Interview: John P Finigan, Norihiko Kato, Randolph S Koppa, Dugersuren Bat-Ochir

As banks enter a bullish cycle, what will be the centres of growth over the next 24 months?

JOHN FINIGAN: The mining sector is the locomotive driving the economy, but more importantly, we get a multiplier effect from this sector and its supply chain. We are seeing a similar phenomenon as in Qatar. When the State of Qatar was developing its major export-oriented industries, the multiplier effect in the post-export development stage – once revenues, taxation and royalties had commenced – was four times the initial capital inputs. We are seeing similar phenomena in Mongolia. Mining is the driving force which creates a much wider dispersion creating additional spin-offs throughout the economy. The Mongolian banking sector is already well developed, offering a full range of conventional banking services. The corporate banking sector has all the products that are needed for the extension of credit and financial intermediation.

Similarly the retail banking sector is equally well endowed. Therefore, in the coming years we are looking at volume growth and prudent, progressive evolutionary expansion rather than revolutionary growth. In the case of Golomt Bank we have traditionally positioned ourselves as the country’s leading corporate bank, and we are working to achieve a more appropriate balance of corporate and retail banking over the next three years.

NORIHIKO KATO: If we look at Mongolia, I believe the entire country will be lifted by this tremendous economic potential and growth that is ahead of us. When we take the mining sector and see the country’s future potential in driving growth and generating income, and view this from the local banks perspective, we are almost spoiled by choice of possibilities that will be created for the sector. However banks must identify their strengths and try to link their capacity to specific opportunities, there is a saying that – if you chase hundred rabbits you won’t catch any. Different banks will inevitably focus on areas where they have the most expertise in. Also, we have to pay careful attention to what the external environment will be in the future, with China’s demand for commodities and debt crisis in Europe, but as far as I see at this point of time, looking across the different segments within the sector, I don’t think we can identify an area that will not grow. The sector is seeing growth right across the board. Corporate and SME business in all sectors are growing. As people become more affluent, growth in the consumer loans and mortgages segments will continue. It is more important for the banks to be aware of the opportunities that can be taken advantage of and to create more value for their customers in each sector.

RANDOLPH KOPPA: I believe looking at the haulage activity in Mongolia is a good indicator of where the country is and where it is going. The number of trucks in Mongolia has increased substantially, which means that mining activity is increasing, and more important Mongolia’s mining sector is gradually moving from the exploration to the production phase. This is an indication of strong economic growth that will lead to a rise in income levels and a rise in spending throughout the entire economy. The banking sector is ideally positioned to ride and fuel this growth. In early 2010 banks were a little cautious, waiting for strong signals from the market. This came in the form of continued global demand for commodities and strong domestic economic performance. The retail banking sector has seen substantial growth in all areas of conventional banking products – in particular, consumer loans. TDB’s loan portfolio is up 80% so far, and the bank’s year-on-year growth from June 2010 to June 2011 was 107%. We expect a loan growth of up to $20-25bn through the end of the decade. More significantly for the sector, we’ve seen a drop in non-performing loans.

Banks are also entering a mortgage boom. There are currently MNT500bn ($390m) mortgage loans in the sector. Some two-thirds of the population is still living in gers or ger-type structures; as incomes rise, they will need to be re-housed. The banks have liquidity and will lend mortgages. The rates are slowly coming down and terms are getting better.

DUGERSUREN BAT-OCHIR: The sector grew very quickly over the second half of 2011, and the major reason was investor confidence. The developments of some of the country’s biggest projects such as Oyu Tolgoi and Tavan Tolgoi, coupled with the growth in the fundamentals of the economy, all helped the banks grow.

I don’t believe the sector has yet fully recovered from the 2008-09 recessionary period, but I do strongly believe it has substantially rebounded, because the economy has more diversified income sources compared with that seen in 2008 and 2009. Future growth in the sector will be mostly driven by consumer and corporate loans. Foreign direct investment to Mongolia has increased dramatically and banks have started lending more aggressively. At the same, there is a more targeted approach to lending that emphasises the quality of the projects.

Consequently, the sector has seen a gradual decrease in non-performing loans. Different banks see opportunities in different areas within the sector. I have no doubt that consumer loan growth will continue and new areas will emerge, such as mortgages. As for XacBank, our strengths lie in business banking for SMEs and in retail banking markets which we started more aggressively tapping into in during last 3 years. We started entering into corporate market to leverage on the Bank’s advantages on strong governance, and wide network of international partners and we expect to achieve more during 2012.

How is the consolidation process taking shape in the sector and should mergers among the bigger banks be encouraged?

KATO: From international experience, the consolidation process is always a very slow and time-consuming process unless it is triggered by a specific difficult situation of a bank and actively driven by the regulator. Here we have 14 banks, outside of the top five banks, the rest are small, so the question is – what are we consolidating? The top five banks dominate the banking sector with over 90% of the market share, so are we consolidating a very small part of the overall banking business?

I do not deny the possibility of consolidation of small banks in the distant future but I strongly believe and would say that the banking sector is already consolidated among the top four or five banks. From my perspective I would say almost zero possibility of consolidation happening between the top five banks. This is because of substantial overall differences in how banks are run in areas such as; market strategies, the ownership structure and etc. I think many of the banks are incompatible and would result in bad marriages. I see almost no realistic opportunities for consolidation. In addition, from the regulatory perspective how would the central bank react to such moves? The healthy competition among the bigger banks should be encouraged for the development of the banking sector and for the benefit of the economy of Mongolia.

KOPPA: The consolidation process is taking place, albeit rather slowly. Mongolia has 14 banks, which is not a bad number for the sector. However, there are only a few banks that dictate the market and essentially make up the banking system. These are TDB, XacBank, Golomt Bank and Khan Bank.

Lately, we have seen smaller banks struggling to keep up with the pace of growth in the sector, although some have managed to carve out a niche in the market. However, as the central bank slowly increases the minimum capital requirement – the next rise is expected in Jan 2013 – some of the smaller banks will struggle. If there are no mergers, they may need to give their licences back. With regard to consolidation among the leading top four or five banks, there have been no discussions of mergers. The tops banks are quite different in their market activities; consolidation, to some extent, does not make sense. To support and finance some of the larger projects, as well as bring more capacity to the sector, banks have increased their capital base by taking on subordinate debt to the maximum extent possible. Most big banks are considering listing; we are aiming to do so in a few years.

BAT-OCHIR: Development Bank has just been established and Capital Market is not yet active and ready, so commercial banks are the leading lenders. Although the banking sector has been growing significantly, capacity is still very small. The industry needs initial public offerings (IPOs), mergers and the ability to attract strategic partnerships. Mongolia is at a point where it needs a substantial amount of capital to help finance and support the growth of the economy, especially for some of the larger infrastructural projects. Theoretically, consolidation needs to happen in the sector not only to successfully compete with international banks in corporate markets but also to be able to meet ever increasing demand in the SME, corporate, and mortgage markets. Although there could be synergies from consolidation amongst largest four or five banks as two of them were traditionally banking with large entities and now trying to diversify their markets and the remaining 3 banks are traditionally strong in retail and to some degree in SME markets; I see many challenges for mergers to happen amongst leading banks due to ownership structure, governance culture, and other reasons. Nevertheless, we might see some mergers and acquisition some time after 2012.

I think partnerships between local banks and international financial institutions should expand to meet overall funding demand in SME and corporate markets. Bigger banks are currently also actively exploring IPO opportunities, and we expect the top banks to go public within the next two or three years. This may result in attracting more strategic foreign partnerships, because local banks know the market and the country’s working environment.

FINIGAN: In my opinion, the consolidation process has already taken place, with a migration to quality following the challenges and the recessionary period of 2008-09. One has seen the affirmation of the dominant oligopoly of the top five banks, which together account for more than 90% of assets. This evolutionary process has emerged of its own volition as people have opted for quality.

We can expect that process to intensify from December 2012 onwards, when the current blanket deposit guarantee is repealed and investors and depositors begin to choose banks based upon their financial criteria than the lowest common denominator of rate competitiveness. The Bank of Mongolia gradings show that the banking system consists of three tiers of which premier Tier A comprising three banks of approximately the same size, Golomt, Khan and TDB controlling almost three quarters of the system institutions. The ensuing comparative with B the fourth-largest bank being only one third of the size of the market leaders. That is a very significant differentiating factor contributing to structural concentration, irrespective of other qualities.

How would you assess the regulatory environment and how has the sector been strengthened over the past three years?

KOPPA: There have been new laws on collateral, mortgages and mortgage foreclosure that provide non-judicial means of getting access to properties. Key laws have been passed recently, but they have not been extensively tested. The court system is working reasonably well – it is a lengthy process, but eventually disputes are resolved. We are looking at the new legislation that would provide a more streamlined method, but we have not had extensive experience in this. We also have to remember that many of the judges were educated and trained in Irkutsk, Russia, so their commercial background and experience is not especially strong.

In my opinion, the most important addition to the new banking law is the tightening of the capital adequacy requirements and a gradual movement towards Basel standards. These changes have been welcomed by the industry, but I believe they could be tougher, as the minimum capital reserves requirement of MNT16bn ($12.5m) is still quite low. Some of the provisions and elements in the law are good and strengthen the banking sector, although they can be a little unclear at times. The reoccurring challenges for us are interpretation, enforcement and proper application of existing laws.

BAT-OCHIR: The biggest change in the recent banking law is the attempt to separate retail and investment banking, which was a response to the recent global crisis. Another very important addition, and an area getting particular attention from the central bank, is the imposition of greater transparency and better corporate governance. The deposit blanket guarantee that came into force over the past few years helped depositors to stay in the market, especially during the recessionary period, and served its intended purpose well. More significantly, however, I believe it helped increase public confidence in the central bank and the government. The deposit guarantee system will cease at the end of 2013 but a different type of deposit insurance scheme will emerge. The minimum capital requirements and reserves are also going to increase from 2012, which we think is perhaps a little too early. Certainly some of the small and medium-sized banks may find it difficult to adapt.

FINIGAN: The Mongolian banks have achieved great progress since the challenging period of 2008 and 2009. The improvement in the regulatory environment is indeed to be commended, but the underlying reality is that the banks mostly achieved this progress themselves by strengthening their own capital and internal procedures. It is certainly a positive attribute that the banking law and regulations have been strengthened, but the regulatory regime serves mainly to ameliorate crises while prudent well-managed banks do not encounter difficulties. Mongolia is a very young and dynamic democracy, and one of its many attractions is the openness of dialogue which we enjoy with the administration and policy makers. Recently, the banking sector was honoured by being granted a long audience with the Prime Minister and the Minister of Finance, to whom the bankers association presented a number of proposals for enhancing the financial system and its regulatory and legislative background. We were all greatly appreciative of the fact that our proposals were received with keen interest.

The Prime Minister fully committed to an active dialogue between the administration, the Mongolian Bankers Association and the central bank, aimed at achieving an optimal rate of progress to benefit Mongolia and its citizens.

KATO: The important point in the regulatory environment is to have a well articulated regulatory framework that is consistently enforced. The danger with any regulator is that sometimes the regulations can be open to interpretations and contain grey areas. However this issue is not unique to Mongolia, which means if there is no absolute clarity in the regulations, different banks will interpret and apply the law in different ways. The banking system in general is a fragile environment and the customers must have confidence that sector is properly regulated, supervised and secure. For example, if we were to look at the Deposit Guarantee Scheme, which was rather successful in treating the symptoms by giving customers the confidence and peace of mind with any bank knowing their deposits are safe, what it does not do is to address the causes of why the guarantee blanket was needed in the first place. To some extent it is a disincentive for the stronger banks and it may even weaken the system in the longer term.