2017Q4 2013Q1 depreciation of GEL in 2015 Source: NBG Potential risks from rapid growth in retail credit, and FX borrowing, but various NBG safeguards are in place © German Economic Team Georgia / Berlin Economics 13 IV. Access to credit 10. Credit to the real sector 11. Loan growth 12. Growth dynamics: corporates vs retail 13. SME lending and credit access 14. Interest rates and spreads © German Economic Team Georgia / Berlin Economics 14 10. Credit to the real (non-financial) sector Credit to real sector to GDP Credit to the real sector 70 % 56 59 60 50 • Credit ratio reasonably high in a 50 45 regional comparison 40 30 • Growth in excess of GDP growth, and 20 accelerated in recent years 10 0 • Retail lending is the main driver of 2014 2015 2016 2017* loan growth Source: NBG, own calculations; *own estimation, Note: absolute values in GEL bn above bars • Corporate lending constrained by high Credit to real sector to GDP: Regional comparison leverage, and access to external 80 % funding by some firms 70 60 50 Bank lending seems to work well, 40 though cannot entirely make up for 30 20 absence of capital market 10 instruments 0 Moldova Romania Ukraine Armenia Georgia Turkey Latvia Source: World Bank, data for 2016 © German Economic Team Georgia / Berlin Economics 15 11. Loan growth Loan growth Total nominal loan growth (FX adjusted) 30 % Loan growth (real & FX adjusted) Total real loan growth (FX adjusted) 20 • Loan growth correlated with 10 variation in economic activity, though consistently exceeds it 0 • Ongoing deepening of credit relative Jan-2015 Jan-2016 Jan-2017 Jan-2014 to GDP Sep-2014 Sep-2015 Sep-2016 Sep-2017 May-2014 May-2015 May-2016 May-2017 Source: NBG, own calculations Aggregate demand seems to be the GDP growth and loan growth driving force for credit expansion 20 % Total real loan growth (left hand 5.5 scale) % 15 GDP growth (right hand scale) There is no evidence of a credit 4.5 crunch 10 3.5 5 0 2.5 Source: NBG, own calculations © German Economic Team Georgia / Berlin Economics 16 12.