How banks in Kazakhstan can avoid additional provisions
Why does it matter to obtain and correctly “read” information about a borrower from open government databases? Modern tools make it possible to predict a client's default at an early stage
In December 2019 the National Bank of Kazakhstan plans to complete the AQR (asset quality review of banks) and to report the results in early 2020. This large-scale review has cost the country's second-tier banks a great deal of effort and time.
AQR and IFRS 9
The past two years have been anything but easy for Kazakhstan's second-tier banks: in 2018 they had to adopt a new international reporting standard, IFRS 9. Moving from the previous IAS 39 to IFRS 9 in the area of impairment is a global project that affects not only methodology and reporting, but also business processes, data and numerous IT systems. IFRS 9 requires banks to calculate provisions automatically, which is hard to do the old way (as some banks did under IAS 39, using ordinary Excel spreadsheets).
At the end of 2018 the National Bank approved the methodological part of the new IFRS 9 impairment models for all second-tier banks. The ordeal seemed to be over, and then AQR appeared on the horizon.
AQR is a logical step after the adoption of IFRS 9. An exercise on this scale will make the country's banking sector more transparent and will make it possible to assess the real condition of second-tier banks.
According to the Chairman of the National Bank of Kazakhstan, Yerbolat Dossaev, the methodology and knowledge acquired will be integrated into the current supervisory process, while the results will be translated into the new SREP supervisory system, including the use of a new supervisory instrument in the form of a supervisory capital add-on.
Market experts tend to agree that using the experience gained during the AQR is absolutely the right decision and amounts to a kind of “upgrade” for the supervisory authority.
Following the AQR, some banks will probably have to raise additional capital. Some financial institutions may turn out to hold problem assets. As a result, provisions will be charged against those assets, which will reduce retained net profit, and that means bankers can forget about “attractive” financial statements.
Independent risk management expert Askar Omarov believes:
— It is no secret that at some banks, presenting information in a favorable light and smoothing over rough edges in reporting documents is regarded as an important practical skill. A loan granted to a borrower who was analyzed only superficially becomes a problem loan and demands closer attention from the bank's internal services, as well as capital to provision properly for potential losses. To keep problems with such a borrower at bay, the bank starts to “decorate” it like a Christmas tree.
The strength of IFRS 9 lies in getting ahead of problems. Are there problems with portfolio quality? Then create provisions. Are there problems with capital adequacy? Then increase capital. Acknowledging problems is the first step towards solving them.
The key factor in recognizing potential losses is not a banker's subjective faith in the borrower's abilities, but an objective assessment of its condition, the so-called “borrower rating process”. This process assesses the borrower's probability of default, the bank's share of losses in that event and other aspects of risk management practice. In the end, the bank must understand what it is risking at the very first stage of its relationship with the borrower.
European banking practice has a concept known as the “Watch list”, or “post-lending monitoring”, which is a banker's frank answer to the question: “is everything in my portfolio really as good as I keep telling myself?”.
Little attention is paid to the Watch list while a bank's loan portfolio is growing fast. But as soon as growth slows, the first signals of the problems caused by overly rapid growth start to appear: the gap between accrued and actually collected interest widens, cash collection on the principal falters, and other troubles follow. The bank then creates provisions that eat into both the capital and the profitability of the lending institution. What helps in this situation is monitoring of potentially problem clients that is unified, tailored and built into the bank's analysis and reporting system. It is good when this is not merely a system of deadline reminders for bank managers, but a working mechanism for analyzing and collecting data from both internal and external sources.
New requirements and technologies
One of the three goals of the AQR declared by the Kazakhstani authorities is “strengthening financial stability by identifying and implementing corrective measures to improve the financial condition of banks”. And a high-quality loan portfolio calls for technology, because processing several hundred thousand loans by hand is hardly feasible.
— Working closely with the banking sector for more than 10 years, we can see how attitudes to technology are changing in lending to micro-businesses, small and medium-sized enterprises and corporate clients. Only a few years ago there was no demand for projects focused on rating, transparency of lending processes, monitoring and much else. The adoption of international standards, the AQR, the growth of the micro and small business lending market and the emergence of serious competition in it have changed the situation. Industrial-grade solutions are now in demand: for the lending process, for calculating provisions across the entire IFRS 9 cycle, for running an internal rating platform, for maintaining a borrower's financial statements and for monitoring companies that have already been granted loans, commented Evgeny Scherbinin, CEO of Prime Source.
Open sources and the Watch list
Open sources make it possible to collect information about a client lawfully. This covers a borrower's problems with the tax authorities, its record of involvement in court cases, any enforcement proceedings, entries in registers of unreliable suppliers and other similar data
Some second-tier banks use such information when reviewing corporate loan applications, but fail to unlock its potential in post-lending monitoring.
Independent risk management expert Daniyar Alpysbayev shares his experience of building a dedicated methodology and an automated Watch List system for spotting warning signals about a borrower:
— The Watch List platform, which is already up and running at several Kazakhstani banks, is based on a system that has been used in European financial markets since 2008.
When that system was being developed, we had two problems: a shortage of data on the market and its poor structuring within the bank's systems.
One of the hardest tasks is collecting and processing information, updated frequently, on how well a borrower services its obligations at other financial institutions. It was not uncommon for the servicing bank to learn about a client's problems elsewhere months later, or only once the client had already been through restructuring. Such sluggishness cut the effectiveness of measures to adjust the strategy towards the client many times over.
As a result, banks did not always assess warning signals about a client properly and were unable to tighten their requirements in time. The transition to IFRS 9, in turn, made it mandatory to take into account any information that would allow a bank to prepare in advance for adverse developments.
Over the past few years, positive change has reached virtually every source of information: a large number of databases have been automated that hold useful information about clients' activity and about how they service their obligations, not only to financial institutions but also to government agencies in respect of mandatory payments.
From my own experience I can say that the completeness of information and the speed of decisions taken on the signals received play a key role in shaping a strategy in the event of a likely default, especially when a client has obligations at several institutions.
Valikhan Sarymsakov, risk management expert, IFRS 9 methodologist
https://forbes.kz/finances/finance/kak_bankam_kazahstana_izbejat_dopolnitelnyih_rezervov/