## _cr04268 — 1. Main Recommendations of the 2004 FSAP Update Mission ## Source details **Canonical URL:** [_cr04268 — 1. Main Recommendations of the 2004 FSAP Update Mission](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04268.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04268.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04268.pdf.json) --- ### Overall stability assessment and system vulnerabilities - Financial sector dominated by private commercial banks; one of the fastest growing sectors in Kazakhstan (para. 1). - Effective implementation of recent legislative and institutional reforms is crucial (para. 1). - Reform agenda anticipates transition to principles for inflation targeting and full liberalization of capital account transactions by 2007; FSA contemplating adopting EU standards (para. 2). - Preconditions for full capital account liberalization: robust financial institutions and markets, adequate monitoring of market risks; NBK will need to monitor a wide range of indicators, including asset prices (para. 2). - Stress testing and prudential assessment highlight vulnerabilities despite comfortable aggregate capital adequacy: - Credit risk and reliance on unbalanced wholesale funding are key vulnerabilities (para. 3). - Some of the largest banks are barely above the minimum capital adequacy requirement (para. 3). - Share of classified assets substantial and increasing despite high real growth; stricter classification requirements introduced in 2003 and rapid credit growth have contributed to deteriorating loan quality (para. 3). - Reported liquidity ratios do not fully reveal some banks’ reliance on potentially volatile wholesale funding (para. 3). - Aggregate exchange rate risk limit “errs on the high side,” but limits on individual currencies reduce risk; banks have some indirect exposure mitigated by appreciation expectations (para. 3). - Authorities advised to resist administrative measures (e.g., ceilings on “excessive deposit rates” introduced by the Deposit Insurance Fund) because such ceilings create risks and could hide severe problems; banks offering relatively high deposit rates should be effectively supervised and then ceilings removed (para. 4). - Private capital market development constrained by low transparency in corporate governance and limited potential issuers; government issuance of larger and less frequent tranches would facilitate corporate bond market development (para. 5). - Kazakhstan Mortgage Company (KMC) has aided development; privatization of KMC should be encouraged while monitoring real estate prices to avoid overheating (para. 6). - Authorities’ intentions to strengthen consolidated supervision, adopt a more risk-based supervisory approach, and implement EU standards by 2007 are commendable; consolidated supervision should be prioritized before considering Basel II (para. 7). - Existing legislation and enforcement powers to combat money laundering (ML) and financing of terrorism (FT/CFT) need strengthening; establishment of a Financial Intelligence Unit (FIU) recommended (para. 8). ### Main recommendations (Box 1) - Supervision - Implement consolidated supervision and ensure adequate resources for scheduled comprehensive on-site inspections. - Implement regulation on risk-management to move from a primarily rule-based to a more risk-based approach. - Stipulate in law that high level officials at the NBK and the FSA can be removed only for cause with reasons made public. - Reassess frequency and detail of reporting requirements for market participants. - Provide continuous training, particularly for nonbank supervisors. - Banking - Take prompt supervisory action, if required, to deal with banks paying excessive interest rates; then remove DIF limits on excessive interest rates. - Increase focus on liquidity risk of individual institutions; some banks rely on potentially volatile wholesale funding. - Consider introducing capital requirements for market risks. - Capital markets - Structure government debt issuance to be more conducive for debt market development. - Insurance - Establish a reliable database to determine reserve requirements and tariffs. - Ensure preconditions to determine appropriate reserve requirements and tariffs before introducing additional compulsory insurance products. - Pension funds - Review regulatory framework for hidden incentives that do not promote prudent investment strategies appropriate for social safety net assets. - Corporate governance - Undergo a Corporate Governance ROSC assessment to evaluate implementation of existing voluntary governance guidelines. - Anti‑money laundering and combating financing of terrorism - Bring criminalization of money laundering and financing of terrorism in line with international standards. - Enact legal framework consistent with international standards, including appropriate checks and balances and an FIU. ### Macroeconomic and financial sector developments since the 2000 FSAP (selected indicators) - Real GDP growth (percent): 1998 -1.9; 1999 2.7; 2000 9.8; 2001 13.5; 2002 9.8; 2003 9.2. (para. 10) - CPI (percent): 1998 1.9; 1999 17.8; 2000 9.8; 2001 6.4; 2002 6.6; 2003 6.8. (para. 10) - Unemployment (percent): 1998 13.1; 1999 13.5; 2000 12.8; 2001 10.4; 2002 9.3; 2003 9.0. (para. 10) - General government balance (cash basis, percent of GDP): 1998 -7.7; 1999 -5.0; 2000 -0.8; 2001 2.6; 2002 1.4; 2003 3.0. (para. 10) - National Fund of the Republic of Kazakhstan (percent of GDP): 2001 5.6; 2002 7.9; 2003 12.3. (para. 10) - Public debt (percent of GDP): 1998 22.5; 1999 29.7; 2000 25.6; 2001 20.9; 2002 17.6; 2003 15.0. (para. 10) - Current account balance (percent of GDP): 1998 -5.4; 1999 -0.1; 2000 4.2; 2001 -4.0; 2002 -3.5; 2003 -0.2. (para. 10) - External debt (percent of GDP): 1998 44.8; 1999 71.3; 2000 69.3; 2001 68.5; 2002 74.1; 2003 76.9. (para. 10) - Gross official reserves (millions of US$): 1998 1,964; 1999 2,003; 2000 2,096; 2001 2,508; 2002 3,136; 2003 4,961. (para. 10) - National Fund (millions of US$): 2001 1,270; 2002 1,917; 2003 3,603. (para. 10) - Short-term external debt (million US$): 1998 2,321; 1999 1,805; 2000 1,021; 2001 1,366; 2002 2,360; 2003 3,771. (para. 10) - Broad money growth (M3, Dec./Dec, percent): 1998 -14.1; 1999 84.4; 2000 45.6; 2001 42.8; 2002 34.1; 2003 26.8. (para. 10) - Financial deepening I (M3 percent of GDP): 1998 8.6; 1999 13.6; 2000 15.4; 2001 17.5; 2002 20.3; 2003 21.8. (para. 10) - Exchange rate average (tenge per U.S. dollar): 1998 78.6; 1999 120.1; 2000 142.1; 2001 146.9; 2002 153.5; 2003 149.7. (para. 10) - Memorandum: Nominal GDP (billions of tenge): 1998 1,733; 1999 2,016; 2000 2,600; 2001 3,251; 2002 3,776; 2003 4,450. (para. 10) - Macroeconomic risks and buffers: - Hydrocarbon exports account for more than half of total exports. (para. 11) - NFRK was US$3.6 billion at end-2003. (para. 11) - Gross international reserves almost US$5 billion at end-2003, exceeding estimated short-term debt (US$3.8 billion). (para. 11) - Private external debt is 65 percent of GDP; large share is intra-company loans (40½ percent of GDP). (para. 11) - Appreciation and inflationary pressures under managed floating exchange rate partly neutralized by NFRK, increased money demand, and sterilization by NBK; rapid credit expansion and high levels of classified loans warrant caution. (para. 12) - Institutional changes: - Effective January 1, 2004, supervision moved from NBK to the Agency on Regulation and Supervision of Financial Markets and Financial Institutions (FSA); FSA accountable to the president, remains on NBK premises and funded by NBK; cooperation agreement addresses premises, services, and information-sharing. (para. 13–14) - FSA chairman’s term not explicitly specified; chairman of FSA and governor of NBK not protected against arbitrary dismissal—deficiencies for autonomy. (para. 13) - Banking system total assets increased to almost 38 percent of GDP; three largest banks hold about 65 percent of deposits by individuals; about half of banks have foreign participation. (para. 14) --- ### _cr04268 — 15. In spite of robust economic growth, the proportion of banks’ classified loans ### Asset quality and provisioning (selected facts) - Classified loans (doubtful and loss) increased from almost 29 percent at end-2002 to 39 percent of total loans at end-2003. - Classified assets and contingent liabilities increased from 19.2 percent of total assets to 29.8 percent during the same period. - Classified loans not on time increased from 12.2 percent of total loans in March to 13.1 percent in December 2003. - Loan loss provisions at end-2003 amounted to 6.2 percent of loans. - Contributing factors: - Introduction of stricter asset classification and provisioning methodology in early 2003. - Rapid credit growth and diversification into riskier businesses. - Authorities noted over-provisioning used to smooth income. - Implication: Problem loans often increase after aggressive credit growth, particularly when banks lend to unfamiliar business types; macro shocks may also worsen portfolios; continued diligence and resources for on-site inspections warranted. ### Prudential metrics and sensitivity scenarios - CAR declined from 17.2 percent at end-2002 to 16.9 percent at end-2003 (preliminary). - Aggregate prudential ratios within comfortable ranges, though several larger banks close to minimum CAR of 12 percent. - Sensitivity illustrations (preliminary data Jan 1, 2004): - A 15 percent increase in classified loans, if fully provisioned from equity capital, would bring the banking system’s CAR down to the minimum statutory requirement. - A 55 percent increase would lead to insolvency of the system. - For the least capitalized of the 10 largest banks, a 25 percent increase in classified loans requiring full provisioning would lead to insolvency. - Recommendation: Intensify FSA sensitivity analysis, cover market risks, identify shocks, develop off-site reporting to calculate shock impacts, and estimate relationships between classified assets and macro indicators. ### Regulatory and institutional developments - New classification/provisioning methodology (early 2003): formula explicitly considers financial condition of borrower and quality of collateral in addition to days in arrears; each asset evaluated using a formula summing values assigned to characteristics. - NBK as lender of last resort: extends loans case-by-case using constructive ambiguity to avoid moral hazard; recommendation that bank’s commitment to address underlying problems be precondition for lender-of-last-resort support. - Legal framework for liquidation (effective January 1, 2004): FSA has more authority to control and monitor liquidator; representative from DIF can join liquidation committee; liquidation request and report must still be approved by court. ### Deposit insurance and supervision - DIF established in 1999; compulsory on January 1, 2004 for banks accepting household deposits; DIF fully owned by NBK. - Deposits insured up to T 400,000 (US$2,900) per bank; deposits from large shareholders and related parties excluded. - DIF targets 5 percent of insured liabilities. - Current accumulated funds sufficient to cover insured deposits of no more than two to three of the smaller banks. - Premiums: 0.25 percent of insured deposits for newly insured banks and 0.16 percent for older banks. - Assessment: Risk-adjusted premiums seem premature; a simple and transparent framework important at this stage. - Supervisory approach: Weak banks should be dealt with through supervisory measures rather than caps on deposit rates; limits on “excessive” interest rates can be circumvented and reduce transparency; banks offering excessive interest rates should attract FSA inspections. ### Financial market structure, pension funds, insurance (selected statistics) - Broad money (M3) increase in 2003: 26.8 percent. - Profitability of commercial banks (unaudited): 1.96 percent of total assets in 2002 and 1.98 percent of total assets in 2003. - Each of the ten largest banks reported profits in 2003. - Growth in banks’ total assets in 2003: 46.5. - Growth in banks' loans in 2003: 45.5. - Growth of claims on households in 2003: 107.8. - Off-balance sheet items (percent of total assets) in 2003: 60.8. - Share of deposits denominated in foreign exchange in 2003: 47.1 percent. - Share of loans denominated in foreign exchange in 2003: 55.5 percent. - Loan to deposit ratio in 2003: 133.8 percent. - Loan to deposit ratio denominated in foreign exchange in 2003: 157.6 percent. - Liquidity ratio (K4) in 2003: 0.90. - Private pension funds as of January 1, 2004: accumulated US$2.5 billion (almost 8½ percent of GDP) on 6.4 million accounts; 16 private pension funds operate with portfolio allocations: government securities 53 percent, corporate bonds 24 percent, foreign investments 10 percent, bank deposits 7 percent. - Capital markets capitalization (percent of GDP) in 2003: 51.5; corporate bonds 4.1; equities 38.4. - Mortgage-backed bonds issued by KMC since 2002: more than T 14½ billion (five emissions). - Corporate bond market capitalization growth to T 182½ billion (US$1.2 billion, 75 emissions) since late 1999. - Securities Market Act (SMA, 2003) improvements: clearer regulatory framework, strengthened enforcement powers, authority to institute sanctions, promotes transparency, prohibits manipulation, clarifies SRO roles, increases capital requirements for central securities depository. - Insurance industry (Jan 2004): 34 insurance companies licensed, 2 life insurers; 2003 gross premiums T 28 billion (0.6 percent of GDP), more than 98 percent non-life; penetration ratio in 2002: 0.66 percent of the population. ### Vulnerabilities, structural concerns, and policy priorities - Vulnerabilities and concerns: - Rapid credit expansion in bank-dominated sector. - Rapid increase in pension fund assets with limited depth of financial markets. - Substantial cross-relationships between financial institutions and influential groupings active in financial and real sectors. - Emergence of financial-industrial groups with non-transparent ownership, raising related party lending and large exposure concerns. - Exemptions from prudential limits reportedly no longer granted; progress in monitoring exposures since 2000 FSAP. - Policy priorities: - Ensure continued diligence in supervision with adequate resources for on-site inspections. - Intensify sensitivity analysis and off-site reporting systems to monitor market and credit risks. - Use supervisory measures rather than deposit rate caps to address weak banks; trigger inspections for risky funding or lending behavior. - Make bank commitment to address underlying problems a precondition for lender-of-last-resort support. - Maintain a simple and transparent deposit insurance framework before moving to risk-adjusted premiums. --- ### _cr04268 — 29. Some banks are vulnerable to credit risks from specific economic sectors ### Credit risk concentration and capital adequacy (illustrative scenarios) - Loan concentration to large business groups remains an issue despite restrictions and improvements since 2000 FSAP. - Illustrative capital-impact scenarios (preliminary end-2003 / January 1, 2004 data): - Applying 100 percent provisioning of current classified loans—excluding loans classified as doubtful but on time—less current provisions, the CAR would decline by about 5½ percentage points for the banking system; five of the 10 largest banks would breach the statutory CAR but remain solvent. - If all loans to the oil sector (less than 7 percent of total bank lending) became nonperforming with full provisioning, the adjusted CAR for the banking system would fall to the statutory requirement and 4 of the 10 largest banks would breach the statutory requirement. - Regulatory limits on single-borrower exposures: - Exposure to a single borrower connected to the bank with special relations limited to 10 percent of equity capital and aggregate of such exposures shall not exceed 100 percent. - For other borrowers the limit is 25 percent (with not more than 10 percent uncollateralized). - The aggregate of large exposures is not limited. - Recommendation: Gauge impact of largest business-group failure on CAR using FSA’s large loan database; consider monitoring real estate prices in large population centers. ### Liquidity risk and funding - Prudential indicators suggest system liquid on aggregate but do not reveal some banks’ reliance on potentially volatile wholesale funding. - Loan-to-deposit ratios for the 10 largest banks range from 56 percent to 120 percent. - Observed practices: some larger banks use special purpose vehicles to solicit funding abroad; need for consolidated analysis of liquidity and monitoring of bond covenants. - DIF introduced interest rate ceilings on deposits to prevent weak banks offering excessive rates, suggesting liquidity constraints in some banks. ### Foreign exchange exposure - Aggregate limit on exchange rate risk high by international practice; limits on individual currencies depend on country rating, which reduces risk. - Regulatory gap: net open position calculation excludes tenge-indexed assets/liabilities; indexed instruments should be included and information compiled. - Derivatives included but regulation does not specify treatment of currency options. - Indirect foreign currency risk may be substantial but difficult to gauge due to lack of data; appreciation expectations currently reduce this risk; occasional surveys recommended. ### Nonbank financial institutions: regulatory capacity and market development - Rapid passage of laws for insurance, pension funds, securities has created a gap between regulatory framework and implementation capacity; near-term focus on implementation of existing laws. - Securitization law under drafting requires careful consideration. - Pension funds: steady contributions and lack of vibrant capital market necessitate supervisory diligence; pension funds favor high-yield short-term investments exposing social safety net assets to reinvestment, issuer, and exchange rate risk. - Market-development measures: only mortgage-backed securities issued to date to help meet demand; need for active, predictable public debt market and structured domestic government issuance to establish benchmarks and yield curve. - Disclosure, corporate governance, public education: corporate governance ROSC assessment recommended; education campaign on nonbank financial products suggested. - Insurance constraints: insufficient databases and actuarial capacity hamper risk measurement, reserve setting, and pricing; until data improves, successful products likely third-party liability and property insurance. ### Assessments and standards updates - Basel Core Principles: substantial improvement since 2000; consolidated supervision and risk-management initiatives introduced late 2003; implementation could not be fully verified. - IOSCO Principles: marked legal improvements; implementation capacity constraints at FSA capital market and pension supervision department (staff of about 30 for securities market and pension funds). - IAIS Insurance Principles: new insurance legislation passed Dec 2003; compulsory use of IFRS since Jan 1, 2003; challenges remain in supervision, actuarial profession, and statistical foundation. - Payment systems: ISMT operates as a real-time gross settlement system; 2003 assessment rated ISMT principles observed or broadly observed with clarifications on finality. - Transparency: NBK strengthened transparency (plans for inflation targeting, SDDS subscription, publishing data and procedures); central bank law lacks explicit criteria for removal of governing body members; FSA law does not yet set modalities of accountability or require publication of audited financial statements; no internal audit function yet established at FSA. --- ### Kazakhstan: Progress since the 2000 FSAP — AML/CFT and Banking Supervision (selected findings) ### AML/CFT legislative and institutional status (summary) - Drafting of AML/CFT law assigned to the Agency Fighting Economic and Corruption Crimes. - Criminal Code recognizes money laundering as a financial crime, but legal definition “does not yet meet recognized international conventions and standards.” - Banking secrecy provisions subject anyone disclosing suspicious transactions, even to authorized bodies, to criminal sanctions. - No FIU exists. - Financing of terrorism added to definition of “terrorist activity” but “financing of terrorism is not criminalized per se” and does not fully satisfy international requirements. - Footnote: “It is anticipated that the law will be adopted by the parliament sometime before end-2004.” ### Main findings on banking supervision (ROSC / Basel Core Principles) - FSA is responsible for banking supervision; NBK retains responsibility for broad financial sector stability. - Implementation of Basel Core Principles “has improved substantially” since 2000; consolidated supervision remains most important remaining issue. - General preconditions: - Very strong economic growth increased credit demand. - Household deposit growth lagged banking sector growth, leaving sector dependent on wholesale funding. - Wide variation in management depth and risk management; smaller banks may face viability challenges. - IFRS required since January 1, 2003; some smaller banks may not have fully converted systems. - Deposit insurance participation mandatory as of January 1, 2004. - Introduction of DIF interest rate ceilings in 2003 is “a cause for concern.” - Key recommendations (verbatim excerpts from Table 1): - Implement the detailed agreement between FSA and NBK. - Stipulate in law that high level officials at the FSA can be removed only for cause with reasons made public; fill staff vacancies. - Legal amendment to explicitly permit supervisory agency to exercise judgment. - Effective implementation of group-wide prudential requirements, including regularly calculating CAR on a consolidated basis. - Effective implementation of prudential requirements on credit risk management introduced in December 2003. --- ### _cr04268 — 8. Loan evaluation and provisioning (Prudential recommendations and supervisory priorities) ### Selected prudential recommendations (items 8–25) - Fine-tune new loan loss provisioning requirements. (8) - Implement group-wide prudential requirements. (9, 20) - Obtain greater certainty that related-party transactions are identified and reported. (10) - Implement prudential requirements on risk management introduced December 2003. (11–13) - Introduce capital requirements for market risk. (12) - Improve internal control and audit application. (14) - Introduce AML law, FIU, and amend bank secrecy provisions. (15) - Develop prudential guidelines for banks linked to AML/CFT work. (15) - Coordinate supervision for financial conglomerates within FSA. (16, 20) - Improve offsite analysis depth, especially liquidity/refinancing risks; review data collection frequency and volume. (18) - Ensure open channels with auditors and prompt action for problem banks. (21–22) - Develop supervision module for oversight of foreign establishments and strengthen relationships with foreign supervisors. (23–25) - Assess home country supervisors’ capacity for consolidated supervision. (25) ### Authorities’ response - Authorities broadly agreed with the assessment and found it unbiased and useful. - Authorities issued regulations on consolidated supervision and risk management but agreed insufficient time had passed to assess implementation effectiveness. (14) ### Key supervisory priorities (concise) - Implement group-wide prudential requirements and consolidated supervision. - Improve identification and reporting of related-party and connected lending. - Strengthen internal control, internal audit, and remedial action frameworks for problem banks. - Introduce market risk capital requirements and deepen offsite liquidity analysis. - Enhance cooperation with foreign supervisors and assess home supervisor capacity. --- ### APPENDIX III — ROSC Summary Assessment of AML/CFT (selected recommendations) ### Main findings and gaps - Assessment based on information up to February 24, 2004. - Kazakhstan criminalized money laundering but definition falls short of international standards; financing of terrorism not criminalized as a separate offense. (Main findings) - No FIU; bank secrecy provisions prevent reporting of suspicious transactions to authorities. (Main findings) - Geographic, organized crime, and transparency challenges heighten AML/CFT risks; delay in implementing appropriate AML/CFT policies could impede development. (Main findings) ### Key recommended legal and supervisory actions (excerpt) - Amend bank secrecy provisions to permit reporting of suspicious transactions to law enforcement. - Amend Criminal Code provision 193 to expand money laundering definition to meet international standards and ensure prosecutability both separately and in parallel with predicate offenses. - Improve legal mechanisms to allow freezing or seizure of property, proceeds and/or assets used or intended for financing terrorism without delay. - Make confiscation of criminal proceeds mandatory so courts are obligated to consider and confiscate proceeds to the extent they exist. - Enact law fully implementing UN Security Resolutions requiring mandatory review of names on terrorist lists, auditing of compliance processes, and penalties for noncompliance. - Require know-your-customer and ongoing monitoring policies across obligated entities; maintain records and documentation for at least five years. (See Record-keeping section) - Create an operationally independent, adequately staffed FIU; expand AML/CFT Task Force membership to include Prosecutor’s Office, Ministry of Interior, and Currency Control Department of NBK; draft a national strategy and implementation program. (Institutional arrangements) ### FATF Special Recommendations on Terrorist Financing (summarized) - Fully implement UN Convention on the Suppression of the Financing of Terrorism; amend Criminal Code to make financing of terrorism a separate criminal offense. - Provide legal mechanisms to freeze/seize property used or intended for financing terrorism. - Require reporting of suspicious transactions to an FIU under AML/CFT law and enable mutual legal assistance and information sharing with foreign counterparts. - Pay attention to informal remittance systems and wire transfer originator information; require enhanced due diligence for non-profit organizations. ### Record-keeping and retention (explicit requirement) - Maintain all customer account information and transaction documentation for a minimum of five years from date of transaction execution. - Maintain records on customer identification, account files, and business correspondence for at least five years after account closure. - Requirements to be regularly audited by supervisory agencies with penalties for noncompliance. *Source: _cr04268 - 1. Main Recommendations of the 2004 FSAP Update Mission; selected sections and appendices from the IMF staff report.* ### 1. Main Recommendations of the 2004 FSAP Update Mission ............................................6 ### _cr04268 - 1. Main Recommendations of the 2004 FSAP Update Mission ............................................6 ### Overall stability assessment and system vulnerabilities - The financial sector is dominated by private commercial banks and has been one of the fastest growing sectors in Kazakhstan, facilitated by early structural reforms, a cautious fiscal stance, increasing oil revenue, and ambitious financial sector reforms (para. 1). - Effective implementation of recent legislative and institutional reforms is crucial to achieve intended objectives (para. 1). - The reform agenda anticipates transition to principles for inflation targeting and full liberalization of capital account transactions by 2007; the financial supervisory authority (FSA) is contemplating adopting EU standards (para. 2). - Preconditions for full capital account liberalization include robust financial institutions and markets, and adequate monitoring of market risks; the NBK will need to monitor a wide range of indicators, including asset prices (para. 2). - Stress testing indicates potential vulnerabilities despite seemingly comfortable aggregate capital adequacy: - Credit risk and reliance on unbalanced wholesale funding are key vulnerabilities. - Some of the largest banks are barely above the minimum capital adequacy requirement. - The share of classified assets remains substantial and has been increasing despite high real growth; new stricter classification requirements introduced in 2003 and rapid credit growth have contributed to deteriorating loan quality (para. 3). - Prudential indicators suggest the banking system is liquid on aggregate, but reported liquidity ratios do not fully reveal some banks’ reliance on potentially volatile wholesale funding (para. 3). - The aggregate exchange rate risk limit “errs on the high side,” but limits on individual currencies help contain risk; banks have some indirect exposure mitigated by appreciation expectations (para. 3). - Authorities should resist pressures for administrative measures (e.g., ceilings on “excessive deposit rates” introduced by the Deposit Insurance Fund) because such ceilings create risks and could hide severe problems in individual banks; banks offering relatively high deposit rates should be effectively supervised, and then such ceilings should be removed (para. 4). - Private capital market development requires more transparent corporate governance and appropriate, non-intrusive oversight; low competition in some sectors and influential financial-industrial groupings limit potential issuers; government issuance of larger and less frequent tranches would facilitate corporate bond market development (para. 5). - Kazakhstan Mortgage Company (KMC) has helped financial sector development and its privatization should be encouraged, while monitoring real estate prices to avoid overheating and potential bubbles (para. 6). - Authorities’ intentions to strengthen consolidated supervision, adopt a more risk-based supervisory approach, and implement EU standards by 2007 are commendable; consolidated supervision should be prioritized before considering adoption of Basel II (para. 7). - Existing legislation and enforcement powers to combat money laundering (ML) and the financing of terrorism (FT/CFT) need strengthening; sound AML/CFT policies with appropriate checks and balances and a Financial Intelligence Unit (FIU) would signal commitment to a level playing field (para. 8). ### Main recommendations (Box 1) - Supervision - Implement consolidated supervision and ensure adequate resources to conduct the scheduled number of comprehensive on-site inspections of commercial banks. - Implement the recently issued regulation on risk-management on banks to move from a primarily rule-based approach toward a more risk-based approach. - Stipulate in law that high level officials at the NBK and the FSA can be removed only for cause with the reasons made public. - Reassess the frequency and detail of reporting requirements for market participants. - Provide continuous training, including upgrading of skills, particularly for nonbank supervisors to meet the challenges of the newly adopted legislation. - Banking - Take prompt supervisory action, if required, to deal with banks paying excessive interest rates; then the limits on excessive interest rates introduced by the Deposit Insurance Fund can be removed. - Increase focus on liquidity risk of individual institutions; some banks rely on potentially volatile wholesale funding. - Consideration should be given to introducing capital requirements for market risks. - Capital markets - Structure government debt issuance to be more conducive for debt market development. - Insurance - Establish a reliable database to determine reserve requirements and tariffs for existing products. - Before introducing additional compulsory insurance products, ensure preconditions to determine appropriate reserve requirements and tariffs are in place. - Pension funds - Review the regulatory framework for hidden incentives that do not promote prudent investment strategies appropriate for social safety net assets. - Corporate governance - Undergo a Corporate Governance Report on Observance of Standards and Codes (ROSC) assessment to evaluate the implementation of existing voluntary governance guidelines. - Anti-money laundering and combating financing of terrorism - Bring the criminalization of money laundering and the financing of terrorism in line with international standards. - Enact a legal framework consistent with international standards, including appropriate checks and balances preventing abuse, as well as a financial intelligence unit (FIU). ### Macroeconomic and financial sector developments since the 2000 FSAP - Context from the 2000 FSAP: the system had escaped serious repercussions from the Russian crisis in 1998 but operated with underdeveloped supporting institutions and infrastructure; supervisory authorities had limited information about close links among large business groups, banks, and government officials; forbearance and supervisory weaknesses were identified; largest banks were subject to credit risk, exchange rate risk, and sizable exposures to the oil industry; credit risk was substantial due to high nonperforming loans and large exposures; borrowers with foreign currency loans had insufficient foreign currency income to service loans (para. 9). - Recent macroeconomic performance and indicators (para. 10 and Table 1): - Real GDP growth (percent): 1998 -1.9; 1999 2.7; 2000 9.8; 2001 13.5; 2002 9.8; 2003 9.2. - Growth of consumer prices (CPI, percent): 1998 1.9; 1999 17.8; 2000 9.8; 2001 6.4; 2002 6.6; 2003 6.8. - Unemployment (percent): 1998 13.1; 1999 13.5; 2000 12.8; 2001 10.4; 2002 9.3; 2003 9.0. - General government balance (cash basis, percent of GDP): 1998 -7.7; 1999 -5.0; 2000 -0.8; 2001 2.6; 2002 1.4; 2003 3.0. - General government non-oil balance (cash basis, percent of GDP): 1999 -6.0; 2000 -4.1; 2001 -3.1; 2002 -3.0; 2003 -3.2. - National Fund of the Republic of Kazakhstan (percent of GDP): 2001 5.6; 2002 7.9; 2003 12.3. - Public debt (percent of GDP): 1998 22.5; 1999 29.7; 2000 25.6; 2001 20.9; 2002 17.6; 2003 15.0. - Domestic public debt (percent of GDP): 1998 4.6; 1999 5.8; 2000 4.1; 2001 3.7; 2002 3.3; 2003 2.9. - External public debt (percent of GDP): 1998 17.9; 1999 23.9; 2000 21.5; 2001 17.2; 2002 14.2; 2003 12.2. - Current account balance (percent of GDP): 1998 -5.4; 1999 -0.1; 2000 4.2; 2001 -4.0; 2002 -3.5; 2003 -0.2. - External debt (percent of GDP): 1998 44.8; 1999 71.3; 2000 69.3; 2001 68.5; 2002 74.1; 2003 76.9. - Gross official reserves (millions of US$): 1998 1,964; 1999 2,003; 2000 2,096; 2001 2,508; 2002 3,136; 2003 4,961. - National Fund of the Republic of Kazakhstan (millions of US$): 2001 1,270; 2002 1,917; 2003 3,603. - Short-term external debt (million US$): 1998 2,321; 1999 1,805; 2000 1,021; 2001 1,366; 2002 2,360; 2003 3,771. - Gross official reserves (month of imports): 1998 3.0; 1999 3.6; 2000 2.8; 2001 2.9; 2002 3.3; 2003 4.5. - Exchange rate average (period average, tenge per U.S. dollar): 1998 78.6; 1999 120.1; 2000 142.1; 2001 146.9; 2002 153.5; 2003 149.7. - Change in real exchange rate (REER) 1/: 1998 21.0; 1999 -26.8; 2000 -0.6; 2001 -1.5; 2002 -5.0; 2003 -2.4. (Note: A negative sign indicates an appreciation.) - Broad money growth (M3, Dec./Dec, percent): 1998 -14.1; 1999 84.4; 2000 45.6; 2001 42.8; 2002 34.1; 2003 26.8. - Financial deepening I (M3 in percent of GDP): 1998 8.6; 1999 13.6; 2000 15.4; 2001 17.5; 2002 20.3; 2003 21.8. - Financial deepening II (M3 in percent of non-oil GDP): 1998 9.2; 1999 15.7; 2000 21.4; 2001 23.1; 2002 26.4; 2003 29.5. - Currency in circulation (percent of GDP): 1998 4.0; 1999 5.1; 2000 4.1; 2001 4.0; 2002 4.3; 2003 5.4. - Turnover of payment systems (times GDP): 1998 1.9; 1999 2.1; 2000 2.7; 2001 3.2; 2002 4.1; 2003 5.1. - Refinance rate, percent end of period: 1998 25.0; 1999 18.0; 2000 14.0; 2001 9.0; 2002 7.5; 2003 7.0. - 3-month treasury bill rate (year-end): 1998 25.6; 1999 16.6; 2000 7.0; 2001 5.2; 2002 5.3; 2003 6.0. - Foreign currency debt rating (Moody's): 1998 Ba3; 1999 B1; 2000 B1; 2001 Ba2; 2002 Baa3; 2003 Baa3. - Foreign currency debt rating (Standard and Poor's) 2/: 1998 B+; 1999 B+; 2000 BB-; 2001 BB; 2002 BB+; 2003 BB+. (Note 2/: In May 2004, Standard & Poor’s raised Kazakhstan’s foreign currency debt rating to investment grade (BBB-) citing increased government revenue from oil exports.) - Memorandum item: Nominal GDP (billions of tenge): 1998 1,733; 1999 2,016; 2000 2,600; 2001 3,251; 2002 3,776; 2003 4,450. - Macroeconomic risks and buffers (para. 11–12): - Hydrocarbon exports account for more than half of total exports. - The National Fund of the Republic of Kazakhstan (NFRK) was US$3.6 billion at end-2003. - Gross international reserves reached almost US$5 billion at end-2003, exceeding estimated short-term debt (US$3.8 billion). - Private external debt is 65 percent of GDP, has grown rapidly, and a large share is intra-company loans (40½ percent of GDP). - Exports and capital inflows have created appreciation and inflationary pressures under the managed floating exchange rate; pressures have been partly neutralized by the NFRK, increased money demand, and sterilization by the NBK. Rapid credit expansion and high levels of classified loans warrant caution (para. 12). - Institutional and legislative changes (para. 13–14): - Effective January 1, 2004, supervision of the financial sector and supervisory staff moved from the NBK to the Agency of the Republic of Kazakhstan on Regulation and Supervision of Financial Markets and Financial Institutions (FSA). - The FSA is accountable to the president; for the foreseeable future it will remain on NBK premises and be funded by the NBK; a detailed cooperation agreement between the FSA and the NBK addresses premises, services, and information-sharing. - The FSA chairman’s term is not explicitly specified; the chairman of the FSA and the governor of the NBK are not protected against arbitrary dismissal during their term, which are deficiencies for autonomy. - The banking system’s total assets increased to almost 38 percent of GDP (Table 2 referenced); the three largest banks hold about 65 percent of deposits by individuals; about half of the banks have some foreign participation. - Halyk Savings Bank was privatized in October 2001 and Eximbank in February 2004; a new state-owned bank (Zhilstroi Bank) was established in 2003 to finance housing construction, and its privatization should be considered (para. 14). *Source: _cr04268 - 1. Main Recommendations of the 2004 FSAP Update Mission (IMF PDF).* ### 15. In spite of robust economic growth, the proportion of banks’ classified loans ### _cr04268 - 15. In spite of robust economic growth, the proportion of banks’ classified loans ### Asset quality and provisioning - Classified loans (doubtful and loss) increased from almost 29 percent at end-2002 to 39 percent of total loans at end-2003. - Classified assets and contingent liabilities increased from 19.2 percent of total assets to 29.8 percent during the same period. - Classified loans not on time increased from 12.2 percent of total loans in March to 13.1 percent in December 2003. - Loan loss provisions at end-2003 amounted to 6.2 percent of loans. - Contributing factors noted: - Introduction of a stricter asset classification and provisioning methodology in early 2003. - Rapid credit growth and diversification of lending into new riskier businesses. - Authorities’ explanation that over-provisioning was used to smooth income. - Observations and implications: - Problem loans often increase after aggressive credit growth, particularly when banks lend to unfamiliar business types. - Macroeconomic shocks may also adversely affect loan portfolio quality. - Continued diligence and adequate resources for comprehensive on-site inspections are warranted. ### Prudential metrics and credit risk scenarios - Capital adequacy ratio (CAR) declined from 17.2 percent at end-2002 to 16.9 percent at end-2003 (preliminary). - On aggregate, prudential ratios are within comfortable ranges, though several larger banks are close to the minimum CAR of 12 percent. - Sensitivity analysis recommendations: - Intensify FSA efforts on sensitivity analysis, covering market risks. - Identify shocks, develop off-site reporting to calculate shock impacts, and estimate relationships between classified assets and macroeconomic indicators. - Impact illustrations: - A 15 percent increase in classified loans, if fully provisioned from equity capital, would bring the banking system’s CAR down to the minimum statutory requirement. - A 55 percent increase would lead to insolvency of the system (preliminary data of January 1, 2004). - For the least capitalized of the 10 largest banks, a 25 percent increase in classified loans requiring full provisioning would lead to insolvency. ### Regulatory and institutional developments - New classification/provisioning methodology (early 2003): - New formula explicitly considers financial condition of the borrower and the quality of the collateral in addition to days in arrears. - Each asset evaluated using a formula summing values assigned to various characteristics, with positive values for adverse characteristics and negative values for mitigating characteristics. - NBK as lender of last resort: - NBK extends such loans on a case-by-case basis, using constructive ambiguity to avoid moral hazard. - In 2001, NBK effectively covered all pensions and depositors of a failed bank by extending a loan to a then state-owned bank that paid depositors of the failing bank. - Recommendation: a bank’s commitment to address underlying problems should be a precondition for a lender-of-last-resort loan. - Legal framework for liquidation (effective January 1, 2004): - FSA given more authority to control and monitor the liquidator. - A representative from the Deposit Insurance Fund can become a member of the liquidation committee. - Liquidation request and report of the liquidation committee must still be approved by the court. ### Deposit insurance and supervision - Deposit Insurance Fund (DIF): - Established in 1999; became compulsory on January 1, 2004 for banks accepting household deposits. - DIF is fully owned by the NBK. - Deposits of individuals insured up to T 400,000 (US$2,900) per bank; deposits from large shareholders and parties related to management excluded. - DIF targets 5 percent of insured liabilities. - Current accumulated funds sufficient to cover insured deposits of no more than two to three of the smaller banks. - Premiums: 0.25 percent of insured deposits for newly insured banks and 0.16 percent for older banks. - Assessment: Risk-adjusted premiums seem premature; a simple and transparent framework is important at this stage. - Supervisory approach: - Weak banks should be dealt with through supervisory measures instead of caps on deposit rates established by the DIF. - A limit on “excessive” interest rates on insured deposits can be circumvented and reduces transparency. - Banks offering excessive interest rates—as determined by the DIF—to attract deposits or lending at very high interest rates should attract FSA attention and trigger inspections. ### Financial market structure, pension funds, and insurance - Banking sector structure and growth (selected indicators): - In 2003, broad money (M3) increased by almost 27 percent. - Profitability of commercial banks (unaudited): 1.96 percent of total assets in 2002 and 1.98 percent of total assets in 2003. - Each of the ten largest banks reported profits in 2003. - Growth in banks’ total assets in 2003: 46.5. - Growth in banks' loans (percent) in 2003: 45.5. - Growth of claims on households during period (percent) in 2003: 107.8. - Off-balance sheet items (percent of total assets) in 2003: 60.8. - Share of deposits denominated in foreign exchange (percent) in 2003: 47.1. - Share of loans denominated in foreign exchange (percent) in 2003: 55.5. - Loan to deposit ratio (percent) in 2003: 133.8. - Loan to deposit ratio denominated in foreign exchange (percent) in 2003: 157.6. - Liquidity ratio (K4) in 2003: 0.90. - Pension funds: - As of January 1, 2004, private pension funds had accumulated some US$2.5 billion (almost 8½ percent of GDP) on 6.4 million accounts. - Sixteen private pension funds operate, with portfolio allocations: government securities 53 percent, corporate bonds 24 percent, foreign investments 10 percent, bank deposits 7 percent. - Capital markets and securities: - Capital markets capitalization (percent of GDP) in 2003: 51.5. - Corporate bonds capitalization (percent of GDP) in 2003: 4.1. - Equities (percent of GDP) in 2003: 38.4. - Mortgage-backed bonds issued by the KMC since 2002: more than T 14½ billion (five emissions). - Corporate bond market capitalization growth to T 182½ billion (US$1.2 billion, 75 emissions) since late 1999. - Securities Market Act (SMA, 2003) improvements: clearer regulatory framework, strengthened enforcement powers, authority to institute sanctions, promotes transparency, prohibits manipulation, clarifies SRO roles, increases capital requirements for the central securities depositary. - Insurance industry: - As of January 2004, 34 insurance companies licensed, of which two are life insurance companies. - In 2003, gross premiums amounted to T 28 billion (0.6 percent of GDP), with more than 98 percent for non-life business. - Penetration ratio in 2002: 0.66 percent of the population. - Low penetration driven by low per-capita income and limited public understanding of insurance benefits. - Government supporting market development through introduction of compulsory insurance in a number of areas. ### Vulnerabilities, structural concerns, and recommended policy priorities - Vulnerabilities and structural concerns: - Rapid credit expansion in a bank-dominated financial sector warrants caution. - Rapid increase in pension fund assets and limited depth of financial markets to absorb them require attention. - Substantial cross-relationships between financial institutions and influential groupings with holdings in both financial and real sectors. - Emergence of financial-industrial groups, several with non-transparent ownership structures, raises concerns about related party lending and large exposures. - Exemptions from prudential limits reportedly no longer granted; progress in monitoring exposures since the 2000 FSAP. - Policy priorities and recommendations: - Ensure continued diligence in supervision, with adequate resources for scheduled comprehensive on-site inspections. - Intensify sensitivity analysis and off-site reporting systems to monitor market and credit risks. - Use supervisory measures rather than deposit rate caps to address weak banks; trigger inspections for banks exhibiting risky funding or lending behavior. - Make a bank’s commitment to address underlying problems a precondition for lender-of-last-resort support. - Maintain a simple and transparent deposit insurance framework before moving to risk-adjusted premiums. *Source: IMF staff report (preliminary data and internal tables as provided in the source content).* ### 29. Some banks are vulnerable to credit risks from specific economic sectors. ### _cr04268 - 29. Some banks are vulnerable to credit risks from specific economic sectors. ### Credit risk concentration and capital adequacy - Loan concentration to large business groups remains an issue despite restrictions on large exposures and improvements since the 2000 FSAP. - The definition of group exposure is broad, but supervisors have limited discretion to deem parties part of a single group when substance of the relationship differs. - Illustrative capital impact scenarios (based on preliminary end-2003 / January 1, 2004 data): - Applying 100 percent provisioning of current classified loans—excluding loans classified as doubtful but on time—less current provisions, the CAR would decline by about 5½ percentage points for the banking system. - In this scenario, five of the 10 largest banks would breach the statutory CAR but remain solvent. - Assuming an extreme case where all loans to the oil sector became nonperforming and full provisioning was required: - The oil sector captures less than 7 percent of total bank lending. - The adjusted CAR for the banking system would fall to the statutory requirement. - 4 of the 10 largest banks would breach the statutory requirement. - Regulatory limits on single-borrower exposures and large groups (as stated in footnote): - Exposure to a single borrower connected to the bank with special relations is limited to 10 percent of equity capital and the aggregate of such exposures shall not exceed 100 percent. - For other borrowers the limit is 25 percent (with not more than 10 percent uncollateralized). - The aggregate of large exposures is not limited. - Recommendation / suggested exercises: - Consider gauging the impact of large business groups on the banking system by estimating the impact on the CAR if the business group with the largest exposure failed; required information is available in the FSA’s large loan database. - Authorities are considering improving monitoring of real estate prices, particularly in large population centers. ### Liquidity risk and funding - Prudential indicators suggest the banking system is liquid on aggregate, but they do not fully reveal some banks’ reliance on potentially volatile wholesale funding. - Loan-to-deposit ratios for the 10 largest banks range from 56 percent to 120 percent. - Observed practices and concerns: - Some larger banks use special purpose vehicles—reportedly for tax purposes—to solicit funding abroad, underscoring the need for consolidated analysis of liquidity. - Monitor whether issued bonds have special covenants (embedded options). - The Deposit Insurance Fund introduced interest rate ceilings on deposits to prevent weak banks from offering excessive interest rates, suggesting some banks may have liquidity constraints that should be investigated. ### Foreign exchange exposure - Aggregate limit on exchange rate risk is high by international practice, but limits on individual currencies depend on the country rating, which reduces risk. - Regulatory gap: - The regulation does not include assets and liabilities denominated in tenge but indexed to foreign exchange in the calculation of the net open position in foreign exchange. - Indexed instruments have reportedly declined in popularity since the 1998 Russian crisis, but indexed instruments—depending on indexation—should be included and information compiled. - Derivatives are included in the net open position calculation, but the regulation does not specify how to treat currency options. - Indirect foreign currency risk: - Banks are exposed to indirect foreign currency risk, which may be substantial but is difficult to gauge due to lack of data. - Appreciation expectations currently reduce this risk. - Consider conducting occasional surveys to better estimate indirect exchange rate risk. ### Nonbank financial institutions: regulatory capacity and market development - Recent legal changes and implementation capacity: - Rapid passage of laws for insurance, pension funds, and securities markets has created a gap between the regulatory framework and implementation capacity of industries and regulators. - Near-term focus should be implementation of existing laws. - Several additional laws—including one on investment funds and one on securitization—are being drafted; securitization law requires careful consideration of asset types and risk reporting. - Industry concern that capacity to absorb further legislation is doubtful. - Pension funds and capital market interaction: - Steady contributions to pension funds and lack of a vibrant capital market necessitate supervisory diligence and capital market development. - Dominance of banks and financial-industrial groupings, low competition in key sectors, and privatization legacy limit potential issuers. - Pension funds’ current investment strategies favor high-yield, short-term investments: - Motivated by lack of long-term assets and a focus on short-term returns to gain market share. - Regulators and industry participants do not fully appreciate attendant risks. - This strategy exposes social safety net assets to higher reinvestment and issuer risk and to exchange rate risk (foreign and currency-indexed assets). - Foreign investments, including index funds, could offer diversification but low interest rates and recent currency appreciation have resulted in negative returns on some foreign investments. - Market-development measures and public debt: - No easy solution to generate long-term financial assets for pension funds; efforts to encourage issuances must continue. - To date, only mortgage-backed securities have been issued to help meet demand. - An active, predictable public debt market is lacking; domestic government issuances could be structured to establish benchmarks and a yield curve for tenge-denominated debt. - Disclosure, corporate governance, and public education: - Information disclosure (ownership, governance, product descriptions, risks) is central to market viability. - A corporate governance ROSC assessment would help identify measures to increase confidence in the market for corporate securities. - An education campaign explaining nonbank financial products to the public would be useful; industry associations are well placed to lead, with government support and transparent risk information. - Insurance industry constraints: - Development hampered by inability to measure risks, set adequate reserves, and price products realistically. - Prospect of more compulsory insurance—particularly in hard-to-insure areas like crop insurance—could exacerbate risks given insufficient databases and actuarial capacity. - Until substantial statistical information is systematically collected, the most successful products are likely to be third-party liability and property insurance. ### Assessments and updates of selected standards and codes - Basel Core Principles for Effective Banking Supervision (re-assessment): - Substantial improvement since the 2000 assessment; more principles are compliant or largely compliant and no principles were non-compliant. - Important recent measures include consolidated supervision and risk-management initiatives; implementation could not be verified due to recent introduction. - The FSA became operational January 1, 2004 and still has to establish a track record. - IOSCO Principles on Securities Regulation (update): - Marked improvements in the legal framework since the 2000 FSAP; new laws and regulations are ambitious and broadly consistent with international practices, but effective implementation is needed. - Capacity constraints at the FSA capital market and pension supervision department: - Staff of about 30 for securities market and pension funds (10 each in the on-site and off-site divisions). - These staff are designated to supervise 120 capital market participants, each reporting at various frequencies. - Monitoring pension funds will increasingly require disproportionate resources, potentially leading to undetected vulnerabilities elsewhere. - Recommendation: reassess supervision of securities and pensions; consider less frequent reporting for some participants and increase continuous dialogue between regulator and industry. - IAIS Insurance Principles (update): - 2000 FSAP recommended new insurance legislation, accounting and auditing standards, development of actuarial profession, and upgraded supervision. - New legislative requirements were passed in December 2003 and are beginning implementation. - Since January 1, 2003, it has been compulsory for financial institutions, including insurance companies, to use IFRS, though small insurers may find this difficult. - Remaining challenges: upgrade supervision to meet new legislation, strengthen implementation and enforcement, develop actuarial profession and reliable statistical foundation and database. - Core Principles for Systemically Important Payment Systems (update): - 2000 FSAP found many principles observed or broadly observed but identified important weaknesses, mainly related to the System of Retail Payments (SRP). - Reforms since 2000: - The Interbank System of Money Transfers (ISMT) is now a real-time gross settlement system. - In 2003 a new assessment of ISMT rated all principles observed or broadly observed; clarifications were suggested on inconsistency between the Law on Payments and Money Transfers and the Bankruptcy Law regarding real-time finality, though authorities find legal arrangements adequate. - Security concerns in payment systems that emerged since 2000 have been promptly addressed; NBK has undertaken on-site inspections and should sanction members not following appropriate security procedures. - Transparency in monetary and financial policies (update): - Since 2000, NBK has strengthened transparency but some shortcomings remain. - Developments: - In 2002 NBK announced plans to move to an inflation targeting framework. - In March 2003 NBK completed subscription to the Special Data Dissemination Standards (SDDS) and started publishing data on the template on international reserves and foreign currency liquidity. - Information on terms of refinance and other central bank facilities are now published; schedule and working-plan of main policymaking body are published. - NBK provides information on internal audit in its annual report and publishes regulations on relationships and transactions with counterparties. - Remaining issues: - Central bank law does not spell out criteria for removal of members of governing bodies; Article 26 of the law on Public Service stipulates misdeeds are grounds for dismissal but does not protect members from arbitrary dismissal. - FSA transparency and accountability: - Authorities state FSA guiding principles will remain unchanged from NBK practices, but new FSA law does not cover all issues previously addressed by central bank law. - FSA law does not set up modalities of accountability or require publication of audited financial statements of operating expenses and revenues. - No internal audit function established yet; internal procedures and public information service/publication program remain to be established. - Public information on financial sector issues is currently published on the NBK website and in its publications. - A detailed agreement outlining areas of interaction between FSA and NBK has been signed. *Source: _cr04268 - 29. Some banks are vulnerable to credit risks from specific economic sectors.* ### 50. Kazakhstan has taken initiatives to prevent money laundering and financing of ### Kazakhstan: Progress since the 2000 FSAP — AML/CFT and Banking Supervision ### Anti‑Money Laundering and Combating the Financing of Terrorism (AML/CFT) — Legislative and Institutional Status - The task of drafting a law on anti-money laundering and combating the financing of terrorism (AML/CFT) has been given to the Agency Fighting Economic and Corruption Crimes. - The Criminal Code recognizes money laundering as a financial crime, but its legal definition “does not yet meet recognized international conventions and standards.” - Banking secrecy provisions “subject anyone disclosing suspicious transactions, even to authorized bodies, to criminal sanctions.” - A financial intelligence unit (FIU) does not yet exist. - Financing of terrorism has been “added to the definition of terrorist activity,” which “will allow authorities to pursue the financing of terrorism in some circumstances,” but “financing of terrorism is not criminalized per se” and therefore this provision “does not fully satisfy the requirements on combating the financing of terrorism or on offering international cooperation in financing of terrorism cases.” - A summary of the assessment—the ROSC of the AML/CFT standards—can be found in Appendix III. - Footnote: “It is anticipated that the law will be adopted by the parliament sometime before end-2004.” ### Main Findings on Banking Supervision (ROSC / Basel Core Principles) - The assessment of implementation of the Basel Core Principles for Effective Banking Supervision (BCP) was completed as part of a Financial Sector Assessment Program update. - Institutional setting: - The Agency of the Republic of Kazakhstan on Regulation and Supervision of Financial Markets and Financial Institutions (FSA) is the body responsible for banking supervision. - The National Bank of Kazakhstan (NBK) retains responsibility for broad financial sector stability. - Significant legal and practical changes have been implemented since the original FSAP. - General preconditions: - Kazakhstan experienced “a period of very strong economic growth,” increasing demand for credit. - Growth of household deposits has lagged banking sector growth, leaving much of the sector dependent on wholesale funding. - Wide variation among banks in management depth and risk management; smaller banks “may face serious challenges in maintaining their viability.” - Improvement in commercial law including registration of collateral and enforcement of security interests. - Judiciary developing greater familiarity with commercial and banking matters, making decisions more predictable. - Distortionary tax effects: restriction on amount of interest deductible for tax purposes adversely affects loan interest rates and may hurt asset quality. - Kazakhstani banks required to use International Financial Reporting Standards (IFRS) since January 1, 2003; “some of the smaller banks…may not have made the investment to fully convert their internal systems to IFRS.” - Deposit insurance regime revised in 2003; participation mandatory for all banks licensed to accept deposits effective January 1, 2004. - Introduction by the deposit insurance fund in 2003 of interest rate ceilings on deposits is “a cause for concern.” - Main findings: - Implementation of the Basel Core Principles “has improved substantially” since 2000. - Significant legal improvements regarding consolidated supervision and risk management were introduced in late 2003. - Effective implementation of these measures would improve the assessment of six principles currently graded as materially non-compliant. - Objectives, Autonomy, Powers, and Resources (CP 1): - Compliance increased due to legal changes and evolution in the judicial system; creation of a single supervisory agency addressed earlier information‑sharing concerns. - Concern: the new agency lacks some elements intended to ensure operational independence of the NBK. - Recommendation: “It would be better for the Chairman and Deputy Chairman of the new agency to serve fixed terms, with the provision that they can only be removed for reasons specified in law, and that the reason for their dismissal be made public if they do not serve a full term.” - Article 922 of the Civil Code: “the state treasury will pay the costs of any court judgment arising from action or non-action by an official in connection with public administration.” - Licensing and Structure (CPs 2–5): - High level of compliance achieved. - Legal requirement for affiliates of banks to provide information used to determine beneficial owners of almost all significant ownership stakes. - Monthly reports from share registries have almost eliminated undisclosed changes in significant ownership. - Prudential Regulations and Requirements (CPs 6–15): - Compliance improved since 2000; steps initiated to address remaining weaknesses. - Introduction of planned law on anti-money laundering, establishment of an FIU, and amendment of bank secrecy provisions are needed to improve prevention of bank misuse by criminal elements. - Methods of Ongoing Supervision (CPs 16–21): - Onsite and offsite supervision standards are “generally good” with significant improvements in offsite analysis and understanding of group structures. - Consolidated supervision remains the most important remaining issue; effective implementation of group wide prudential limits (introduced in late 2003) would substantially improve assessment. - Formal Powers of Supervisors (CP 22): - Exercise of remedial powers appears much improved. - Exemptions from prudential requirements are no longer granted by the supervisory authority. - Banks with identified weaknesses are subject to more intensive monitoring; “according to the FSA, all banks are currently reporting compliance will all prudential norms.” - Concern reiterated: deposit interest rate ceilings introduced by the deposit insurance fund in 2003; administrative measures to curb excessive deposit rates may indicate banks with mismanagement, illiquidity and/or insolvency and suggest problem banks may not be promptly identified and addressed. - Cross‑Border Banking (CPs 23–25): - Importance of implementing these principles increased as Kazakhstani banks are more active internationally. - Full compliance requires supervisory approaches for oversight of foreign operations and development of agreements/memoranda of understanding with foreign supervisors. - Table 1. Recommended Action Plan to Improve Compliance with the Basel Core Principles — Selected recommended actions (verbatim): - 1.1 Objectives - “The recently signed detailed agreement between FSA and NBK should be implemented.” - 1.2 Independence and resources - “It should be stipulated in law that high level officials at the FSA can be removed only for cause with the reasons made public.” - “Fill existing staff vacancies.” - 1.4 Enforcement powers - “Legal amendment to explicitly permit the supervisory agency to exercise judgment should be adopted.” - 1.6 Information sharing - “The recently signed detailed agreement between FSA and NBK should be implemented.” - 3. Licensing - “Due consideration should be given to whether the proposed legal and managerial structure would hinder effective supervision.” - 5. Investment criteria - “Establishment or acquisition of a subsidiary if it might impair effective supervision should be prohibited.” - 6. Capital adequacy - “Effective implementation of the recently introduced group wide prudential requirements, including regularly calculating the capital adequacy ratio on a consolidated basis.” - 7. Credit policies - “Effective implementation of the prudential requirements on credit risk management introduced in December 2003.” *Source: IMF staff report text (excerpt)._cr04268 — Kazakhstan: Progress Since the 2000 FSAP (Appendices I–II).* ### 8. Loan evaluation and provisioning ### 8. Loan evaluation and provisioning ### Prudential recommendations (selected items 8–25) - Fine-tune the new loan loss provisioning requirements. (8) - Effective implementation of the recently introduced group wide prudential requirements. (9, 20) - Obtain greater certainty over time that all related parties transactions are actually identified and reported. (10) - Effective implementation of the prudential requirements on risk management introduced in December 2003. (11, 12, 13) - Introduce capital requirements for market risk. (12) - Continued improvement in the application by banks of the prudential requirements for internal control and audit. (14) - Introduce planned anti-money laundering law, a Financial Intelligence Unit (FIU), and amend the pertinent bank secrecy provisions. (15) - Develop specific prudential guidelines for banks in conjunction with broader work on AML/CFT issues. (15) - Development of effective internal policies within the FSA to coordinate the work of the division responsible for financial conglomerates with the functional supervisors. (16, 20) - Further improve the depth of offsite analysis, particularly regarding liquidity and refinancing risks. (18) - Review the volume and frequency of data collection with a view to eliminating daily and weekly analysis, except of identified problem banks. (18) - Ensure open channels of communication with auditors. (21) - Ensure prompt action to address identified problem banks. (22) - Develop a supervision module to focus specifically on the oversight by bank management of foreign establishments. (23) - Develop working relationships with foreign supervisors, including information exchange and coordination of activities. (24) - Develop stronger working relationships with home country supervisors. (25) - Assess home country supervisors’ capacity for consolidated supervision. (25) ### Authorities’ response - The authorities were broadly in agreement with the assessment and found it unbiased and useful. - The authorities have recently issued regulations on consolidated supervision and risk management, but agreed that insufficient time had passed to assess the implementation and effectiveness of these regulations. (14) ### Supervision and supervisory practice (cross-cutting) - Emphasized effective implementation of newly introduced prudential requirements (December 2003) across risk management, market risk, and other risks. (11–13) - Strengthen onsite and offsite supervision coordination within the FSA, particularly for financial conglomerates. (16, 20) - Offsite supervision should place more emphasis on liquidity and refinancing risks and streamline reporting frequency. (18) ### AML/CFT integration with prudential oversight - Develop specific prudential guidelines for banks linked to broader AML/CFT reforms, including a planned AML law and establishment of an FIU. (15) ### Key supervisory priorities (concise) - Implement group-wide prudential requirements and consolidated supervision. - Improve identification and reporting of related-party and connected lending. - Strengthen internal control, internal audit, and remedial action frameworks for problem banks. - Introduce market risk capital requirements and deepen offsite liquidity analysis. - Enhance cooperation with foreign supervisors and assess home supervisor capacity. ### Source attribution *From: _cr04268 - 8. Loan evaluation and provisioning* ### APPENDIX III — REPORT ON THE OBSERVANCE OF STANDARDS AND CODES—SUMMARY ASSESSMENT OF AML/CFT ### Overview and methodology - This ROSC assesses the FATF 40 Recommendations and 8 Special Recommendations for AML/CFT. (1) - Prepared by a team of IMF, World Bank staff, and an independent criminal law expert. (1, footnote 16) - Assessment is based on information available at the time it was completed (February 24, 2004). (3) ### Main findings (summary) - Kazakhstan’s rapid economic growth has been largely based on substantial oil, gas, and mineral reserves, and privatization process. (4) - Geographic location renders it a convenient drug trafficking corridor; organized crime, regional insecurity, transparency issues in natural resources, and need to encourage foreign investment create substantial AML/CFT challenges. (4) - Delay in implementing appropriate AML/CFT policies and procedures could impede Kazakhstan’s development efforts. (4) - Kazakhstan has criminalized money laundering, but its definition does not yet meet international standards. (5) - No FIU exists; bank secrecy provisions impose criminal liability upon those who disclose suspicious transaction data even to authorities authorized to act on such information. (5) - Government officials have participated in AML/CFT training programs, indicating emerging political will. (5) ### Criminalization of ML and FT - No enacted AML/CFT law yet; drafting coordinated by the Agency Fighting Economic and Corruption Crimes. (6) - Criminal Code recognizes money laundering as a financial crime, but legal definition falls short of international standards. (6) - Financing of terrorism not criminalized as a separate offense; financing included within definition of “terrorist activity” in the Law of the Republic of Kazakhstan of July 13, 1999 No. 416-1 on Combating Terrorism (Law No. 295, as amended, Feb. 19, 2002). (7) - Inclusion of financing within “terrorist activity” allows pursuit in some circumstances but does not fully satisfy International Convention on the Suppression of the Financing of Terrorism requirements. (7) ### Structural and procedural impediments - Kazakhstan remains a relatively cash-based economy and has a significant unregulated economy, complicating investigations and convictions for organized crime, money laundering, and terrorist financing. (8) - The UN Security Council Resolutions relating to prevention/suppression of financing of terrorism have not been fully implemented; authorities have begun to circulate UN terrorist lists to financial institutions but screening is not a legal obligation and noncompliance cannot be sanctioned. (9) - Authorities cannot freeze, without delay, funds or other property of terrorists designated by the UN or by individual governments without first initiating a court action and obtaining a judicial ruling that the individual or entity is a terrorist or terrorist organization. (9) ### Confiscation, seizing, and freezing - Confiscation regime has property and value-based provisions, but is not mandatory; requires a criminal conviction. Freezing and seizing of assets are available on a provisional basis. (10) - Freezing/seizing used mainly as an additional penalty; lack of provisions for expeditious seizing or freezing bank accounts or other accounts without delay is a serious impediment. (11) - Legal mechanisms should permit freezing/seizure of property, proceeds, and/or assets used or intended for financing terrorism. (11) ### FIU and information flows - No FIU exists; drafting of AML/CFT law would provide legal authority for establishment. Creation of an FIU should be a priority to analyze suspicious transaction details and forward information for investigation and prosecution. (12) ### Law enforcement, prosecution, and capacity building - Methods to combat ML and FT need further development; training of law enforcement officials is crucial for asset tracing, money laundering, and terrorism financing investigations. (13) - Law enforcement agencies should be required to develop and disseminate typologies and methods of ML/FT used regionally and internationally. (13) - Kazakhstan has a modern system for collecting/processing statistical data on pre-trial investigations; similar systems should be implemented for trial and post-trial procedures. (13) ### International cooperation - Kazakhstan is a party to the Vienna Convention and the International Convention on the Suppression of the Financing of Terrorism and various bilateral/multilateral treaties, providing legal bases for assistance. (14) - Kazakhstan has signed the CIS Chisenau Convention (1993) and the 1999 CIS Treaty on Combating Terrorism; further expansion of legal mechanisms for information sharing and mutual cooperation should be considered. (14) - Chapter 55 of the Criminal Procedure Code requires letters rogatory for legal assistance with countries without treaties, which can cause substantial delays. (14) - Amendments should permit bilateral Memoranda of Understanding between FIUs for broader and more efficient information sharing. (15) ### Institutional arrangements and strategy - AML/CFT Task Force is drafting an AML/CFT law and would provide legal basis for an FIU. (16) - Task Force composition is limited and should be expanded to include the Prosecutor’s Office, Ministry of Interior, and Currency Control Department of the National Bank of Kazakhstan. (16) - Task Force should also draft a national strategy and implementation program. (16) ### Preventive measures for financial institutions - Current secrecy provisions prevent reporting of suspicious transactions to authorities; bank secrecy in the Banking Law prevents disclosure even to bodies authorized to act on such information. Reporting of suspicious transactions should be required by law; provisions imposing civil or criminal liability for such reporting should be repealed. (17) - Secrecy provisions that relate to other prudentially regulated sectors should be amended to allow reporting to authorized bodies without risk of criminal or civil liability, while maintaining penalties for unauthorized or inappropriate disclosure. (17) - AML/CFT law should require financial sector entities, relevant private sector entities and certain professionals to implement policies and procedures for identifying and reporting suspicious transactions to the FIU; compliance should be regularly audited and penalties available for non-compliance. (18) - The FIU, together with law enforcement, should cooperate with the FSA and NBK to provide training and materials on identifying suspicious transactions, legal obligations, penalties, and reporting mechanisms. (18) - Laws and regulations should require all professionals and entities subject to AML/CFT obligations to classify clients/customers into realistic risk categories and implement know-your-customer documentation proportional to those risks; ongoing monitoring procedures should be implemented and regularly audited, with penalties for noncompliance. (19) ### Source attribution *From: _cr04268 - 8. Loan evaluation and provisioning* ### 20. Relevant laws and regulations should be amended to require that all persons, entities, ### _cr04268 - 20. Relevant laws and regulations should be amended to require that all persons, entities, ### Record-keeping and retention requirements - All persons, entities, and service providers subject to AML/CFT law obligations should maintain all customer account information and transaction documentation for a minimum of five years from the date of execution of the transaction. - Records on customer identification, account files, and business correspondence should be maintained for at least five years after the account is closed. - These requirements should be regularly audited by appropriate supervisory agencies, and instances of noncompliance should be penalized. ### Key recommended legal and supervisory actions (excerpted from Table 1 and Appendix III) - Sign, ratify and implement the UN Convention Against Transnational Organized Crime (Palermo, 2001), and the Council of Europe Convention on Laundering, Search, Seizure and Confiscation of the Proceeds of Crime (Strasbourg, 1990, ETS No. 141). - Amend relevant laws to fully implement the UN Convention Against Illicit Traffic in Narcotic Drugs and Psychotropic Substances (Vienna Convention, 1988), and the UN Convention for the Suppression of the Financing of Terrorism (1999). - Amend bank secrecy provisions to permit the reporting of suspicious transactions to law enforcement authorities. - Amend relevant Criminal Code provision 193 to expand the definition of money laundering to meet international standards and ensure prosecutability both separately and in parallel with all predicate offenses. - Improve legal mechanisms to allow the freezing or seizure of property, proceeds and/or assets used or intended for use in the financing of terrorism without delay. - Make confiscation of criminal proceeds of money laundering and terrorist financing matters mandatory so that courts are obligated to consider and, to the extent proceeds exist, confiscate them. - Enact a law fully implementing UN Security Resolutions requiring mandatory review of names on terrorist lists, auditing of compliance processes, and penalties for noncompliance. - Amend secrecy provisions of the Banking Law and other financial secrecy laws to allow reporting of suspicious transactions without risk of civil or criminal liability. - Require implementation of know-your-customer policies and procedures across relevant financial sector and other appropriate entities. - Require ongoing monitoring of client transactions, with monitoring procedures related to risk classifications and higher-risk categories subject to more frequent monitoring. - Ensure AML/CFT obligations and enhanced due diligence apply to branches and subsidiaries, and to transactions involving jurisdictions that do not apply FATF Recommendations. - Consider including in the AML/CFT law a provision requiring reporting of all cash transactions above a certain threshold limit and step up monitoring of cross-border transactions. - Require internal policies and procedures to prevent and detect money laundering and terrorist financing for all obligated entities and professional service providers; supervisory authorities should regularly audit compliance and deny licenses where supervisors have reasonable grounds to suspect involvement in organized crime, money laundering, terrorist financing, and/or terrorist groups. - Conclude bilateral treaties permitting straightforward sharing of information and mutual cooperation in criminal matters; amend laws and regulations to permit sharing of information concerning suspicious transactions and customers with counterpart agencies abroad. - Sign memoranda of understanding permitting broad sharing of information concerning suspicious transaction activities and terrorist financing between financial sector supervisory bodies and counterpart agencies abroad, including between the Kazakhstani FIU and foreign FIUs. - Consider additional provisions on mutual assistance to allow assistance on a case-by-case basis without the need for a bilateral or multilateral treaty or letters rogatory; consider increasing the number of bilateral treaties, particularly with countries generating a number of requests. - Permit modern investigative techniques under the Criminal Code to obtain evidence and investigate cross-border cases of money laundering and terrorist financing. ### FATF Special Recommendations on Terrorist Financing (summarized) - Fully implement the UN Convention on the Suppression of the Financing of Terrorism. - Amend the Criminal Code to make financing of terrorism a separate criminal offense. - Provide legal mechanisms to freeze or seize property, proceeds and/or assets used or intended for use in the financing of terrorism. - Require reporting of suspicious transactions to a FIU under the envisaged AML/CFT law. - Permit appropriate supervisory agencies and law enforcement officials to provide information and mutual legal assistance to foreign counterparts for investigation and prosecution of terrorists and groups financing terrorist activities. - Pay attention to alternative (informal) remittance systems and their potential role in terrorist financing. - Require heightened attention to wire transfer payments, particularly wire transfers without adequate originator information. - Require entities and professionals obligated to report suspicious transactions to pay particular attention to activities of non-profit organizations and indications of suspicious activities or transactions related to terrorist financing. ### Other recommended institutional action - Create a Financial Intelligence Unit (FIU), which meets international standards and is operationally independent, adequately staffed, and supervised. ### Authorities’ response - The authorities concurred with the assessment. - The authorities expect that the practical implementation of the recommendations on amending the existing legal and institutional framework will become rather complex. *Source: _cr04268 - 20. Relevant laws and regulations should be amended to require that all persons, entities,* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04268.pdf_