Tashkent, Uzbekistan (UzDaily.com) -- Stronger lending regulation in Uzbekistan should mitigate overheating risks in the retail lending market and gradually improve banks’ loan book quality, Fitch Ratings says. However, the agency expects asset-quality pressures to build in 2024–2025 as legacy loans, issued under weaker underwriting standards, season.

The Central Bank of Uzbekistan (CBU) and the government have introduced several regulatory initiatives in the past couple of years to tighten banks’ underwriting standards in higher-risk segments and reduce credit risk. These include increased regulatory risk-weights (up to 200%) for loans issued at interest rates significantly above the CBU key rate; maximum payment-to-income limits on all retail loans (60% from July 2024, 50% from 2025); loan-to-value limits on mortgages and car loans; a 25% cap on the proportion of car loans in banks’ loan portfolios from 4Q23; and tighter conditions on subsidised family business lending.

Fitch Ratings said that the measures are in response to rapid retail loan growth (39% CAGR over 2019–2023, and 50% annually in 2022 and 2023). Retail exposures increased to 32% total loans at end-2023, more than double the proportion at end-2018, and we expect it to approach 50% over the next few years.

This rapid growth began from a low base following the start of market reforms in 2017, and was driven by pent-up consumer demand, higher household incomes, and the lifting of several lending restrictions. Uzbekistan is still significantly underbanked, with retail loans equivalent to just 14% of GDP at end-2023, suggesting high growth potential, the agency said.

Fitch Ratings said retail loans tend to be risky in economically volatile emerging markets such as Uzbekistan. Rapid credit growth at high interest rates (the average rate on retail loans was 25% at end-1Q24), particularly in riskier segments such as unsecured cash and car loans, could result in an onerous debt burden on retail borrowers, with the risk of significant loan-quality deterioration in an economic downturn.

Recent CBU data show the measures may already be having an impact, with early signs that the retail lending market may be cooling, particularly for car loans, after almost doubling in 9M23. Following the introduction of the quantitative cap, new car loan issuance decreased by 6% yoy in 4Q23 and 44% yoy in 1Q24, the agency noted.

Family business loans, issued by selected policy banks, shrank by 15% yoy in 4Q23 and 55% yoy in 1Q24. Fitch Ratings views this segment as the riskiest in the sector due to weak underwriting standards and a focus on lower-income borrowers. Family business loans have led to large credit losses at some banks recently, and their gradual winding-down should help reduce credit risk.

Cash unsecured loans (18% of sector retail loans at end-1Q24) is the only segment that grew significantly in 4Q23 and 1Q24, by 58% yoy in both quarters. Growth should moderate from 2H24 when tighter lending rules take effect, but we still expect 40% yoy growth over the full year, Fitch Ratings added.

The shift to granular retail lending should gradually strengthen Fitch’s assessment of the local operating environment (currently ‘b’, well below Uzbekistan’s ‘BB-’ sovereign rating). Retail lending is more granular, and in Uzbekistan can only be done in local currency. The shift will therefore gradually reduce the high loan concentrations (by borrower and industry) and dollarisation that remain key structural weaknesses of the banking sector. Higher margins on retail lending should also improve banks’ profitability and capital buffers, although managing the cost of risk will be key, Fitch Ratings underlined.

Nevertheless, Fitch Ratings expects asset quality to remain under pressure in the near term, with impaired loans likely to edge up further this year as loans issued amid the rapid credit growth of 2018–2020 mature, and banks adopt more conservative loan classification policies.