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Kyrgyzstan Review, 10 years ago

F. Development of the Financial System

i. The banking system

338.         The banking system is the heart of  the Republic’s financial sector.  The efficiency of monetary policy and achievement of sustainable economic growth as a basis for poverty reduction, and raising the living standards of the people of the Kyrgyz Republic, depend on it to a large extent.
                Raising the efficiency of banks and therefore their contribution to implementation of the National Strategy for Poverty Reduction assumes, first of all, rehabilitation of the banking system and the creation of sound conditions for the banks that are more efficiently managed, while removing the problem banks from the system.  In 1999-2001, a package of measures on removing the problem banks from the banking system was undertaken to make the banking system healthier, to improve its quality and reliability. These banks were subject to special administrative procedures through liquidation on the grounds of unsatisfactory management and internal quality control, as well as violation of the banking legislation that led to deterioration of their financial status.
339.         As a result of these measures, the viable  banks were preserved, and a systemic risk in the banking system was neutralized.  After removal of the problem banks, the banking system ended 2001 fiscal year with net profit amounting to 70.6 million soms, whereas the financial output for 2000 was negative (the losses amounted 52.7 million soms).  The assets of the commercial banks since the beginning of 2001 have increased by 24.9 percent and amounted to 5,897.9 million soms as of July 1, 2002.  Despite this, the ratio of the assets of the commercial banks, as well as deposits, to GDP remain low and constitute about 8 and 4 percent, respectively.  Apart from this, during the last 1.5 years, the quality of the banks’ assets has not improved for all practical purposes, the share of “problem” and/or “non-working” assets in total assets making up 11.5 percent as of July 1, 2002.
340.         Tightening of the regulatory requirements for the minimum own capital of the commercial banks has encouraged growth of the aggregated capital of the banking system. The total capital of the commercial banks increased by 74.9 percent from the beginning of 2001 and amounted to 1,563.4 million soms as at July 1, 2001.  However, it should be noted that increase in requirements for the minimum statutory capital has not led to consolidation of the banking system.  A positive trend of changes in the structure of the commercial banks’ income and expenses has been observed over the last two years, resulting in significant reduction in both interest and operating expenses, as well as in an increased share of interest income from lending.  These facts reflect the completion of the process of overcoming the crises that have taken place in the banking system in 1998-2000, and the formation of the prerequisites for further rehabilitation and strengthening of the financial condition of the banking sector.
341.         At the same time, it should be noted that a number of problems persist, the following being the key ones:
·         low level of confidence among the population and the businessmen in the banking system;
·         inadequate quality of management and internal control and audit in the commercial banks;
·         inadequate protection of interests and rights of the commercial banks and other financial institutions as creditors;
·         impossibility of efficient enforcement of the banking supervision sanctions stipulated in the legislation due to difficulties arising from legal proceedings;
·         underdeveloped system of early warning and prompt response to the problems arising in the commercial banks.
343.         Resolution of these problems and further strengthening of the banking system remains a priority task of the Government and the National Bank of the Kyrgyz Republic.  A number of measures will be taken to increase confidence of the population and entrepreneurs in the banking system and increase the level of financial intermediation.  In order to raise the responsibility of major shareholders and commercial banks’ management regarding managing the attracted resources, relevant amendments to the Law on Banks and Banking and other legislative acts have been developed and submitted to the Jogorku Kenesh.  These amendments also provide for strengthening the bank supervision.  The measures will be undertaken to introduce realistic corporate management principles and culture, standards of disclosure of financial reporting by commercial banks that should result in increased management and internal control efficiency in banks and increased transparency and reliability of the data on their financial condition.
344.         For the purpose of promptly identifying and the neutralizing problems arising in commercial banks, the measures laid down by Regulatory Response Policy, approved by the Government and the National Bank , will be strictly applied.  In order to provide access for the population and businessmen of the country to quality banking services, the National Bank will continue to work on formation of a system of anti-monopoly regulation of commercial banks’ activity.  A simplified registration procedure for branches and savings banks in the regions will remain.  Preservation and further development of the branch network of the banking system in the regions and expansion of the range of services provided by the commercial banks will also be ensured.
345.         Creation of a favorable climate for business development in the Republic will contribute to reduction of financial organizations’ credit risks, which will lead to increased lending.  Protection of the interests of banks as creditors and increased borrowers’ responsibility for targeted use of credits, and their timely repayment, will also contribute to this process.  For this purpose, it is necessary to amend legislation regulating collateral and introduce principles of corporate management and international accounting standards into borrowing enterprises.  It is also important to ensure competence and objectivity of court proceedings and significantly reduce costs and time taken up by litigation, as well as to ensure enforcement of the court decisions related to repayment of the loans by the borrowers.  In order to increase the role of borrowers’ positive credit history, an independent Credit Bureau will be developed.
346.         Further utilization of the financial resources from the credit lines of the IDA, EBRD, German Bank for Reconstruction and Development, the World Bank project, Rural Financing-2, and other sources, through the commercial banks, will facilitate increase in lending to priority sectors of the economy, financing of small and medium business development in Kyrgyzstan.
347.         Expanding the activity of the Kyrgyz Investment Credit Bank (KICB) on lending to the enterprises of the country on a medium and long-term basis, will promote development of the real sector of economy and creation of new jobs.  Further continuation of the successful performance of the Kyrgyz Agricultural Financial Corporation with preservation of its operative independence is also important, as the Corporation now is the main source of credit resources in the agricultural and agro-industrial sector of the country
348.         The goal of banking system development is to create a steady and reliable system of financial institutions capable to mobilize efficiently the internal financial resources of the country and meet the requirement of the population in loans and qualitative banking services.
349.         The short-term strategy for the development of the banking sector consists of three basic elements. First, measures will be undertaken that will result in increased capitalization of commercial banks. Starting from July 1, 2001, the requirement for the minimum authorized capital for existing banks was raised to 100 million soms. For new banks, the required minimum authorized capital was established at 300 million soms.  In addition, the National Bank set the additional requirement for the minimum capital (own capital) of a bank at 25 million soms.  Strict compliance with these requirements will result in strengthening of the banking sector and increase in its stability.  In order to consolidate the banking system, further increases in the minimum size of commercial banks’ capital will be considered.
350.         Given the importance of strengthening market discipline, the second important measure is to strengthen the capacity of the Debt Restructuring Agency (DEBRA).  DEBRA was transferred to the Ministry of Finance, with preservation of the status of noncommercial self-governing organization.  Pursuant to amendments to the Law on Bankruptcy, DEBRA is the body authorized to carry out bankruptcy procedure against commercial banks.  In order to strengthen the Agency, measures will be taken to increase the professional skills of its staff, improve activity planning and introduce modern information technologies, improve a system of financial reporting and methods of study of credit files and debt collection.  These reforms should provide a convincing signal as to the intentions of the Government and the NBKR to recover financial assets from the debtors and thus provide the banks with strong incentives to reasonably manage their attracted financial resources. A separate law will be developed to regulate the processes of re-structuring and bankruptcy of commercial banks and other financial institutions.
351.         The third main element of the reforms in the banking system will be increasing the efficiency of banking supervision. The methodology used to analyze the financial status of the commercial banks will be improved, and also the system of early identification of problems in commercial banks will be formed. These measures will ensure that shortcomings in banks’ performance will be detected at an early stage and prompt actions will be undertaken to eliminate these problems in line with the Regulatory Response Policy to protect the investors’ interests.  The legal framework and court proceedings related to the commercial banks activity will be improved to make the banking system healthier and to ensure its steady development, as well as to enforce efficiently and timely banking supervision sanctions in order to protect the interests of the commercial banks’ depositors, primarily, small depositors. Measures will be taken to ensure competent and objective consideration of such cases.  Various options for the creation of a system of deposit protection needed for strengthening public confidence in the banking system and mobilization of domestic savings, are also being studied.  Such system should be based on the Law on Deposit Protection and is aimed, first of all, at protection of interests of the small depositors.  The system of deposit protection will be introduced when the revival and soundness of the banking sector is effected.
352.         In order to activate the development of the banking system, to attract modern banking technologies and management methods and also to improve a competitive environment, the National Bank will continue to work on attracting a strategic investor for privatization of the Settlement Savings Company (SSC).  The privatization strategy for SSC should take into account the fact that the Company carries out the socially important function of servicing cash flows of the state budget and the Social Fund and, in some regions, is the sole banking institution.  A specially set up government working group will prepare scenarios for the creation of a postal bank to ensure availability of the banking services in all regions of the Republic, in particular, in the remote areas, and to support the payments system.  In order to encourage competition in the banking sector, various scenarios of “Kairatbank” development will be considered.
353.         The program for support and the development of credit unions will be continued that will result in creation of a system of effective financial institutions in all regions. Sustainable credit unions will be licensed to provide banking services.  Such development of the system of credit unions, preservation of a SSC branch network, future conversion of the Kyrgyz Agricultural Financial Corporation into a rural bank, and creation of a Postal bank, will raise competitiveness in the market for financial services in the regions and increase their quality and reduce cost, i.e. make them available to the rural population and entrepreneurs.
354.         Based on the Laws On Financial Leasing and On Letters of Credit, the range of services provided by the commercial banks will be expanded.  Upon creation of the appropriate regulatory and legal basis for development of the real estate and land market, as well as the securities market, various forms of mortgage lending will be developed.  Implementation of these measures will:
·         facilitate increased efficiency of the commercial banks’ performance as financial intermediaries;
·         mobilize domestic financial resources and increase lending to the economy;
·         provide access to qualitative banking services over the entire country; and
·         ensure efficient banking supervision in order to provide security and reliability of the banking system and its steady development to achieve the goals of the NPRS.
The payment system
355.         Currently, the payment system participants in the Kyrgyz Republic are the National Bank of the Kyrgyz Republic, 18 commercial banks with 140 branches located within the Kyrgyz Republic and the National Automated Clearing House.  Interbank payments are executed on the basis of documentary payment orders.  Apart from the payment order forms adopted by the NBKR, other forms of the payment order that are incompatible with each other have been adopted by the Central Treasury, State Tax Inspectorate and Social Fund, consistent with their own individual requirements.  Payments are made through either a clearing system or a gross settlement system.  Manual processing and the need for physical transfer of the paper payment orders, limit the opportunities of the existing payment system.  It also restrains the further development of the system in ways that will accelerate remittance of payments and growth in the number of payments.  This situation has a direct impact on the value and volume of transactions in the financial markets.  Besides, it limits the possibilities of the banks and their branches in the remote areas, and narrows the range of their services.
356.         Payment systems based on bank credit cards are at the initial stage of their development in Kyrgyzstan.  As of July 1, 2002, 2,826 cards were in circulation, 130 terminals were installed. The value of payments was 278.5 millions soms, which constitutes an insignificant share in total value of transactions made.  There are no settlement systems based on the electronic trade.  Thus, at present, settlements systems based on bank credit cards do not have a noticeable impact on the deposit base and the value of non-cash settlements.
357.         The mechanism of money remittances through the state instrumentality, "Kyrgyz Pochtasy”, is specified in the agreements between the postal administrations of the parties on exchange of remittances.  Under the World Postal Union document, Rules of the Agreement on Postal Payments Services, approved in 1999, postal, cable transfers, and remittances through electronic mail can be used.  “Kyrgyz Pochtasy” foreign exchange settlement accounts with commercial banks acting as agents. The bank/agent converts the cash received and credits it in som to the account of the “Kyrgyz Pochtasy”.  The communication enterprises receive and pay out cash in national currency.  At the same time, there are problems related to the time frame of remittances, cost and quality of the provided services.
358.         To increase efficiency, reliability and security of the payment system, and to determine the general principles of non-cash settlements in domestic currency in the Kyrgyz Republic, a new Regulation on Non-Cash Settlements in the Kyrgyz Republic will be introduced.  The development of this draft regulation was brought about by the need to bring into compliance the procedures for non-cash settlements, with the changes that have occurred in the financial system since the Republic gained independence.  A joint decree of the Government and the NBKR, On Amendments and Addenda to the Decree of the Government of the KR and the NBKR #370, June 22, 1998, On Measures of Providing Efficient Payment System of the KR and Raising Responsibility of Commercial Banks for Timely Payments, was drafted and approved to raise the responsibility of the commercial banks for timely clearing of payments.  To further encourage development of the plastic cards market a Regulation, On Bank Payment Cards in the KR, was approved by the NBKR Board.  This regulation is a first step in establishing a regulatory and legal basis in the payment cards area, aimed at maintenance and enhancement of the card market and its further development in the Republic.
359.         To improve the technology on international payments, the NBKR has conducted preliminary work on installation of the shared SWIFT node.  Availability of the shared SWIFT node will enable the commercial banks with least cost to join the international network and make payments based on  international standards.  Expansion of the SWIFT network in the Kyrgyz Republic will also provide the possibility for making domestic payments in the Republic, using electronic payment documents in the SWIFT format.  In view of this, corresponding amendments have been introduced to the regulations on the interbank gross settlement system.  In addition, under the conditions of expanding trade and economic relations with the FSU and non-FSU countries, the shared SWIFT node solves one more important task for the banking system of the Kyrgyz Republic, by providing conditions for the integration of the payment system of the Republic with the international systems and payment systems of the CIS countries.  In order to increase the share of the non-cash settlements in the economy and to attract additional resources to the banking system, the joint decree of the Government and the NBKR, On Measures for Improving the Procedures for Disbursement of Salaries to Government Employees and Customs and Tax Payments Through the Accounts with the Commercial Banks in the Kyrgyz Republic and other corresponding regulations will be implemented.
360.         An interdepartmental working group will work out a national program on measures for 2003-2005 for the introduction of a non-cash payments system and on creation of the infrastructure capable of ensuring effective execution of recurring payments (salaries, pensions, communal services and taxes).  In order to increase the share of non-cash payments and the efficiency of the payments system by creating conditions for the development of payment services by using various payment instruments and ensure their availability for the payment services users, the law, Main Directions of Payment System Development for 2002-2005, will be implemented.  The share of non-cash payments as a basis for timely salary and pensions disbursements and collection of regular recurring payments, which provides a free choice of the banks for the individuals in making payments, will be increased mainly through a clearing system for recurring payments (bulk clearing) that will work in parallel with the card clearing infrastructures.
361.         As the network of postal institutions is widely developed and is widespread overall the Republic, including the most remote areas, creation of a Postal Bank will allow the expansion of a range of payment services for the population and to receive social payments (wages, pensions, the benefits) and to pay the accounts through the commercial banks.
362.         Within the framework of anti-monopoly regulation of the payment services market, a regulatory and legal framework governing the activity of the payment system operators, such as clearing houses, card-clearing centers, transportation of valuables, including delivery of cash, etc., will be developed.  Besides, the measures on development of tariff policy on payment services will be undertaken, that will provide the pricing mechanism aimed at reduction of payment system costs as a whole and processing costs of each separate payment document.
363.         In order to implement the provisions of the joint decision of the Government and the National Bank, it is intended to develop a system for the processing of retail and recurring payments of the population.  The measures assume creation of a clearing institution to process batches of clients’ recurring payments.  The presence of such systems in the market will considerably simplify the banks’ servicing of their customers, as well as collection, processing and accounting for payments to large corporations that provide recurring services to the population (such as “KyrgyzGas”, “KyrgyzEnergo”, “KyrgyzTelecom etc.).  In addition, these systems will result in cost savings on cash in circulation and will ensure increases in the number of the accounts of the population with the banks and increases in the volume of non-cash settlements.
[1] Assuming baseline macroeconomic program under the PRGF prevails.