The delegation of Moody’s Investors Service visited Uzbekistan in mid-March, 2013. During the visit, the specialists of the rating agency met representatives of local banks, the Central Bank, ministries and governmental bodies of Uzbekistan.

Moody’s Investors Service has been working in Uzbekistan for the last five years. The agency has so far assigned ratings to 14 organizations in Uzbekistan, including 13 commercial banks and one insurance company.

Uzbekistan is the fourth largest market for Moody’s Investors Service in the CIS by number of ratings assigned, after Russia, Kazakhstan and Ukraine.

In an interview to UzDaily, Olga Ulyanova underlined that in the recent years, Uzbekistan’s economy shows stable high growth at the level of 7-8% annually. “This distinguishes Uzbekistan from other CIS countries, especially after the crisis, when many countries have recorded a slowdown, while economies of some countries even shrank,” she said.

“Uzbekistan escaped from this situation and GDP volatility in Uzbekistan is not high. This means that national economy of Uzbekistan is, to some extent, protected from negative global macroeconomic trends,” Ms Ulyanova added.

The analyst of Moody’s Investors Service assumed that the country has achieved this due to significant diversification of its economy in the recent years, having decreased concentration to primary industries and agriculture.

The share of raw materials in total exports is declining, while the contribution of machinery, chemistry and products with high value added is increasing. For example, instead of cotton-fibre, Uzbekistan has started to export yarn or textile products, she said.

Olga Ulyanova added that one of the reasons why Uzbekistan has been demonstrating stable high growth is that the country has no over-dependency on certain individual export items or industries.

According to the analyst of Moody’s Investors Service, this favourable macroeconomic situation has translated into the banking sector.

She underlined that the most of the borrowers, both individuals and companies, currently demonstrate good creditworthiness. Ms Ulyanova said that the asset quality of Uzbek banks will remain stable in the foreseeable future, and the expectation is that the share of problem loans in the banks’ portfolios will not grow dramatically.

Besides, the banking sector of Uzbekistan is not depended on international funding sources. Only several individual financial institutions, in particular the National Bank for Foreign Economic Activity of the Republic of Uzbekistan, have high share of international funding in their liabilities, but this financing mostly relates to specific large strategic projects, she said.

“The major part of Uzbek banks’ international funding comprises the resources stemming from international development institutions. These financing, along with commercial objectives, has certain social objectives, and is frequently issued under the guarantees provided by the government. We expect that Uzbekistan will continue to benefit from such financing since these funding sources are backed by real strategic projects,” the analyst said.

Majority of Uzbek banks are funded from local markets and mainly by customer accounts, which means that they have minimum exposure to the risks of potential closure of external capital markets, Ms Ulyanova stated.

“We observe low penetration of financial services into the national economy of Uzbekistan. Currently, the ratio of total assets of the Uzbek banking sector to the country’s GDP stands at approximately 30%. This is a low value and we believe that the banking system has significant growth potential,” she noted.

Moody’s estimates that, as of the end of 2012, in both Russia and Ukraine the total assets of these countries’ banking sectors to their GDP stood at around 80%, in Kazakhstan this ratio was about 44% and in Belarus – 60%.

The banking system of Uzbekistan has significant potential for expansion in certain individual segments of the market, such as financial services to retail and small and medium-sized entities. The system faces great opportunities to grow, she added.

The senior analyst of Moody’s said that the banking system of Uzbekistan is growing on average 30% annually over the last several years. She said that the rapid growth brings about certain risks.

“The rapid growth of banks’ credit portfolios cannot be achieved without a compromise on the quality of loans. We do not observe a growth of the share of problem loans in the sector’s total loan book, but we also did not see its decrease on the background of the fast growth. According to banks’ reports prepared in accordance with the International Financial Reporting Standards (IFRS), the share of problem loans makes up 11-12%,” she said.

Olga Ulyanova said that problem loans or, in other words, individually impaired loans are not necessarily those loans, on which the borrowers are not paying today, but these are the loans, which have high probability of default already in the near future, especially in case of deterioration of the country’s macroeconomic conditions.

“The recovery on such loans can be much lower than that expected at the origination. If the level of such loans is hovering around 11-12% over the last 2-3 years and is not decreasing, this means that the nominal volume of problem loans is growing at a pace comparable with the growth rate of total loan portfolios, i.e. on average 30% annually, which reveals the banks’ weak underwriting standards,” the analyst said.

“If the country’s economic conditions worsen, for example, certain export commodities no longer generate high revenues, we may see a deterioration of the borrowers’ credit quality, and a large amount of problem loans will crystallize in the quickly augmented loan portfolios. Therefore, the rating agency is wary of rapid growth: the examples of other countries we’ve observed so far show that rapid loan growth leads to deterioration of banks’ asset quality,” she said.

Olga Ulyanova noted: “The second risk, as we discussed earlier, is that the majority of Uzbek banks are funded by customer accounts and in many cases (about 50% of all client accounts) this funding is short-term or even “on demand”. Furthermore, bank clients in Uzbekistan have the right to withdraw their resources from banks even prior to the contractual maturity.”

The analyst of Moody’s said: “On the one hand, we understand that corporate customer accounts will not flow away from the system, as they can only be transferred to another bank. However, such a scenario bears risks as the clientele funding in Uzbek banks is concentrated and in some cases the banks are dependent on resources of just two or three corporate depositors. If resources of the large depositors flow away from a bank, which we have already seen for some Uzbek banks, this will at least trigger a significant reduction in the banks’ business volumes.

“Furthermore, if there occur a nervousness in the market and distrust of clients to financial institutions, we may see a domino effect whereby corporates would transfer their funds to the state banks seeking to get implicit government guarantees. As a result, private players may be left with scarce funding. Alternatively, the clients can move from a bank with problems to another bank. We do not say that such a scenario is very likely for Uzbekistan, but we saw such cases in other countries.”

Olga Ulyanova said that Uzbekistan will face the necessity to develop long-term local debt market. “We understand why companies in Uzbekistan are not attracting funding from international markets directly. Foreign currency financing mainly comes to the banks from international financial institutions (including development institutions) and the