Kyrgyz Republic: Promoting Financial Sector Resilience

Finance / Central banking systems

The TA project will assist the National Bank of the Kyrgyz Republic (NBKR) to establish the required systems and processes for a fully functional Basel III regulatory framework. While Pillar 1 of the Basel III framework is largely in place, Pillar 2 entails banks to carry out internal capital adequacy assessment and NBKR to put in place a supervisory review process thereof. Among many things, this requires NBKR to have a strong stress-testing and econometric forecasting internal capacity to (i) identify unexpected adverse outcomes across a range of risk factors, including credit, market, liquidity, operational risks and (ii) estimate related capital and liquidity requirements. These forward-looking assessments will also support effective communication to the public and facilitate the development of risk mitigation or contingency plans for stressed conditions.

As such, ADB assistance will support NBKR in setting up the following elements of Pillar II:

(i) Establishing NBKR capabilities in stress-testing and econometric forecasting as integral elements for forward-looking prudential supervision.

(ii) Enhancing microprudential supervision by using stress-test results in monitoring and estimating impacts on asset quality, liquidity, and solvency of individual banks.

(iii) Establishing macroprudential supervision by using stress-test results in monitoring and estimating macroeconomic impacts on asset quality, liquidity, and solvency of the overall banking system.

(iv) Guiding NBKR's communication with banks' management to perform appropriate capital adequacy assessment to support a more shock resilient banking system.

(v) Improve NBKR's staff skills for effective stress testing and econometric modelling, which is a new area for most of the NBKR staff.

The Kyrgyz Republic's banking sector steadily grew by a solid compound annual growth rate (CAGR) of 15% throughout 2013-2018. Over the same period, loan book and customer deposits grew by 19% and 16%, respectively. Quality of the loan portfolio remained satisfactory with non-performing loans at 8% of gross loans. Capital adequacy ratio stood at a solid 24% in 2018, which is twice the prudential ratio of 12%. Liquidity of the banking system was adequate with the liquidity ratio (short term assets to short term liabilities due within 30 days) at 67%, comfortably above the central bank minimum requirement of 45%. The range of the banking services also expands, with the growing popularity of digital financial products (e.g. banking services accessible through mobile phones and instant online loans). Despite the current positive trends of the Kyrgyz Republic banking sector's development, some areas of concern have been noted. The Kyrgyz Republic banking sector remains small with the ratio of assets to gross domestic product (GDP) at a low 39.8% in 2018. With credit to economy at 23% of GDP, the banking sector is shallow. Only 40% of the adults have banking accounts, suggesting weak financial inclusion. Women have lower access to finance with 39% of adult women having banking accounts compared to 41% among male. Due to the lower ownership of assets, women's access to bank credits is lower as they often cannot meet banks' collateral requirements. High dollarization levels in loans (45%) and deposits (65%) make the banking sector prone to market volatility and increased credit risks.

Capacity development of the banking sector regulator, supported under this TA, is required to prevent the risks that increase with the growth of financial sector and build investors' confidence in the Kyrgyz banks. Alignment with Basel III standards will also make the regulatory capital ratios of the Kyrgyz banks internationally comparable for investors and rating agencies. This will in turn facilitate the Kyrgyz banks' access to global capital markets. This TA is also important given increasing sophistication of the banking operations driven by the introduction of new banking services, such as digital financial products. New untested digital financial products present new challenges for the commercial banks and the National Bank of the Kyrgyz Republic (NBKR) in terms of assessing and managing operational and liquidity risks related to these products.

This TA project is aligned with the Kyrgyz Republic`s National Strategy 2018 -2022 "Unity, Trust and Creation", which stipulates strengthening of the NBKR`s capacity as a financial sector regulator.