## _cr14258 ## Source details **Canonical URL:** [_cr14258](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14258.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14258.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14258.pdf.json) --- ### MACRO-FINANCIAL SETTING AND FINANCIAL VULNERABILITIES - Pre-crisis growth was high and unbalanced, driven by the non-tradable sector, particularly construction, supported by a surge in bank credit and an appreciating real exchange rate. - Between 2005 and 2007, Kazakhstan’s banks borrowed from abroad the equivalent of 44 percent of GDP and channeled a substantial part into non-tradable sectors. - The credit boom was financed largely through external wholesale funding and a sizeable increase in bank leverage; the drying up of external funding during the crisis forced aggressive deleveraging, triggering declines in stock and real estate prices and a strong deceleration in non-oil activity. - A 20 percent devaluation in 2009 exacerbated problems from unhedged foreign currency borrowing and amplified contractions in demand and loan-servicing difficulties. - Government action during the crisis included acquisition of majority stakes in three large banks (Alliance, Temirbank, and BTA) and minority stakes in two others (KKB and Halyk Bank); despite restructuring some external liabilities, bad assets were not resolved and NPLs built up significantly. ### FINANCIAL SYSTEM STRUCTURE AND KEY STATISTICS - Banking sector dominance and composition: - 38 commercial banks. - Banks account for 77 percent of total financial system assets and 44 percent of GDP. - Public sector assets represent 60 percent of total banking assets at end-February 2014. - 17 banks operating in Kazakhstan, including 14 foreign subsidiaries. - As of January 2014, Kazakh banks have a presence in Kyrgyzstan, the Netherlands, Russia, Tajikistan, Luxembourg, Belarus, Georgia, Armenia, and Ukraine. - Market concentration: - The five largest banks accounted for more than half of banking assets in 2013. - Consumer lending: top three banks account for one half of the market share and the top seven for 76 percent. - Insurance and non-banking: - Insurance sector: 34 companies; assets are 3 percent of total financial sector assets. - Mortgage companies and other non-banking organizations: less than 1 percent each of total financial sector assets. - Securities exchange (KASE) is small; 81 listed companies as of December 2013. - Cross-border positions (selected): - Banks external borrowing reached $11.5 billion (5 percent of GDP) in September 2013. - Banks’ assets abroad stood at $6.4 billion (2.9 percent of GDP) as of December 2013. - Main source countries for external borrowing: United Kingdom 54 percent; China 21 percent. ### BANKING SECTOR: SOLVENCY, LEGACY PROBLEMS, SUPERVISION - Asset quality and capital metrics: - System-wide NPL ratio about 30 percent; NPLs concentrated in the five largest banks. - NPLs as percent of gross loans: 2008: 5%; 2009: 22%; 2010: 24%; 2011: 31%; 2012: 30%; 2013: 31%. - Provisions as percent of NPL: 2008: 69%; 2009: 75%; 2010: 63%; 2011: 70%; 2012: 77%; 2013: 83%. - System aggregate CAR stabilized around 17 percent; Tier I around 13 percent in recent years. - Currency and interest metrics: - 38 percent of loans are in foreign currency, mostly to unhedged borrowers. - Foreign currency loans as percent of total loans: 2008: 52%; 2009: 57%; 2010: 50%; 2011: 44%; 2012: 38%; 2013: 38%. - Foreign currency liabilities as percent of total liabilities: 2008: 60%; 2009: 54%; 2010: 44%; 2011: 40%; 2012: 35%; 2013: 43%. - Profitability and funding: - Banks’ return on assets (ROA) is low. - Credit growth: about 13 percent annually; growth in lending by consumer-oriented small- and medium-sized banks reached nearly 50 percent in December 2013. - Cost of one-year deposit about 8 percent; lending rate above 40 percent. Ceiling on interest rates on consumer loans is 56 percent. - Wholesale funding declined from 50 percent to 20 percent of banking system’s total liabilities by end 2013. - Supervisory transition needs: - FSIs understate weaknesses due to concerns about collateral valuation, inadequate loan classification, and under provisioning, exacerbated by adoption of IFRS-IAS39 and limited supervisory skill upgrades. - Need faster transition to risk-based oversight: adopt advanced risk-assessment tools, intensify use of stress test results, train supervisors in collateral valuation, access real estate information, and hire appraisal expertise. ### STRESS TESTS — DESIGN, RESULTS, AND IMPLICATIONS - Design: - Tests: baseline consistent with IMF WEO forecasts and two stress scenarios with temporary reductions in growth over a 3-year period ending in December 2016. - Adjusted baseline: collateral value reduced by the equivalent of the change in house prices since December 2006, resulting in a provisioning shortfall of 12.3 percent of nonperforming exposure. - All 38 banks performed bottom-up cash flow-based liquidity tests (Basel III LCR); interbank contagion risks explicitly modeled. - Solvency results: - Baseline: effects of February devaluation and phase-out of capital instruments ineligible under Basel III lead to steady decline in capital ratio, partially eroding initial buffers but remaining above regulatory threshold; Tier 1 dips below the conservation buffer but remains above regulatory minima. - In baseline, seven banks accounting for nearly half of system assets fail to meet regulatory minima in projections; capital shortfall equivalent to 2 ½ percent of GDP. - In stress scenarios, two additional banks fail, totaling 9 banks accounting for slightly more than half of assets. - Under the more severe scenario, capital deficiency reaches 5 percent of GDP. - Concentration risk: default of the largest three exposures of each bank would reduce capital ratios by around 7 percentage points; eleven banks (~one third of system assets) would breach regulatory minimums if their three largest exposures defaulted. - Banks could generally absorb immediate implementation of Basel III capital definitions; however, increases in capital would be needed to maintain buffers or withstand shocks; unchanged NPLs imply many banks would likely need external or governmental capital injections. - Liquidity and contagion: - Under Basel Committee scenario, system LCR exceeds 2 but 12 banks (a third of assets) would see coverage ratio drop below hurdle. - Under a more severe scenario (deposit outflows increased, secured funding fell by 30 percent, customers drew 30 percent of committed lines), system coverage ratio still exceeds 100 percent but 17 banks (56 percent of assets) would not be able to cover outflows. - Direct contagion through bilateral interbank exposures is limited: net lending exposures <1 percent of total banks’ assets (0.3 percent of GDP); only six banks have net bilateral exposures above ten percent of regulatory capital; pure interbank contagion stress does not result in bank failures. ### NON-PERFORMING LOANS (NPLs): SLOW PROGRESS AND MULTI-TRACK RESOLUTION - NPL stock remains large (more than 30 percent of loans) and unresolved; poses a contingent liability for the public sector. - 2011 three-pronged approach limitations: - PLF could not acquire NPLs collateralized with real estate or those in state-owned banks’ books; virtually no loans transferred to PLF; SPVs underused; real estate-backed NPLs not written off. - Obstacles to resolution: - Bank secrecy laws prevent PLF access to loan documentation. - Property registration rules restrict collateralized debt transfers when liens of third parties exist. - Non-neutral taxation on loan restructuring/write-offs (taxation of recovery of loan-loss provisions; inability to recognize write-off losses for tax purposes). - Recommended multi-track strategy: - Four-track strategy: (i) debt write-offs; (ii) foreclosures, repossession, recovery under insolvency; (iii) sales by PLF and SPVs of NPL bundles or NPL/mortgage-backed securities; (iv) PLF and SPVs acquiring ownership in collateral for bundled marketing. - Enabling legal and tax changes: loosen bank secrecy rules, make foreclosure and insolvency proceedings less costly and more transparent, eliminate tax burden of debt write-offs/forgiveness (including withholding tax in case of debt forgiveness to individuals), and suspend VAT on fixed asset purchases and foreclosures in NPL resolution context. - Strengthening PLF/SPVs: - PLF/new centralized AMC should have strong mandate, operational independence, and budgetary independence; broad mandate for bundling NPLs; adequate financial and staffing resources. - Require reporting to parliament and public and subject to strict audits. - Pooling distressed assets to create economies of scale and different approaches by NPL type (write-offs, outsourcing small-value NPLs, securitization, bundled marketing). - Viability depends on access to non-domestic sources of capital; attract international investors by addressing regulatory uncertainty, non-transparent financial transactions, and weak governance. ### FINANCIAL SAFETY NET, RESOLUTION FRAMEWORK, AND CRISIS MANAGEMENT - Resolution framework amended in 2009 to include restructuring, purchase and assumption (P&A), and bridge bank options. - Practical shortcomings: - P&A and bridge bank options require approval of depositors and/or creditors rather than giving supervisor full authority. - No clear triggers for stages from temporary administration to resolution and liquidation. - License revocation and resolution occur under separate procedures with a lag; KDIF mandated to start paying depositors within 14 business days of court ruling of forced liquidation, which may pressure NBK and impede P&A. - Law contains no solvency requirement or penalty interest requirement for ELA; ELA procedures need adjustment to limit availability to solvent institutions and ensure penalty rates. - Emergency Liquidity Assistance (ELA) and systemic liquidity: - NBK has authority to provide ELA in domestic and foreign currency; recent use includes a ‘special purpose lending facility’ in October 2011 (one-year FX repurchase agreement collateralized by bonds issued by SK). - Recommendation: ELA only to solvent institutions and, if in foreign currency, only if sufficient foreign currency reserves are available. - Deposit insurance (KDIF): - KDIF strong capital position but governance issues: fund equity to insured deposits ratio: 11 percent. - Full coverage afforded to over 99 percent of deposit account holders; total amount of deposits insured: 55 percent of total deposits. - KDIF Board includes two current directors of banks — not best practice. ### PAYMENT SYSTEMS, FMIs, AND INTRA-DAY LIQUIDITY RISK - Systemically important FMIs: KISC, KASE, KACD — all majority-owned by NBK. - Lack of legal certainty on finality of payments and settlements: law on payment and transfers does not define final and irrevocable transfer; Securities Market Law does not provide finality of securities transactions — amendments recommended. - ISMT intra-day liquidity risk: - Lack of an intra-day liquidity support from NBK to the Inter-Bank System for Money Transfer (ISMT) exposes the system to liquidity risk. - No reliable access to liquidity in ISMT; liquidity risk high during evening settlement of foreign exchange transactions and large value end-of-day payments; similar problems with incoming settlement instructions from securities market. - Systemic liquidity management: - Banks rely on local interbank market and increasingly on FX swap market; about five banks account for nearly 70 percent of interbank activity. - Turnover in FX swap market often exceeds interbank market; increased use of FX swaps complicates NBK’s systemic liquidity management under a tightly managed exchange rate. - Many banks fail to build sufficient tenge liquidity reserve buffers, especially around quarterly tax reporting periods. ### INSURANCE, PENSIONS, AND SECURITIES MARKET VULNERABILITIES - Insurance: - Insurance assets are 3 percent of total financial sector assets; solvency indicators currently at adequate levels but may be artificially supported by reinsurance agreements not closely supervised. - Legislative changes in 2010 introduced retroactive mandatory coverage for professional sickness, creating an unfunded liability equivalent to one third of the sector’s total capital. - Earthquake exposure could wipe out the entire capital of the nonlife sector and is not adequately reinsured. - Reinsurance supervision is inadequate; careful analysis of reinsurance agreements is needed to verify effective risk transfer. - Pension system consolidation: - At end-2013: accumulated pension assets in 9,449,901 depositors’ individual pension accounts amounted to 3,731.9 billion KZT (around 12 percent of GDP) for the mandatory pension scheme. - Increase in pension accumulations over January 1, 2013 to January 1, 2014: 17.4 percent. - Voluntary pensions accumulated assets at end-2013: 1.4 billion KZT in 42,906 accounts. - LP-2013 consolidated pension assets into the Single Funded Pension Fund (UAPF), government-owned; NBK has fiduciary management mandate; UAPF to be monopoly of mandatory pension system. - Governance concerns: NBK chairs UAPF board, chairs CMA, is supervisor, custodian, and statutory asset manager — separation of ownership, management, and supervision recommended. - Performance concerns: low or negative net real returns on individual accounts; World Bank pre-reform calculations (zero real return) indicate replacement ratio could fall from current 26 percent to 16 percent even with reforms; actuarial studies show additional five percent contribution increases replacement ratio from five to 16 percent depending on scenarios. - Consolidation operational risks: transfer of historical records, differing valuations of illiquid assets, external audit and decisions on allocating losses or gains to member accounts. - Temporary investment guidelines limit investments to highly liquid, low-risk instruments (Republic of Kazakhstan government securities, refined gold, financial instruments of national companies and rated second-tier banks, bonds issued by international financial organizations). - Securities markets and infrastructure: - Oversight improved (IFRS, single securities registry) but sector suffers from mispricing, uncertainty, and reputational risks due to uneven implementation. - Lack of intra-day liquidity support and legal finality for payments/settlements are key FMI vulnerabilities. - Measures lacking to address reputational risks, default risk, misconduct, and financial disruptions. ### MACROPRUDENTIAL MEASURES AND TIMING (SELECTED) - MaPPs and rules: - Dynamic Provisioning introduced January 2013; currently suspended (from January 2014) while its volume retained in capital structure at end-2013. - Reserve Requirement Ratios (MRRs): from December 2012 MRR ratios: 2.5 percent on short-term domestic liabilities; 0 percent on long-term domestic liabilities; 6 percent on short-term foreign liabilities; 2.5 percent on long-term foreign liabilities. - Liquidity ratio k4 regulatory value: 0.3; tightened minimums in 2012 and 2013 to at least 0.08 and 0.09 respectively. - Limits on open FX positions: net foreign currency position limit: 25 percent; NBK introduced a 30 percent limit on open foreign currency off-balance sheet positions effective from July 2014. - Measures in non-collateralized consumer lending effective from April 1, 2014: (i) 50 percent cap on debt-to-income ratio; (ii) increase in retail lending risk weight to 100 percent (from 75 percent); (iii) 30 percent limit for growth in consumer loans for each bank. - General Countercyclical Capital Buffer and Capital Surcharges on SIFIs planned from 2016. - NBK announced three MaPPs on December 2013 to be effective April 1, 2014: 50 percent cap on DTI; increase retail lending capital risk weight from 75 to 100 percent; 30 percent bank-by-bank ceiling on growth in consumer loans. ### KEY RECOMMENDATIONS (FSAP SELECTED ACTIONS AND TIMING) - Financial stability monitoring: - Closely monitor quality of foreign currency-denominated loans. [NBK] — I - Closely monitor banks’ concentrated large exposures. [NBK] — I - Banking oversight and supervision: - Rebalance supervision towards a more risk-based approach. [NBK] — MT - Support supervisor’s capacity to challenge banks’ provisioning. [NBK] — I - Intensify supervision of cross-border operations and sign MoU. [NBK] — NT - Regularly analyze indirect credit risk and market risk, including foreign exchange rate risk. [NBK] — I - Monitor impact of adopted MaPPs and assess effectiveness. [NBK] — MT - Financial safety net, NPL resolution, and systemic liquidity: - Revise P&A and bridge bank resolution options to exclude requirement for depositor and creditor approval. [NBK] — MT - Limit ELA to solvent institutions able to pay a penalty rate. [NBK] — NT - Develop procedure for documenting financial stability analysis in cases of state support. [NBK] — NT - Implement multi-track approach for resolving NPL overhang. [NBK] — NT - Reduce procedural enforcement costs from non-registered/junior pledge holders. [Government/Legislator] — NT - Revise insolvency law to strengthen secured creditors’ priority. [Government/Legislator] — NT - Provide tax incentives for out-of-court restructuring and debt write-offs/sales. [Government/Legislator] — NT - Operationalize PLF with broad mandate and adequate resources. [NBK/Government/Legislator] — NT - Facilitate NPL transfers into SPVs by revising bank secrecy rules and property rights registration. [Government/Legislator] — NT - Pensions, insurance, securities market: - Include in UAPF’s Charter a clear mandate for UAPF to maximize retirement income for its members. [Government/Legislator] — I - Adjust mandatory worker’s compensation to avoid collapse of insurance sector. [Government/Parliament] — I - Reduce uncertainty in continuity of market rules; confirm legal fact and time of settlement finality. [Government, NBK] — I (I = Immediate within one year; NT = Near-term 1–3 years; MT = Medium-term 3–5 years.) *Source: IMF staff report content unit _cr14258 — IMF Financial Sector Assessment and associated chapters and appendices as provided in the supplied content.* ### EXECUTIVE SUMMARY __________________________________________________________________________ 5 ### EXECUTIVE SUMMARY ### MACRO-FINANCIAL SETTING AND FINANCIAL VULNERABILITIES - Prior to the global financial crisis, Kazakhstan experienced high and unbalanced growth with significant financial vulnerabilities driven by the non-tradable sector, particularly construction, which expanded on the back of a surge in bank credit and an appreciating real exchange rate. - Between 2005 and 2007, Kazakhstan’s banks borrowed from abroad the equivalent of 44 percent of GDP and loaned a substantial part of those funds to non-tradable sectors. - The credit boom was financed largely through external wholesale funding and a sizeable increase in bank leverage; as the crisis erupted, external funding dried up forcing banks to deleverage aggressively, triggering declines in stock and real estate prices and a strong deceleration in non-oil activity. - A 20 percent devaluation in 2009 worsened unhedged foreign currency borrowing problems, amplifying contractions in demand and loan-servicing difficulties. - The government acquired majority stakes in three large banks (Alliance, Temirbank, and BTA) and minority stakes in two others (KKB and Halyk Bank) during the crisis; despite restructuring some external liabilities, bad assets were not resolved and NPLs built up significantly. ### FINANCIAL SYSTEM STRUCTURE AND KEY STATISTICS - The banking sector dominates the financial system: - 38 commercial banks. - Banks account for 77 percent of total financial system assets and 44 percent of GDP. - Public sector assets represent 60 percent of total banking assets at end-February 2014. - There are 17 banks operating in Kazakhstan, including 14 foreign subsidiaries. - As of January 2014, Kazakh banks have a presence in Kyrgyzstan, the Netherlands, Russia, Tajikistan, Luxembourg, Belarus, Georgia, Armenia, and Ukraine. - Market concentration: - The five largest banks accounted for more than half of banking assets in 2013, though concentration has been declining as medium-sized banks expanded lending. - Consumer lending: top three banks account for one half of the market share and the top seven for 76 percent. - Public funded pension system: - Previously comprised of ten private pension funds; the government began nationalization in early 2013 to consolidate all assets in the Unified Accumulation Pension Fund (UAPF) by April 2014. - The government is the single shareholder of the UAPF and NBK has the fiduciary management mandate. - Two global banks exited the country in the past year. ### BANKING SECTOR: SOLVENCY, LEGACY PROBLEMS, AND SUPERVISION - Solvency and fragility: - The banking system has relatively comfortable cushions above minimum capital requirements, but these are likely to shrink as the effects of the February 2014 devaluation on credit quality work through and capital requirements become tighter. - Cushions could vanish and capital deficiencies would arise under stress. - High NPLs depress bank profitability, render banks vulnerable to further credit-quality deterioration, and limit banks’ ability to increase capital to meet envisaged tighter capital requirements. - Recovery from the crisis is incomplete: marked deleveraging occurred but legacy NPLs remain unresolved. - Need for a faster transition to risk-based oversight: - Emphasize risk through adoption of more advanced risk-assessment tools and more extensive use of stress test results for risk analysis. - With adoption of IFRS loss impairment as the standard for provisioning, more intense supervisory scrutiny is needed to counter reliance by some banks on unrealistic valuation of collateral and resulting under provisioning. - Supervisory requirements include training in collateral valuation, access to available information on real estate, and hiring staff with expertise in appraisals. ### FINANCIAL SAFETY NET, RESOLUTION FRAMEWORK, AND CRISIS MANAGEMENT - Upgrades during the crisis: - The resolution framework was amended in 2009 to include restructuring, purchase and assumption (P&A), and bridge bank options. - Shortcomings and actions during the crisis: - The government bypassed sequential crisis management tools by nationalizing banks and restructuring external liabilities. - The resolution framework lacks special authority and requires approval of depositors and creditors. - Emergency Liquidity Assistance (ELA) framework adjustments are needed to limit availability to solvent institutions. - Recommendations to bolster the safety net and crisis preparedness include procedural and institutional changes (see Recommendation bullets below). ### NON-PERFORMING LOANS (NPLs): SLOW PROGRESS AND MULTI-TRACK RESOLUTION - The large stock of NPLs that emerged during the crisis has not been resolved. - Measures adopted recently represent a step in the right direction, but further action is needed: - Required measures include debt write-offs; foreclosures, repossession of collateral, and recovery under insolvency proceedings; sale of NPLs and collateral by the Problem Loan Fund (PLF) and bank-owned SPVs. - Operationalizing this approach requires legal and tax changes: improvements in the insolvency regime; removal of obstacles to transfers of collateralized debt to the PLF and SPVs; introduction of tax incentives for debt write-offs and sales of collateral at below face value. ### INSURANCE, PENSIONS, AND SECURITIES MARKET VULNERABILITIES - Insurance sector: - Legislative changes in 2010 expanded coverage of the mandatory work accident plan but did not provide needed funding. - Earthquake exposure could exhaust the capital of the nonlife sector without adequate reinsurance. - Nationalized pension system: - UAPF governance structure leaves it vulnerable to conflicts of interest or pressures to support infrastructure development. - Recommendation to include in UAPF’s Charter a clear mandate for UAPF to maximize the retirement income for its members. - Securities sector and market infrastructure: - Despite significant improvements, the securities sector suffers from mispricing, uncertainty, and reputational risks. - Lack of legal certainty about settlement finality is a concern. - Measures to address reputational risks, default risk, misconduct, and financial disruptions are lacking. - The lack of intra-day liquidity support from NBK to the interbank payments system exposes it to liquidity risk. ### FSAP KEY RECOMMENDATIONS (SELECTED ACTIONS AND TIMING) - Financial stability monitoring: - Closely monitor quality of foreign currency-denominated loans. [NBK] — I - Closely monitor banks’ concentrated large exposures. [NBK] — I - Banking oversight and supervision: - Rebalance the emphasis of supervision towards a more risk-based approach. [NBK] — MT - Support the supervisor’s capacity to challenge banks’ decisions on provisioning. [NBK] — I - Intensify supervision of cross-border operations of Kazakh banks and sign MoU. [NBK] — NT - Analyze regularly indirect credit risk and market risk, including foreign exchange rate risk. [NBK] — I - Monitor the impact of the adopted MaPPs and conduct assessments of effectiveness. [NBK] — MT - Financial safety net, NPL resolution, and systemic liquidity management: - Revise purchase and assumption and bridge bank resolution options to exclude a requirement for depositor and creditor approval. [NBK] — MT - Limit emergency liquidity assistance to institutions that are solvent and financially capable of paying a penalty rate of interest. [NBK] — NT - Develop a procedure for documenting financial stability analysis in cases of provision of state support to the financial sector. [NBK] — NT - Implement a multi-track approach for resolving the overhang of NPLs. [NBK] — NT - Reduce procedural costs of enforcement obstacles arising from non-registered or junior pledge holders in foreclosures. [Government/Legislator] — NT - Revise the insolvency law to strengthen protection for legal rights of secured creditors by giving them a higher priority in creditors’ ranking. [Government/Legislator] — NT - Incentivize out-of-court restructuring by providing tax incentives at creditor’s and debtor’s level for debt write-offs, partial forgiveness, bad debt and collateral sales. [Government/Legislator] — NT - Operationalize the PLF by providing for its broad mandate in NPLs resolution, including bundling of NPLs and adequate financial and staffing resources. [NBK/Government/Legislator] — NT - Facilitate NPLs transfers into SPVs including by revising bank secrecy rules and property rights registration of the debt assignments and collateral transfers. [Government/Legislator] — NT - Public pensions, insurance, and securities market oversight: - Include in UAPF’s Charter a clear mandate for UAPF to maximize the retirement income for its members. [Government/Legislator] — I - Adjust the mandatory worker’s compensation to avoid collapse of the insurance sector. [Government/Parliament] — I - Reduce uncertainty in continuity of market rules; confirm legal fact and time of settlement finality. [Government, NBK] — I (I = Immediate within one year; NT = Near-term 1–3 years; MT = Medium-term 3–5 years.) *Source: IMF Financial Sector Assessment—Executive Summary (Kazakhstan).* ### 7. The insurance sector and the rest of non-banking institutions are small. The assets of ### _cr14258 - 7. The insurance sector and the rest of non-banking institutions are small. The assets of ### Insurance sector and non-banking institutions - The assets of the insurance sector (34 companies) are 3 percent of total financial sector assets. - Mortgage companies and other non-banking organizations represent less than 1 percent each of total financial sector assets. - The securities exchange (KASE) is quite small, with very limited activity in equities and corporate debt. - The largest markets are those for foreign currency transactions among banks and government repurchase transactions made in the automated repo market. - There are 81 listed companies as of December 2013. ### Banking sector — the current situation - The crisis prompted banks to revise lending strategies to avoid duration and currency mismatches; the system has been streamlined and rendered less vulnerable to external developments, including the February 2014 devaluation, but deep-seated vulnerabilities remain. - System-wide NPL ratio is about 30 percent, concentrated in the five largest banks and reflecting mainly loans to corporations and SMEs. - Banks’ return on assets (ROA) is low, reflecting both low earnings and loan-loss charges. - The system’s aggregate capital asset ratio (CAR) has stabilized at around 17 percent and the Tier I capital ratio has remained at around 13 percent in recent years. - Banks are exposed to foreign currency risk, as 38 percent of loans are in foreign currency, mostly to unhedged borrowers. - Financial soundness indicators (FSIs) understate bank weaknesses due to concerns about collateral valuation, inadequate loan classification, and under provisioning, exacerbated by adoption of IFRS-IAS39 and limited supervisory skill upgrades. - Credit growth: credit continues to grow at about 13 percent annually; growth in lending by consumer-oriented small- and medium-sized banks reached nearly 50 percent in December 2013. - Cost of one-year deposit is about 8 percent; lending rate is above 40 percent. The ceiling on interest rates on consumer loans is 56 percent. - On December 2013, NBK announced three MaPPs to be effective on April 1, 2014: a 50 percent cap on the debt-to-income (DTI) ratio, an increase in the retail lending capital risk weight from 75 to 100 percent, and a 30 percent bank-by-bank ceiling on growth in consumer loans. - Wholesale funding (bond and cross-border interbank borrowings) declined from 50 percent to 20 percent of the banking system’s total liabilities by end 2013. - The share of FX-denominated loans has declined by nearly 20 percentage points since 2009; the share of FX deposits has risen; both shares now stand at 40 percent. - Government announced on February 21, 2014 intentions to use 500 billion tenge to support the economy in 2014; half will be channeled to SMEs through the banking sector. - Recent state divestment actions: SK announced intention to sell its 89.9 percent stake in Temirbank and 16.6 percent of Alliance Bank; regulatory approval for sale reducing state participation in Alliance Bank to 51 percent; KKB and another local investor initiated acquisition of equity stakes in BTA; SK would temporarily retain a minority stake in BTA. - Basel and provisioning framework: Basel II modeled capital adequacy requirements; NBK announced adoption of Basel III definitions of capital (but not risk weights); implementation of Basel III scheduled to commence in 2015 with full implementation expected by 2019. Beginning in 2013, NBK introduced new rules for loan-loss provisioning (specific provisions based on IFRS and dynamic provisions based on a formula), though the adoption of dynamic provisions was suspended shortly after. ### Banking vulnerabilities (risk drivers) - Lower-than-anticipated growth in emerging markets (EM), especially China and Russia, possibly aggravated by the Ukraine crisis, could reduce FDI, lower medium-term growth, and cause additional decline in housing prices. - A sustained decline in oil and other commodity prices could cause marked deceleration in domestic growth and a depreciation of the tenge. - Insufficient progress to bring down NPLs would depress bank profitability, limit ability to increase capital and extend credit, and pose a contingent liability for the public sector. - Concerns about another devaluation, rapid consumer lending growth, and/or inconsistent implementation of regulatory reforms could trigger a confidence crisis, system-wide deposit withdrawals, reduced access to wholesale funding, liquidity crunch, and/or asset fire sales. ### Stress tests — design - Tests carried out in a baseline consistent with IMF WEO forecasts and two stress scenarios characterized by temporary reductions in growth over a 3-year period ending in December 2016. - Baseline includes failure to bring down high current level of NPLs and the introduction of Basel III deductions impacting estimated capital ratio. - Hurdle rates set at regulatory minima in line with Kazakhstan’s gradual phasing in of Basel III minimum capital requirements beginning in 2015. - Risks analyzed: lower-than-anticipated EM growth, decline in oil prices; confidence crisis assessed through combined funding and market liquidity stress scenario. - Adjusted baseline calculated to illustrate impact of overvaluation of collateral and forbearance: collateral value reduced by the equivalent of the change in house prices registered since December 2006, resulting in a provisioning shortfall of 12.3 percent of nonperforming exposure. - NBK staff and FSAP team performed separate solvency tests; all 38 banks performed bottom-up cash flow-based liquidity tests (Basel III LCR). Interbank contagion risks explicitly modeled. ### Stress tests — solvency results and implications - Baseline: credit losses mainly from February devaluation and phase-out of capital instruments ineligible under Basel III lead to steady decline in banking system’s capital ratio, partially eroding initial buffers but remaining above regulatory threshold; Tier 1 ratio dips below the conservation buffer but remains above regulatory minima. - In the baseline, seven banks accounting for nearly half of the system’s assets fail to meet regulatory minima in projections; capital shortfall equivalent to 2 ½ percent of GDP. - In the stress scenarios two additional banks fail to meet capital requirements, bringing total to 9 banks accounting for slightly more than half of the banking system’s assets. - Under the more severe scenario, capital deficiency reaches 5 percent of GDP. - Banks failing tests include state-owned and private large banks, as well as smaller banks; NBK’s stress tests confirm these estimates. - Adjusted baseline: situation worsens significantly, highlighting potential significant impact of inadequate valuation of bank assets and forbearance. No stress tests were conducted on this adjusted baseline. - FX-induced credit risk is elevated; loan portfolios are highly sensitive to changes in oil and gas prices. - Exchange rate is a key driver of indirect credit risk for corporate and household/SME sectors. - Direct FX risk is small given banks’ limited open positions. - Sovereign and other market risks are low: an adverse two-standard deviation move (97 basis points increase in the 5-year sovereign yield) has very limited impact. - A permanent 20 percent drop in all other asset prices, including real estate prices, could be absorbed by banks. - Concentration risk is significant: default of the largest three exposures of each bank would reduce capital ratios by around 7 percentage points; eleven banks (about a third of banking system’s total assets) would breach current regulatory minimum requirements if their three largest exposures defaulted. - The banking system as a whole could digest immediate implementation of Basel III capital definitions; with only one exception, all banks in the sample remain above the new minimum capital requirement in 2015 if Basel III deductions were phased out immediately and in full. - However, increases in capital would be needed to maintain current buffers or to withstand analyzed shocks; with unchanged NPLs, a number of banks would likely need external or governmental capital injections to comply with the new regulatory solvency framework. ### Liquidity stress tests and contagion analysis - Cash flow-based liquidity stress tests used the Basel III LCR framework and scenarios motivated by recent runs on Kazakh banks. - Under Basel Committee scenario, banking system’s stock of High Quality Liquid Assets (HQLA) is more than sufficient (LCR exceeds 2); however: - 12 banks, accounting for a third of the banking system’s assets, would see coverage ratio drop below the hurdle rate. - Under a more severe scenario (deposit outflows increased, secured funding fell by 30 percent, and customers drew 30 percent of committed lines), system coverage ratio would still exceed 100 percent but: - 17 banks (56 percent of total assets) would not be able to cover the outflows. - Direct contagion through bilateral interbank exposures is limited: - Banks net lending exposures account for less than 1 percent of total banks’ assets (0.3 percent of GDP). - Only six banks have net bilateral exposures above ten percent of their regulatory capital. - Pure interbank contagion stress does not result in bank failures, indicating weak connectivity among banks. - Conducting scenario contagion analysis on stressed capital levels resulting from severe stress (sustained decline in commodity prices) would cause an additional (but small) bank to drop below minimum capital requirements; results consistent with NBK’s contagion model. *Source: IMF staff and NBK material in the IMF FSAP chapter provided.* ### 25. Cross-border linkages have become less important. Banks external borrowing reached ### 25. Cross-border linkages have become less important. Banks external borrowing reached ### Cross-border linkages and external positions - Banks external borrowing reached $11.5 billion (5 percent of GDP) in September 2013. - Banks’ assets abroad stood at $6.4 billion (2.9 percent of GDP) as of December 2013. - Main source country for external borrowing: - United Kingdom: 54 percent (reflecting eurobond issuances by Kazakh banks in international markets). - China: 21 percent (credit line to the Kazakhstan Development Bank). ### NBK stress testing and risk assessment - Findings and gaps: - NBK’s stress testing framework could be improved. - Current recommendation: explicitly assess FX-induced credit risk and market risk, including asset price risk, sovereign risk, foreign exchange rate risk, and interest rate risk, at least through sensitivity analyses. - Liquidity risk: NBK should use the liquidity stress testing tool provided by the FSAP team; banks should be encouraged to apply this framework for surveillance and supervisory assessments. - NBK should continue estimating the impact of regulatory reforms, coordinating closely with banks. - NBK would benefit from better use of available central bank data, including more effective collaboration between the Financial Stability and Statistics Departments. - Note on systemic importance measure: - The stress-test measures the systemic importance of individual banks: a bank is more systemically important if its assumed default results in the larger decline in the system’s capital. ### Insurance and pensions: vulnerabilities and structural risks - Insurance sector: - Not of systemic importance, but faced with severe financial risks. - Solvency indicators are currently at adequate levels but may be artificially supported by reinsurance agreements that have not been closely supervised. - Portfolios are liquid and support nonlife liabilities, but there is an asset-liability mismatch for long-term business. - Legislative changes in 2010 introduced retroactive mandatory coverage for professional sickness, creating an unfunded liability equivalent to one third of the sector’s total capital. - Earthquake exposure could wipe out the entire capital of the nonlife insurance sector and is not adequately protected through reinsurance. - Main life-insurance risk: unification of the pension sector. - Pension system nationalization and unification: - New consolidated system will likely produce savings from synergies; hidden transition costs related to operational and valuation risk will likely emerge in coming years. - Regulation directing investment of pension funds into low-yielding government bonds has been removed; asset management fees have been cut by half. - Remaining gap: no explicit mandate to maximize returns of retirement income of members, important given NBK’s potential conflicts of interest as regulator of banks and pension funds. ### Financial safety net: systemic liquidity management and crisis tools - Systemic liquidity management in normal times: - Banks rely on the local interbank market and increasingly on the FX swap market to manage liquidity, complicating systemic liquidity management. - Local interbank market is auction-driven where 26 banks trade with each other—and with 25 other financial institutions—through repos. - Owing to insufficient collateral and segmented interbank market, several banks have increasingly turned to the FX swap market. - About five banks account for nearly 70 percent of interbank activity. - Turnover in the FX swap market often exceeds turnover in the interbank market. - Increased use of the FX swap market for managing tenge liquidity complicates NBK’s task of managing systemic liquidity under a tightly managed exchange rate. - Liquidity management by banks is often inefficient, especially around quarterly tax reporting periods; many banks fail to build sufficient tenge liquidity reserve buffers, creating spillovers and undermining other banks’ capacity to manage and forecast system liquidity. - Emergency Liquidity Assistance (ELA): - NBK has authority to provide ELA in domestic and foreign currency. - Procedures include last resort lending (for banks) and special purpose lending (for banks and non-banks). - Law contains no solvency requirement for ELA and no requirement that facilities be extended only to solvent institutions or at a penalty interest rate. - No cases of ELA in past five years, including during recent deposit run; however, a ‘special purpose lending facility’ was used in October 2011 (one-year FX repurchase agreement collateralized by bonds issued by SK), a blend of ELA and open assistance (solvency support). - SK provided liquidity support to nationalized institutions via deposit placements. - Recommendation: ELA should only be extended to solvent institutions and, if provided in foreign currency, only if sufficient foreign currency reserves are available. - Amended bank resolution framework: - Post-2009 amendments introduced bank restructuring, purchase and assumption (P&A), and bridge bank options. - Practical limitations: - P&A and bridge bank options require approval of depositors and/or creditors instead of giving the supervisor full authority. - No clear triggers for stages from temporary administration to resolution and liquidation. - No crisis simulation exercise has ever taken place. - License revocation and resolution occur under separate procedures with a lag; KDIF is mandated to start paying depositors within 14 business days of court ruling of forced liquidation, which may pressure NBK to rush resolution decisions and impede options such as P&A. - Current legal framework lacks limitation of judicial review; best practice indicates judicial review should not annul resolution measures or reinstate status quo; remedies should be limited to compensation of damages. ### Crisis preparedness: corrective actions, governance, deposit insurance, and coordination - Corrective action arrangements: - Banks and Banking Law contemplates early response and remedial measures for rapid deterioration or prudential norm violations, including changing organizational structure, limiting acceptance of deposits, ceasing dividend payments, increasing provisions for loan losses, dismissing bank executives, and suspending high risk operations. - Dismissal of executives applied to the chairmen of three banks in recent years. - Law grants NBK power to authorize a party to become a large participant in a bank, but recent practice raises concerns about effectiveness: - Presidential Decree in early 2014 temporarily lifted NBK’s requirement to verify compliance with prudential standards for a proposed purchase (KKB for BTA), raising safety and soundness concerns given very large holdings of NPLs by BTA. - Deposit Insurance (KDIF): - KDIF has a strong capital position but problematic governance. - KDIF responsibilities: standard ‘pay-box’ duties, limited financial assistance to sound institutions in P&A transactions, and examination authority over member banks. - No depositor payouts since 2007; KDIF not involved in recent crisis resolution. - KDIF adjusted fund equity to insured deposits ratio: 11 percent. - Full coverage of deposit insurance afforded to over 99 percent of deposit account holders. - Total amount of deposits insured: 55 percent of total deposits. - KDIF Board of Directors includes two current directors of banks, which is not considered good practice. - Systemic risk monitoring and coordination: - Council of Financial Stability and Financial Market Development (the Council) created in 2010, chaired by the Governor of NBK, meets monthly; membership includes NBK, Executive Office of the President, Ministry of Finance (MoF), antitrust agency, and association of financial institutions. - Council’s mandate includes macro-prudential policy recommendations and overseeing Basel III implementation. - Council introduced SIFI identification procedure based on five criteria with a 10 percent threshold for each variable: shares of bank assets, bank loans, personal bank deposits, deposits by commercial entities, and interbank payments. - Council has not published a list of SIFIs; markets perceive 2 banks meet the SIFI criteria. - Law on the Insurance of Deposits provides for information-sharing between NBK, former FSC, KDIF, but does not stipulate coordination mechanisms among safety net players regarding individual troubled banks. ### Delinquency management and NPL resolution - Slow progress resolving NPLs: - 2011 three-pronged NPL resolution approach: (i) selling NPLs to Problem Loans Fund (PLF, NBK-funded AMC); (ii) transferring NPLs to bank-specific SPVs (decentralized AMCs); (iii) writing NPLs off. - Program limitations: - Did not allow transfer to PLF of NPLs collateralized with real estate (most common collateral) or those in state-owned banks’ books. - Virtually no loans were transferred to the PLF; SPVs underused; real estate-backed NPLs not written off by banks. - Obstacles to NPL transfer and write-offs: - Bank secrecy laws prevent PLF access to loan documentation needed for appraisal. - Property registration rules restrict collateralized debt transfers when liens of third parties exist. - Non-neutral taxation for loan restructuring/write-offs: taxation of recovery of loan-loss provisions on write-offs and banks’ inability to recognize write-off losses for tax purposes. - Recommendation: full assessment of banking system’s NPLs; NPLs largely concentrated in real estate and construction, with collateral often unfinished construction difficult to price or sell; consider a risk-based review of assets held by institutions with highest NPL concentrations. - Recent measures and remaining gaps: - In 2013, NBK introduced an NPL ceiling of 20 percent, which declined to 15 percent in 2014. - PLF’s mandate broadened; further recapitalization envisaged with funds from Kazakhstan’s National Fund. - Changes to tax rules and insolvency regime providing incentives to debt restructuring expected shortly; reforms to loosen bank secrecy rules in restructuring and facilitate debt assignment under preparation. - Remaining issues: proposed changes may not significantly alleviate tax burden associated with debt restructuring or remove insolvency framework deficiencies; PLF likely to remain underfunded even after planned recapitalization; clarity needed on how large write-offs to meet NPL ceiling would be treated in banks’ balance sheets. - Multi-track approach to resolve NPL universe (recommended): - Four-track strategy: - (i) debt write-offs; - (ii) foreclosures, repossession of collateral, and recovery under insolvency proceedings; - (iii) sales by PLF and SPVs of bundles of NPLs, either directly or through NPL/mortgage-backed securities where claims have value; - (iv) PLF and SPVs acquiring ownership in collateral for bundled marketing. - Enabling measures required: - Legal and tax changes to loosen bank secrecy rules, make foreclosure and insolvency proceedings less costly and more transparent, eliminate tax burden of debt write-offs/forgiveness (including withholding tax in case of debt forgiveness to individuals), and suspend VAT on fixed asset purchases and foreclosures in NPL resolution context. - Strengthening PLF and SPVs: - PLF or a new centralized AMC should have a strong mandate, operational independence, and budgetary independence to limit political interference. - Mandate expansion and consideration of special powers; temporary employment of specialized consultants for business and operational restructuring. - Revamped PLF or new centralized AMC must be required to report regularly to parliament and the public and be subject to strict audits. - Pooling of distressed assets for disposal can create economies of scale; use different approaches by NPL type (write-offs for irrecoverable NPLs, outsourcing small-value NPLs to debt collectors, securitization for significant unsecured NPLs, bundled marketing for secured claims with attractive collateral). - Financial engineering should consider potential investor interest and create prospective demand; provide buyers access to relevant information and due diligence; approach international markets for distressed assets and funded real estate development companies. - Viability of an agency to engineer these products depends crucially on access to non-domestic sources of capital. - Policy actions to attract international investors needed: address regulatory uncertainty, non-transparent financial transactions (including sale of nationalized banks), and weak governance, which contributed to exit from local market of three foreign banks in recent years. *Source: IMF staff report content unit _cr14258* ### 54. Obstacles faced by SPVs in the realization and sale of NPLs also need to be addressed. ### _cr14258 - 54. Obstacles faced by SPVs in the realization and sale of NPLs also need to be addressed. ### Obstacles for SPVs in NPL realization and sale - The legal and tax obstacles described earlier also hamper SPV’s ability to realize NPL collateral. - Continued banking relationships with clients may discourage SPVs from engaging in vigorous and impartial resolution of existing NPLs. - Structural separation and a clear mandate for independent decision-making for SPV managements is needed to help break the links between banks and corporates in the context of NPL resolution. - Tight supervision of SPVs’ activities will be needed to prevent them from hiding the true volume of NPLs through mutual transactions among banks and regulatory barriers for such trades should be contemplated. - Opaque securitization could create systemic risk in poorly supervised jurisdictions; therefore, a pre-condition for its introduction will be full transparency, adequate valuation, and proper risk management and supervision. ### Broadening NBK’s resolution toolkit - It is essential to re-assess the viability of banks holding high percentages of NPLs and, if necessary, deploy resolution tools for the unwinding of their operations. - The banks that were nationalized in 2009 are expected to be placed back in private hands in the coming months. - Given the systemic size and/or troubled nature of some of these institutions, they should be placed under a monitoring plan involving a high degree of scrutiny and would contemplate their potential unwinding if they failed to make substantial progress in resolving in a timely manner their outsized level of NPLs. - In anticipation of a future resolution in the form of a P&A or bridge bank, it will be necessary to make amendments to the relevant Banking Law provisions for these untested resolution options. - In particular, it will essential to remove the requirement of depositor and shareholder approval (see section on the Financial Safety Net). ### Strengthening financial sector oversight: avoiding another surge in bad loans - NBK is responsible for regulation and supervision of banks, insurers, pension funds, investment funds, credit bureaus, and securities markets. - During 2011–13, the Committee for the control and supervision of the financial market and financial organizations (FSC)—then a sub-division of NBK—performed the supervisory and regulatory functions. - NBK is accountable to the President, who, inter alia, appoints its chair (with the consent of the Parliament) and his/her deputies; the President also approves NBK’s structure, overall staff size, and wage system. - The law does not specify the conditions under which the NBK chairman and his/her deputies may be removed from office. - In January 2014, a Presidential decree abolished the FSC and its departments were subsequently absorbed by NBK. ### Payment systems and FMIs - The Payment Systems Department (PSD) of NBK and the FSC-NBK are the overseers of the Financial Market Infrastructure (FMI). - Systemically important FMIs in the Kazakh market: Kazakhstan Interbank Settlement Center (KISC), Kazakhstan Stock Exchange (KASE), and Kazakhstan Central Depository (KACD). - All of them are majority-owned by NBK. - PSD-NBK oversees the FMIs operated by the KISC as well as payment instruments and services, while FSC oversees the FMIs operated by the KASE and KACD. ### A. Bank Regulation: Achieving Better Implementation - Supervision is intensive and intrusive, but oriented towards compliance. - Some forms of risk-based supervision, such as CAMELS ratings, have been introduced, but supervisors focus mainly on the conformity of banks’ processes and practices with regulations. - Less attention is devoted to the assessment of banks’ risks. - Supervisors should rely more on risk assessment tools and a more intensive use of stress test results in the area of capital adequacy. - Training and staff exchanges with foreign supervisory authorities should be considered. Key supervisory weaknesses and recommendations: - Introduction of IFRS-IAS39—which leaves room for discretion in the assessment of provisions—without adequate training for supervisors has weakened their ability to scrutinize banks’ provisions. - NBK should contemplate additional training of examiners on collateral valuation and secured improved access by supervisors to the Real Estate Registry. - Weaknesses in the assessment of market risk (non-inclusion of commodity risk) in the trading book and interest rate risk in the banking book need to be addressed, including by providing guidance on model risk and validation. - Interest rate risk in the banking book should be assessed separately from market risk. - Home-host relationships are inadequate in light of the active cross-border activity of the main Kazakh banks; more frequent contacts and information exchanges with foreign supervisors are needed. Basel III implementation: - NBK is planning to start the implementation of Basel III in 2015 and to complete it by 2019. - During this period, priority to the implementation of Pillars 2 and 3 of the Basel framework. - Pillar 2 requires the introduction of ICAAP requirements; the design of a supervisory review process based on both, NBK’s own risk assessment system and the review of banks’ ICAAP reports. - Disclosure requirements should converge as much as possible towards those set by Basel in order to foster market discipline and encourage banks to upgrade their risk management systems. AML/CFT: - Parliamentary approval of amendments to the Law on Anti-Money Laundering and Combating of Terrorism Financing (AML/CFT) is expected this year. - Kazakhstan’s AML/CFT framework was evaluated by the Eurasian Group (EAG) in 2010; the 2011 mutual evaluation report revealed major deficiencies, notably with respect to guidance on customer due diligence requirements, politically exposed persons, correspondent banking, identification of high-risk accounts and identification of beneficial owners. - Prompt implementation of amendments to the AML legislation is a high priority for NBK. - Regulations and guidelines for monitoring are being drafted and will be issued when the law is passed to become effective on January 1, 2015. - The authorities are recommended to comply with the FATF revised standard. - Kazakhstan is tentatively scheduled to undergo a reassessment by EAG in April 2017. ### B. Insurance Sector: Stronger Prudential Requirements and Reinsurance Supervision - Insurance legislation has been updated and supervision brought closer to international best practices, but more emphasis on risk is needed. - Largely in response to the crisis, the sector’s regulation underwent a major overhaul. - Over 88 changes updated Law No 126-II on Insurance Activity and 14 changes related to insurance were made to the Civil Code. - The solvency regime is basically Solvency I with some enhancements. - To compensate for the lack of sensitivity inherent to Solvency I, NBK requires sensitivity testing and asset liability matching analysis on a regular basis. - The regime does not map insurers’ risks into capital requirements. - The supervisory approach has some risk-based features, but all insurers continue to be treated with the same intensity. - NBK has a wide set of preventive and corrective measures that are enforced consistently. Reinsurance supervision: - Supervision of reinsurance is inadequate. - The use of reinsurance by insurance companies has lead to a mechanical improvement in solvency indicators, but this may mask insufficient risk transfer. - Careful analysis of the reinsurance agreements is needed to verify that they are effectively transferring risk. - The proper level of reinsurance protection acquired by the insurers needs to be a focus of supervision. ### C. NBK Management of Pensions: Sound Investment Practices are Key - The pensions system has been consolidated into a single pension fund (UAPF) owned by the government and managed and supervised by NBK. - The Charter of the UAPF delegates the fiduciary ownership role of UAPF to NBK and charges the Council for Management of the UAPF Assets (CMA) chaired by NBK with designing its investment policy. - The law preserves the key parameters of the funded pension system created in 1997, including the government guarantee of the preservation of contributions in real terms. Governance concerns and recommendations: - The governance of UAPF is not in line with best practice. - NBK chairs the board of the UAPF in its role as fiduciary owner, makes investment decisions as chair of CMA, and is the supervisor, custodian, and statutory asset manager. - Separation of the control functions from the ownership is recommended. - CMA should be subject to the same transparency and accountability standards required from listed companies in major markets, and should avoid investments whose risks that are not well understood—direct infrastructure financing and investments to support entities in financial distress. ### D. Securities Markets: Reducing Uncertainty and Mitigating Mispricing and Reputational Risks - Oversight of the securities markets has improved. - The powers of the entities in charge of securities regulation and supervision have expanded, and customer protections and market transparency have improved. - Improvements include the adoption of IFRS and Auditing Standards for issuers and public interest entities; strengthened accountability for unlisted securities through the establishment of a single securities registry; and the requirement that licensed firms establish a system of risk management and internal controls to better identify and manage operational and other risks. Ongoing problems: - The securities sector suffers from mispricing, uncertainty, and reputational risks due to uneven implementation. - Instability in the rules governing market practices and inconsistent approaches to reform create uncertainty about the validity of transactions to the detriment of market development and pricing. - With only a few transactions occurring in a secondary market over a lengthy period of time, it is difficult to establish whether the price obtained in the market is true and bona fide. - This may prevent properly haircutting and valuing collateral or accounting for net asset values in open-ended funds. - Standard measures to address reputational risks, default risk, misconduct, and financial disruptions are lacking and should be adopted. ### E. Financial Market Infrastructure: Addressing Gaps in Risk Management - There is legal uncertainty on the finality of payments and settlements. - The law on payment and transfers does not define when a transfer or payment is final and irrevocable in the FMI. - The Securities Market Law does not provide finality of securities market transactions. - Amendments to the relevant laws should be passed to eliminate uncertainty regarding finality and irrevocability of payments and settlements. *Source: _cr14258 - 54. Obstacles faced by SPVs in the realization and sale of NPLs also need to be addressed.* ### 69. The lack of an intra-day liquidity support from NBK to the Inter-Bank System for ### _cr14258 - 69. The lack of an intra-day liquidity support from NBK to the Inter-Bank System for Money Transfer (ISMT) ### Intra-day liquidity risk in the ISMT - The lack of an intra-day liquidity support from NBK to the Inter-Bank System for Money Transfer (ISMT) exposes the system to liquidity risk. - There is no reliable access to liquidity in the ISMT. - Liquidity risk can be high during: - evening settlement of foreign exchange transactions (when liquidity from the repo market is not available); - large value payments occurring at the end of the day. - Similar problems exist with incoming settlement instructions from the securities market. ### Key macroeconomic indicators (selected series from Table 2) - Real GDP — 2010: 7.3; 2011: 7.5; 2012: 5.0; 2013: 6.0; 2014: 5.7; 2015: 6.1; 2016: 5.7; 2017: 5.5; 2018: 5.4; 2019: 5.4 - Real oil — 2010: 6.1; 2011: 1.4; 2012: -2.2; 2013: 3.5; 2014: 1.2; 2015: 7.2; 2016: 5.6; 2017: 5.2; 2018: 4.9; 2019: 4.8 - Real non-oil — 2010: 7.9; 2011: 10.2; 2012: 8.0; 2013: 6.9; 2014: 7.3; 2015: 5.8; 2016: 5.7; 2017: 5.6; 2018: 5.6; 2019: 5.6 - Consumer price index (p.a) — 2010: 7.1; 2011: 8.3; 2012: 5.1; 2013: 5.8; 2014: 9.1; 2015: 8.2; 2016: 7.3; 2017: 6.8; 2018: 6.5; 2019: 6.3 - NBK refinance rate (eop; percent) — 2010: 7.0; 2011: 7.5; 2012: 5.5 (table shows dots thereafter) ### External and fiscal indicators (selected from Table 2) - Current account balance (percent of GDP) — 2010: 0.9; 2011: 5.4; 2012: 0.3; 2013: 0.1; 2014: 1.9; 2015: 1.8; 2016: 1.6; 2017: 1.5; 2018: 1.3; 2019: 1.3 - Exports of goods and services — 2010: 65.5; 2011: 89.5; 2012: 91.8; 2013: 88.4; 2014: 90.3; 2015: 91.5; 2016: 94.0; 2017: 97.3; 2018: 101.0; 2019: 105.7 - NBK gross reserves (eop) — 2010: 28.3; 2011: 29.3; 2012: 28.3; 2013: 24.7; 2014: 24.2; 2015: 24.9; 2016: 25.4; 2017: 26.1; 2018: 26.8; 2019: 27.5 - NFRK assets (eop) — 2010: 31.0; 2011: 43.6; 2012: 57.8; 2013: 70.5; 2014: 79.8; 2015: 95.5; 2016: 112.3; 2017: 129.8; 2018: 148.2; 2019: 167.6 - Total external debt (in percent of GDP) — 2010: 118.2; 2011: 125.4; 2012: 136.9; 2013: 147.7; 2014: 149.5; 2015: 154.1; 2016: 160.4; 2017: 166.8; 2018: 173.7; 2019: 179.9 ### Banking sector structure and trends (selected from Table 3 and Figures) - Number of banks — 2013: 38 - Domestic-majority owned banks — 2013: 21 - Foreign-majority owned banks — 2013: 17 - Bank assets (in US$ billions) — 2013: 15,461.7 (table shows sequence across years) - Bank assets as percent of GDP — 2013: 44.9 (series shows decline from earlier peaks) - Selected market indicators (Figures): - Kazakhstan and Russia 5-year CDS (basis points) — charted series Jun-13 to Dec-13 (numerical axis 120 to 270) - KAZPRIME 7D repo rate — charted series Jun-13 to Dec-13 (percent axis 0 to 18) ### Financial soundness indicators (selected from Table 4) - Regulatory capital (2008–2013, in thousands of tenge) — 2008: 1,947,847,477; 2009: (913,609,096); 2010: 1,821,426,747; 2011: 1,955,839,253; 2012: 2,072,261,186; 2013: 2,347,419,468 - Risk weighted assets — 2008: 13,106,297,519; 2009: 11,326,657,760; 2010: 10,312,308,873; 2011: 11,331,483,460; 2012: 11,533,713,396; 2013: 12,698,095,997 - Regulatory capital as percent of risk-weighted assets — 2008: 15%; 2009: -8%; 2010: 18%; 2011: 17%; 2012: 18%; 2013: 18% - Non-performing loans (NPL) as percent of gross loans — 2008: 5%; 2009: 22%; 2010: 24%; 2011: 31%; 2012: 30%; 2013: 31% - Provisions as percent of NPL — 2008: 69%; 2009: 75%; 2010: 63%; 2011: 70%; 2012: 77%; 2013: 83% - Loans as percent of deposits — 2008: 198%; 2009: 156%; 2010: 131%; 2011: 132%; 2012: 135%; 2013: 134% - Liquid assets as percent of total assets — 2008: 14%; 2009: 19%; 2010: 21%; 2011: 21%; 2012: 18%; 2013: 17% - Foreign currency loans as percent of total loans — 2008: 52%; 2009: 57%; 2010: 50%; 2011: 44%; 2012: 38%; 2013: 38% - Foreign currency liabilities as percent of total liabilities — 2008: 60%; 2009: 54%; 2010: 44%; 2011: 40%; 2012: 35%; 2013: 43% ### Non-banking financial sector (selected from Table 5) - Pension funds: Pension assets (bn KZT) — 2005: 650.2; 2006: 915.1; 2007: 1,211.9; 2008: 1,412.9; 2009: 1,860.8; 2010: 2,260.1; 2011: 2,652.2; 2012: 3,188.3; 2013: 3,735.9 - Insurance sector (non-life) solvency margin — 2005: 2.9; 2006: 2.3; 2007: 2.4; 2008: 2.4; 2009: 2.9; 2010: 3.6; 2011: 3.4; 2012: 3.7; 2013: 3.2 - Real estate: House price inflation (percent change in house price index) — 2005: 34.9; 2006: 41.8; 2007: 58.2; 2008: 1.4; 2009: -9.8; 2010: -1.1; 2011: 7.0; 2012: 6.7; 2013: 13.0 ### Implicit policy considerations (from cited risks and indicators) - The absence of an NBK-provided intra-day liquidity facility for the ISMT creates operational liquidity vulnerability for interbank settlement, particularly at evening FX settlement and end-of-day large-value payment times. - Banking-sector metrics indicate: - Elevated NPL ratios (e.g., 31% in 2013) with rising provisioning coverage (provisions as percent of NPL: 83% in 2013). - Material foreign currency exposure in loans and liabilities (foreign currency loans 38% of total loans in 2013; foreign currency liabilities 43% of total liabilities in 2013). - Liquidity ratios show some improvement in liquid assets but remain moderate (liquid assets as percent of total assets: 17% in 2013). - Non-banking sector developments (pension funds growth, insurance solvency margins, house price volatility) are relevant to financial stability monitoring and payment-system resilience. *Source: IMF staff report excerpt (pages and figures as provided in the supplied content).* ### Appendix I. KAZAKHSTAN: LIST OF RECENT ### Appendix I. KAZAKHSTAN: LIST OF RECENT MACROPRUDENTIAL POLICY MEASURES ### Macroprudential measures: overview and specifics - Dynamic Provisioning - Introduced in January 2013, with an aim to limit procyclicality. - Currently suspended (from January 2014), while retaining its volume in the structure of capital as accumulated at end-2013. - Reserve Requirement Ratios (MRRs) - Introduced in May 2006, amended in 2012, with an aim to limit liquidity risks. - Prior to 2012: MRRs applied to required share of bank liabilities associated with cash in vault and correspondent accounts with the NBK, in both tenge and foreign currency. - November 2012 amendments differentiated MRRs between short-term (less than 1 year) and long-term (over 1 year) bank liabilities to: (i) help limit inflow of short-term speculative capital, (ii) diversify portfolio of banks, (iii) develop market of long-term bank instruments, and (iv) reduce pressure on the foreign exchange market. - From December 2012 MRR ratios: - 2.5 percent on short-term domestic liabilities - 0 percent on long-term domestic liabilities - 6 percent on short-term foreign liabilities - 2.5 percent on long-term foreign liabilities - Liquidity Requirements - Introduced in 2005, amended in 2009 and in 2012. - Maximum value of к9 ratio (liabilities of non-residents to equity) relaxed from 2 to 3, starting in July 2009. - Current liquidity ratio k4 (average monthly highly liquid assets of a bank to average monthly demand liabilities) differentiates between tenge and foreign currency liquidity, with the regulatory value equal to 0.3. - In 2012, liquidity ratios were tightened: - From July, 2012—at least 0.08 - From July, 2013—at least 0.09 - Contingent liabilities added to the calculation of capital adequacy ratio (k1-1). - Limits on Open FX Positions or Currency Mismatches - Introduced in 2002 with limits: - for currencies of countries with the S&P rating of at least "A" (or equivalent): 12.5 percent - for euro: 12.5 percent - for currencies of countries with the S&P rating below "A" (or equivalent): 5 percent - net foreign currency position limit: 25 percent - NBK introduced a 30 percent limit on open foreign currency off-balance sheet positions, effective from July 2014. - Aim: preventing speculative pressure in the spot market and controlling foreign exchange risk off-balance sheet on a net basis. - Measures in non-collateralized consumer lending (effective from April 1, 2014) - (i) a 50 percent cap on debt-to-income ratio - (ii) an increase in the retail lending risk weight for capital adequacy to 100 percent (from 75 percent) - (iii) a 30 percent limit for growth in consumer loans for each bank - Aim: minimizing risks associated with rapid growth in consumer lending. - General Countercyclical Capital Buffer - Plan to introduce from 2016. - Capital Surcharges on SIFIs - Plan to introduce from 2016. *Source: Appendix I of the provided content.* ### Appendix II. Kazakhstan: Funded Pension System ### Structure and recent reforms - Pension reform started 1998; ownership of individual accounts and public awareness increased. - At the end of 2013: - Accumulated pension assets in 9,449,901 depositors’ individual pension accounts amounted to 3,731.9 billion KZT or around 12 percent of GDP for the mandatory pension scheme. - Increase in pension accumulations based on mandatory pension contributions over January 1, 2013 to January 1, 2014: 17.4 percent. - Voluntary pensions accumulated assets at end-2013: 1.4 billion KZT in 42,906 depositors’ individual pension accounts. - LP-2013 (Law on Pensions of the Republic of Kazakhstan, June, 2013) consolidated all pension assets of existing funded pension funds into the Single Funded Pension Fund (UAPF). - LP-2013 establishes UAPF as a joint-stock company fully owned by the government; monopoly of mandatory pension system; participates in voluntary pension business and payout of annuities. - Transforms voluntary occupational pension for persons in arduous and hazardous work into a mandatory pension with a five percent of salaries’ cost to employers; affects around 350 thousand employees currently with only 4,231 individual accounts and 83 billion KZT. - Raises, in ten years, the retirement age of women from 58 years to that of men, 63 years. ### Key preserved parameters and removed regulations - Preserved features since 1998: - Government guarantees preservation of contributions in real terms. - Duty of UAPF to maintain individual records of pension accumulations and payments. - Separation of accounting and financial reporting for pension assets and UAPF own assets. - Regulations removed or not yet implemented under LP-2013: - Prudential requirements no longer applicable to UAPF: own capital and peers’ return benchmarking. - Separation of the custodian from the pension fund management removed. - Related party investments rules removed. - Portfolio structure publication has yet to take place. - Onsite inspection has not been carried out and supervision requirements have not been specified. ### Performance, sustainability concerns, and fiscal costs - Main problem: prevalent low, even negative, net real return on pension savings in individual accounts; under-performance vis-à-vis real wage increments. - No estimate of total cost of government guarantee; currently costs are low but expected to grow. - In 2013, government budget paid 10 billion KZT to 100,000 pensioners. - Performance of pension assets returns against real wage index (selected dates): - 01.01.2007: Rate of return of Funds* (in%) 12.69; Real wage index** (in %) 16.60 - 01.01.2008: Rate of return of Funds* (in%) 9.47; Real wage index** (in %) 0.40 - 01.01.2009: Rate of return of Funds* (in%) -0.84; Real wage index** (in %) 3.70 - 01.01.2010: Rate of return of Funds* (in%) 11.95; Real wage index** (in %) 1.20 - 01.01.2011: Rate of return of Funds* (in%) 4.39; Real wage index** (in %) 7.50 - 01.01.2012: Rate of return of Funds* (in%) 2.59; Real wage index** (in %) 12.40 - 01.01.2013: Rate of return of Funds* (in%) 4.00; Real wage index** (in %) 0.90 - 01.01.2014: Rate of return of Funds* (in%) 2.37; Real wage index** (in %) na - Source: NBK. * based on data from www.afn.kz; ** based on data from www.stat.gov.kz. - World Bank calculations (pre-reform, zero real return) indicate collapse of replacement ratio; even with raising women retirement age to 63 and additional five percent contribution, replacement ratio would be at 16 percent, down from current 26 percent (without base pension). - Actuarial studies indicate the additional five percent contribution will increase replacement ratio from five to 16 percent, depending on scheme and investment return scenarios. - Critical necessity: invest at a rate higher than inflation. ### Consolidation process, governance, and operational risks - Ownership and management - UAPF owned by government; fiduciary ownership role delegated to NBK. - Governing authority: Board of Directors; executive authority: Executive Board; oversight authority: Internal Audit Service. - Supervision and consumer protection remain with NBK. - Consolidation ongoing: of 10 initial private pension funds, two remain to be consolidated; these two account for 44 percent of the assets. - Consolidation scheduled to be completed in April 2014. - Governance of investment policy - Council for Management of the UAPF Assets (CMA) created by presidential decree 753 of February 2014 as a consultative body to the President. - UAPF investment policy statement subject to approval by National Bank Executive Board with assistance of CMA. - CMA functions include considering and developing proposals to improve management of pension assets and developing proposals for a list of permitted investment instruments and approval of this list. - CMA composition (chair and members) includes: - The Assistant to the President of the Republic of Kazakhstan - The Deputy Prime Minister of the Republic of Kazakhstan - Minister of Finance of the Republic of Kazakhstan - The Deputy Chairman of the National Bank of Kazakhstan - The Chairman of the association of legal entities "Association of Financiers of Kazakhstan" (by agreement) - The Chairman of the Board of Directors of NUH Cimento Sanayi AS, an independent expert (as agreed) - The Managing Partner of «Global Sovereign Advisors», independent expert (as agreed) - The Head of the "Deutsche Bank AG" in the Republic of Kazakhstan, Managing Director «Deutsche Bank AG», independent expert (as agreed) - The Honorary chairman of the Society of Actuaries of Kazakhstan, Chairman of the «Sze Associates Ltd», independent expert (as agreed) - The Chairman of the Exchange Council, an independent Director of JSC "Kazakhstan Stock Exchange” (as agreed) - Asset management arrangements - Asset manager of UAPF is, by statute, the NBK. - Management handled by National Bank on basis of a fiduciary management contract among National Bank, the Government and the UAPF. - Investment committee to assist NBK will consist of the deputy governor and department heads. - NBK may use expertise from managing sovereign oil fund when considering international investments. - External asset managers may be engaged; NBK retains full fiduciary responsibility and can transfer asset management in total or partially to external companies. - Main conditions to qualify as a pension asset manager (established by NBK) include: - possession of a license to manage an investment portfolio; - absence of violations, during the last reporting month preceding application, of prudential standards established by the National Bank; - absence of losses based on results of one of two complete fiscal years; - if applicant is member of a banking conglomerate, use consolidated financial statements of parent entity for assessing compliance with above requirement; - possession of experience for one of the two preceding complete fiscal years in management of assets (excluding investment funds’ assets) equivalent to at least 50,000,000 times the monthly unit of account established in the law on the republic budget for the relevant fiscal year that is current as of the time of management of the assets; - if applicant is member of a banking conglomerate, assets under management by members of said banking conglomerate licensed to engage in investment portfolio management are counted toward meeting the requirement; - possession of a minimum credit rating no lower than “B+” on the Standard & Poor’s international scale, or a rating of comparable level by one of the other rating agencies by the management company’s parent entity and/or the management company. - Of the legal entities currently still in existence as pension funds, only one would fulfill these requirements. - Operational risk from consolidation - UAPF created a new IT system to receive assets and liabilities of each pension fund; transfer teams address IT compatibility issues. - Schedule to transfer all pension assets by April 2014 is intensive due to complexity, including transfer of complete historical data (up to 15 years) with much paper records distributed across subsidiaries. - Transfer of assets uses valuations used by each private pension fund: - traded assets: market value at date of consolidation - illiquid assets: valuations as carried out by private pension fund - asset classification and unit value preserved on transfer - NBK will conduct an external valuation of all assets using one of the international audit firms once consolidation is concluded. - Executive board of NBK will decide on valuation results and how to transfer possible losses or gains to UAPF members. ### Investment policy, temporary guidelines, and asset composition - Temporary investment guidelines during consolidation (Resolution No. 70 of the National Bank Executive Board) - Investments limited to highly liquid, low-risk financial instruments until consolidation completes. - Permitted instruments include: - Republic of Kazakhstan government securities - refined gold - financial instruments of Republic of Kazakhstan national companies and rated second-tier banks - bonds issued by international financial organizations - These guidelines have had little effect on the existing asset composition. - Investment portfolio totals (selected years, in KZT billion) - Total pension sector assets: - 2004: 481 - 2005: 635 - 2006: 898 - 2007: 1,195 - 2008: 1,378 - 2009: 1,840 - 2010: 2,224 - 2011: 2,546 - 2012: 3,129 - 2013: 3,631 - RK government securities, including: - 2004: 259 - 2005: 213 - 2006: 212 - 2007: 303 - 2008: 425 - 2009: 749 - 2010: 1,001 - 2011: 1,154 - 2012: 1,579 - 2013: 1,849 - Corporate securities of foreign issuers: - 2004: 9 - 2005: 12 - 2006: 71 - 2007: 104 - 2008: 143 - 2009: 222 - 2010: 186 - 2011: 146 - 2012: 159 - 2013: 119 - KZ Corporate securities: - 2004: 153 - 2005: 260 - 2006: 464 - 2007: 554 - 2008: 639 - 2009: 679 - 2010: 757 - 2011: 724 - 2012: 812 - 2013: 1,039 - Deposits with tier two banks: - 2004: 53 - 2005: 112 - 2006: 146 - 2007: 177 - 2008: 123 - 2009: 92 - 2010: 176 - 2011: 177 - 2012: 325 - 2013: 307 - Other: - 2004: 7 - 2005: 37 - 2006: 5 - 2007: 57 - 2008: 48 - 2009: 98 - 2010: 104 - 2011: 345 - 2012: 254 - 2013: 317 ### Transition measures and effects on life insurance sector - Resolution No. 77 of the National Bank Executive Board: transfers of pension accumulations from funded pension funds to insurance companies suspended until consolidation completes. - Prohibition on annuities payouts and transfers among pension funds to limit outflows. - Impact: affected life insurance sector that had been growing from providing annuities from mandatory pension funds and workers compensation. - Life insurance products (selected entries, in KZT thousand) - 2009: Life 1,334,183.00; Annuity 7,999,092.00; Accident 4,548,504.00; Sickness 8,443,463.00; Total 22,323,234.00 - 2010: Life 1,655,326.00; Annuity 16,990,515.00; Accident 6,941,470.00; Sickness 10,546,724.00; Total 36,134,035.00 - 2011: Life 6,473,350.00; Annuity 24,005,477.00; Accident 11,476,636.00; Sickness 12,402,728.00; Total 54,358,191.00 - 2012: Life 15,023,353.00; Annuity 37,417,168.00; Accident 18,185,196.00; Sickness 16,550,012.00; Total 87,175,729.00 - Sep. 2013: Life 21,293,557.00; Annuity 25,944,567.00; Accident 14,289,575.00; Sickness 16,729,991.00; Total 78,257,690.00 ### Key findings and policy implications (from the content) - Increasing returns on accumulated pension assets is critical to prevent collapse of replacement ratios; investing at a rate higher than inflation is necessary. - The additional five percent employer contribution enacted in 2014 is expected to increase replacement ratios (from five to 16 percent under various scenarios), but improvement depends on investment returns. - Consolidation into the UAPF centralizes management and supervision but raises operational risks related to IT, historical record transfers, valuation of illiquid assets, and potential future fiscal costs stemming from government guarantee obligations. - Temporary investment restrictions aim to limit risk during consolidation but have not significantly changed asset composition to date. - Qualification requirements for external asset managers are stringent; currently only one existing pension fund legal entity would meet them. *Source: Appendix II of the provided content.* ### 12. The reform is expected to have several positive immediate effects but it will also add ### _cr14258 - 12. The reform is expected to have several positive immediate effects but it will also add ### Immediate effects and main risks of consolidation - Positive immediate effects under the consolidated system: - Cost savings created by synergy. - Higher negotiation power for the investments. - Better control of the payment of the contribution by the employers. - Main risks and concerns: - Checks and controls of the UAPF will become of paramount importance to keep investment policy free from undue interference. - Crowding out of private investors would require special attention. - Lack of competition and of a benchmark could generate subpar performance. ### Hidden or implicit transition costs related to consolidation - Measures and their consequences: - Since February 2013, investment instruments of the pension funds have been restricted to highly liquid, low-risk financial instruments, including Republic of Kazakhstan government securities, refined gold, the financial instruments of Republic of Kazakhstan national companies and second-tier banks, and bonds issued by international financial organizations. - This transitional measure has increased the reinvestment risk of the pension assets and provided for an extremely low annual return. - Operational and valuation risks: - High operational risk in transferring individual accounts with their full historic transactions from different IT systems into a newly developed IT system of the UAPF. - Valuation differences arising from different accounting interpretation applied by the different pension funds could result in a reduction of the individual accounts’ value and an additional liability for the UAPF if the impairment reserve transferred to compensate for assets under stress results insufficient. - Recommendations: - Fair treatment of members should guide the revaluation of the transferred assets. Once the consolidation is completed and the external audit valuation concluded, the guidance principle for allocating possible losses or gains to individual accounts should be based on a fair treatment principle of all members. - Clear requirements on operational effectiveness should be introduced and monitored. In the absence of competition, the UAPF needs clear benchmarking and control of its effectiveness to avoid excessive costs and operational inefficiencies. ### Governance structure weaknesses and required reforms - Current governance vulnerabilities: - NBK performs multiple roles: chairs the board of the UAPF in the fiduciary role of the owner; chairs the Council for the Management of the UAPF Assets (CMA) that decides on the investment policy and is the statutory asset manager; is the custodian, the supervisor and the consumer protection responsible. - Representation at the CMA of the contributors through an independent respected knowledgeable contributor is missing. - Nomination procedures and service duration terms for independent members are not specified in the law. - Importance of governance: - Ensuring good governance is essential to maximize retirement income for participants. - With consolidation into a single pension fund, the largest institutional investor is under the fiduciary ownership and management of the NBK, and the investment policy will have a direct impact on the development and behavior of the financial sector. - Sufficient independence and knowledge of the investment board, and proper representation and voice of pension participants, are of upmost importance. - Specific governance risks to avoid: - Political undue interference with investment decisions (example: setting minimum investment shares in fixed income securities with negative real yield). - Avoid investments that are not fully understood, like direct infrastructure financing. - Ensure appropriate level of risk appetite and return consistent with long-term liabilities. - Forbid payments of annuities on an unfunded fashion by paying internally without setting appropriate technical reserve. - Prevent use of accounting discretion to fill gaps (allocation of assets in different accounting categories at will, arbitrary valuation of illiquid assets). - Prevent directing investments for supervisory purposes to support entities in financial difficulties. - Recommendations: - Reconsider the multiple roles assigned to the NBK to achieve separation of management from control; current governance structure is not in line with basic governance best practice. - Separate the supervisory function from the ownership of the UAPF to avoid supervisory capture and conflict of interests; supervision and ownership should not be handled by the same institution. - Appoint an external custodian for the UAPF accumulation assets; custodian must be independent to add value as an additional control function. - Implement transparency and timely reporting: frequent, detailed and useful reporting policies should be implemented by the UAPF to gain credibility as a new institution. ### Investment policy weaknesses and recommendations - Current situation: - Central weakness from poor investment returns remains unsolved; the investment policy is still to be determined. - Past inappropriate prudential regulation directing investments into government bonds with real negative returns has been removed and asset management fees have been cut in half. - No indication exists on how to derive an investment strategy resulting in long-term investments with appropriate yields. - The investment policy for the UAPF, to be determined in the coming months, needs to allow for appropriate investment instruments, sensible risk appetite, duration matching of liabilities and a clearly stated objective to maximize returns for retirement income. - Recommendations: - State a clear overarching objective in the law: a clear mandate for the UAPF to maximize retirement income for its members should be stated in the UAPF charter or the pension law. - Ensure investment strategy reflects the nature of the liabilities; give due regard to the long term character of the liabilities when designing strategy and performance metrics. - Ensure full transparency and accountability of the CMA, including: - a. Individual accountability of the CMA members - b. Full transparency of the board decisions, including publications of the minutes with individual Council members’ statements and opinions - c. Fixed-term appointments for the independent council members - d. Rotation of the chairman - e. Appointment of a strong pension participants’ representative. - Use external asset managers to optimize returns; involve several asset managers to allow for competition and diversification, especially in the absence of a benchmark. - Ensure availability of all necessary expertise for investment decisions, including actuaries to support investment decisions. - Engage special expertise for complex investments: a specialized party should evaluate infrastructure and other forms of direct investments; invest in these areas through financial instruments issued for that purpose. - Consider a reduced role of the UAPF in the payout phase: assign life insurers to annuities’ payout to leverage technical skills in longevity assessment and add external control when transferring assets. - Draft clear accounting rules to support transparency and market-consistent valuation of the assets. ### Additional five percent contribution (planned for 2014) - Opportunities and caveats: - The additional five percent contribution planned to be introduced during 2014 presents an opportunity to improve the pension system. - The additional five percent contribution will help offset the low replacement ratio but should not be a substitute for tolerating underperforming accumulated pension assets. - Including a death benefit to cover future salary payments until retirement age should be evaluated. - Notional schemes under consideration, where the assets are accounted for in individual accounts but do not physically exist, require increased governance and investment discipline to avoid creating uncovered liabilities. - Footnote: Several funded pension systems include this benefit and the actuarial cost could be around 0.5 percent of the insured salary. - Recommendations: - Independent and intrusive governance and investment discipline will be key for success. If outstanding governance and elevated investment discipline for managing the additional five percent contributions cannot be guaranteed, a traditional DB or DC should be preferred. - Keep administration cost low; maximize synergies while ensuring diversification and low maintenance investments. - Enhance the pension system with meaningful benefits; consider adding death benefits in the form of income replacement until retirement age given an attractive cost benefit analysis. ### Linkages between insurance, pension sectors, and banking sector - Observations: - About a quarter of the insurance sector assets (750 million USD) are held in bank deposits; the amount is not of systemic relevance for the banking sector. - The banking channel is not relevant to the distribution of insurance; few companies use it to place life products and bank loan related insurance. - The pension sector has provided liquidity in the form of direct deposits and repo transactions for an estimated amount of 20 percent of total accumulated assets (four billion USD). - With consolidation into a single pension fund with no bank ownership, access to liquidity will change but is not expected to dry out according to the current investment policy of the NKB. - Profits of the pension fund have been positive: 75 million USD in 2012 and 90 million in 2013; this source of income will no longer be available for the bank owners of pension funds, but given its size the effect cannot be seen as systemic relevant to the banking sector. - Footnote: In the last years, 65 percent of the deposits are held with the owner bank. - Recommendation: - Investments in the financial sector need increased attention. Management of assets by the NBK, which at the same time is the bank supervisor, could be a source of conflict of interests that needs to be managed when providing liquidity to the banking sector in the form of direct investments. Proper safeguards should be incorporated into investment decisions in areas of NBK supervisory competence. ### Selected items from Appendix III: Risk Assessment Matrix (high-level) - Threat 1: Lower than anticipated growth potential in emerging markets, especially in Russia and China - Staff assessment: High (Nature/Source of Main Threats) - Likelihood of severe realization in the next 1–3 years: Medium - Expected impact on financial stability if realized: Medium - Key points: - Russia and China make up 30 percent of gross exports. - Scenario effects: deceleration of output growth, contraction in FDI, increased credit risk, fall in house prices, FX depreciation pressures. - Threat 2: Sustained decline in commodity prices (particularly oil prices) - Staff assessment: Medium (Nature/Source of Main Threats) - Likelihood of severe realization in the next 1–3 years: High - Expected impact on financial stability if realized: High - Key points: - Petroleum exports are the key driver of Kazakhstan’s growth. - Scenario effects: output growth deceleration, reduced oil exports and oil-related capital inflows, increase in nonperforming loans, real estate collateral devaluation, sustained downward pressure on the Kazakh Tenge, increased systemic liquidity risk and FX-induced indirect credit risk. - Threat 3: Loss in confidence triggers domestic banking crisis - Staff assessment: Medium (Nature/Source of Main Threats) - Likelihood of severe realization in the next 1–3 years: Medium - Expected impact on financial stability if realized: Medium - Key points: - Triggers: fears of further currency devaluation, inconsistent implementation of regulatory reforms, concerns about rapid consumer lending growth. - Almost 40 percent of loans are denominated in foreign currency. - Scenario effects: systemic domestic banking crisis, considerable liquidity withdrawals, asset fire-sales, reduced credit supply, negative effects on investment, exports and FDI. - Notes on stress tests: - Risks incorporated through an adverse macroeconomic scenario in the solvency stress test and a liquidity stress test covering market and funding liquidity shocks. *IMF staff report content as provided in the source document.* ### 4. Failure to ### 4. Failure to reduce the level of NPLs ### Staff assessments - Staff assessment: High - Staff assessment: Medium ### Key findings on current NPL situation - At more than 30 percent to total loans, the high stock of NPLs constitutes a looming contingent liability for the state/public sector. - Addressing the ongoing deterioration of asset quality has been challenging, and hopes that growth recovery would restore bank balance sheets have not materialized. - The current strategy anchored on an asset management company (PLF), and special purpose vehicles, for instance) has not had a significant impact because of insufficient political support, legal obstacles, and the exclusion of NPLs collateralized with real estate. - Persistently high NPLs are hampering financial intermediation and this would be further aggravated by waning foreign investor interest in extending credit to Kazakh banks. - Uncertainty about how this problem will be addressed, and with banks unwillingness to support the government’s diversification strategy, may cause investor and consumer confidence to drop. ### Channels of adverse effects and system-wide implications - High levels of nonperforming loans may adversely affect asset prices and the banks’ loss rates on both nonperforming and performing credit exposures. - The negative carry from excess liquidity and low lending activity undermines banks’ profitability. - The considerable size of this contingent liability likely reduces the government’s scope for further stimulus, implying an additional hit on economic activity. - Widespread concerns about under-provisioning for already defaulted exposures (for instance, due an optimistic collateral valuation and misclassification of restructured loans) would require an increase in loan-loss provisioning or, equivalently, result in higher effective loss rates when these exposures are finally written off. ### Linkages to macro-financial stress testing (RAM risk #4) - The consequences of a failure to bring down the high current level of nonperforming loans are analyzed for RAM risk #4. - Nonperforming loans weigh heavily on banks’ profitability and hold back bank intermediation. - An additional increase in NPLs, together with higher loss rates due to real estate collateral devaluation, put additional pressure on loan generation and bank profitability (as reflected in stress scenario 2 narrative). - In the stress tests, these risks are incorporated through an adverse macroeconomic scenario and by means of specific sensitivity analyses. *International Monetary Fund — excerpt from: 4. Failure to reduce the level of NPLs (Kazakhstan FSAP material)* ### Appendix Table 3. Liquidity Risk: Scenarios and Run-off Rates ### Appendix Table 3. Liquidity Risk: Scenarios and Run-off Rates ### Overview - Table reports run-off rates (Percent) for liquidity risk under three scenarios: "Basel III LCR", "Severe Stress 1", and "Severe Stress 2". - Source: Basel Committee of Banking Supervision, IMF staff. ### Retail Deposits - Demand deposits - Demand deposits53050 - Stable deposits - Stable deposits53050 - Less stable retail deposits - Less stable retail deposits103050 - Term deposits, residual maturity > 30d - Term deposits, residual maturity > 30d000 ### Unsecured Wholesale Funding - Demand and term deposits, residual maturity < 30d, small business - Stable deposits53050 - Less stable deposits103050 - Operational deposits generated by clearing, custody, and cash management activities - Operational deposits generated by clearing, custody, and cash management activities253050 - Portion covered by deposit insurance - Portion covered by deposit insurance555 - Cooperative banks in an institutional network - Cooperative banks in an institutional network252525 - Nonfinancial corporates, sovereigns, central banks, multilat dev banks, PSEs - Not fully covered by deposit insurance404060 - Other legal entity customers - Other legal entity customers100100100 ### Secured Funding - Secured funding with a central bank, or backed by Level 1 assets - Secured funding with a central bank, or backed by Level 1 assets000 - Secured funding backed by Level 2a assets - Secured funding backed by Level 2a assets153050 - 253050 - Funding backed by RMBS eligible for Level 2b - Fundign backed by RMBS eligible for Level 2b253050 - Funding backed by other Level 2b assets - Funding backed by other Level 2b assets505050 - Other secured funding transactions - Other secured funding transactions100100100 ### Additional Requirements (Derivatives and Collateral) - Valuation changes on non-Level 1 posted collateral securing derivatives - Valuation changes on non-Level 1 posted collateral securing derivatives202020 - Excess colateral held by bank related to derivate transactions that could be called anytime - Excess colateral held by bank related to derivate transactions that could be called anytime100100100 - Liquidity needs related to collateral contractually due on derivatives transactions - Liquidity needs related to collateral contractually due on derivatives transactions100100100 - Increased liquidity needs related to derivative transactions allowing collateral substitution - Increased liquidity needs related to derivative transactions allowing collateral substitution100100100 ### ABCP, SIVs, conduits, SPVs, or similar; Asset-backed securities - Liabilities from maturing - Liabilities from maturing100100100 - Asset backed securities - Asset backed securities100100100 ### Undrawn but Committed Credit and Liquidity Facilities - Retail and small business - Retail and small business53050 - Nonfinancial corporates, sovereigns, central banks, multilat dev banks, PSEs - Credit facilities103050 - Liquidity facilities304050 - Supervised banks - Supervised banks404050 - Other financial institutions - Credit facilities404050 - Liquidity facilities100100100 - Other legal entity customers, credit and liquidity facilities - Other legal entity customers, credit and liquidity facilities100100100 ### Other Contingent Funding Liabilities - Trade finance - Trade finance53050 - Customer short positions covered by customers' collateral - Customer short positions covered by customers' collateral505075 - Additional contractual outflows - Additional contractual outflows100100100 - Net derivate cash outflows - Net derivate cash outflows100100100 - Any other contractual cash outflows (not listed above) - Any other contractual cash outflows (not listed above)100100100 *Source: Basel Committee of Banking Supervision, IMF staff.* ### 12. Kazakhstan has a two-tier banking system with the NBK comprising the first tier and ### Kazakhstan banking sector (excerpt) ### Banking system structure and concentration - Two-tier system: NBK as first tier; commercial banks as second tier (Development Bank of Kazakhstan excluded). - Number of banks: 38 commercial banks, including 17 banks with foreign participation and one bank 100 percent owned by the state. - Size and concentration: total assets equivalent to 45 percent of GDP; top five banks account for 56 percent of banking system assets (as at November 1, 2013). ### Impact of the global financial crisis and government support - Pre-crisis behavior: between 2000 and 2007 banks incurred high levels of foreign debt to fund rapid credit expansion concentrated in construction and real estate. - Crisis effects: credit growth stopped, deposits were volatile, property prices decreased, oil prices declined—causing significant bank losses and destabilization in 2008–2009. - Government capital injections into the banking sector: estimated at 6.4 percent of GDP in 2009 (comparatives: United Kingdom 3.9 percent and United States 2.2 percent of 2009 GDP). ### Prudential regulation and capital standards - FSA regulatory enhancements: September 2005 amendments set limits/rules for capital adequacy, single party exposure, liquidity ratios, open currency positions; November 2005 regulations on regulatory capital and risk management; February 2007 limits on foreign borrowings (“external liabilities”). - NBK capital requirements: - Tier 1 capital to RWA ratio requirement: 6.0 percent. - Total capital adequacy ratio requirement: 12.0 percent. - As of November 1, 2013: total capital adequacy ratio of commercial banks was 18.5 percent and Tier 1 capital to RWA ratio was 13.5 percent. - Basel III timeline: Basel III capital requirements to be implemented in Kazakhstan during the period from 2015 to 2019; transition period and minimum capital requirements defined based on NBK research. ### Asset quality, NPLs, and remediation measures - Nonperforming loans (NPLs): NPLs accounted for 29.4 percent of all loans as of November 1, 2013. - NBK measures to address NPLs: - Establishment of a Fund for Problem Loans in 2012 (fully owned by the NBK) to buy NPLs (excluding personal real estate mortgages and consumer loans) and manage such assets (restructuring and/or sale of collateral). - Permitted transfer of NPLs to banks’ own subsidiaries authorized to manage, sell, restructure and securitize problem assets. - Special terms and conditions for bad debt remission without additional tax liabilities when transferred to the PLF. - Since 2013, enforcement of special regulatory ceilings on NPLs to stimulate reduction by banks. ### Liquidity policy and funding structure - Reserve requirement adjustments: - With effect from March 2009: minimum monetary reserves decreased from 2.0 percent to 1.5 percent with respect to domestic liabilities and from 3.0 percent to 2.5 percent with respect to other liabilities. - Effective May 31, 2011: minimum reserves increased from 1.5 percent to 2.5 percent with respect to domestic liabilities and from 2.5 percent to 4.5 percent with respect to other liabilities. - Liquidity profile: banks exceed regulatory liquidity ratios and minimum reserve requirements; system liquidity is relatively high but short-term liabilities are the main funding source. - Structural funding limitation: limited range of collateral for attracting longer-term liquidity (including from the NBK); lack of long-term funding sources remains a problem. ### Foreign participation and market access - Branching restriction: foreign banks are prohibited from opening branches in Kazakhstan; foreign banks must establish a Kazakhstan subsidiary or joint venture. - Classification by foreign participation: banks with foreign participation exceeding one-third are classified as foreign-owned; less than one-third direct or indirect foreign ownership are considered domestic banks. - As at November 1, 2013, examples of foreign-participation banks included RBS Kazakhstan, Citibank Kazakhstan, HSBC Bank Kazakhstan, and Sberbank Kazakhstan. ### Financial stability framework and macroprudential role of NBK - NBK responsibilities: monitor macroeconomic and macrofinancial factors; carry out macroprudential regulation; determine criteria for systemic importance; may establish additional prudential standards and limits for systemically important financial institutions; act as lender of last resort. - Crisis powers: in case of systemic crisis, NBK independently or jointly with the Government may introduce restrictions on certain types of banking and other operations. - Financial Stability Council (established 2010): consultative/advisory body under the President; Chairman of NBK is Chairman of the Council; membership includes representatives of the President, Deputy Prime Minister, Heads of Antimonopoly Agency, Ministry of Finance, Deputy Chairman of NBK, and Chairman of “Association of Financiers of Kazakhstan”; functions include developing proposals on systemic risks, strategy and principles of regulation, and coordination with state bodies. ### Legal, accounting, and supervisory infrastructure - Legal framework: system of business laws (Civil Code; Law on joint stock companies No 415-II dated May 13, 2003; Law on bankruptcy No 67-I dated January 21, 1997; Law on consumer protection). - Accounting and auditing laws: Law on accounting and financial reporting N 234-III dated February 28, 2007 and Law on audit N304-I dated November 20, 1998; banks required to prepare financial statements in accordance with IFRS; auditing in accordance with the ISA; NBK sets qualification requirements for auditors of financial institutions. - Supervisory reforms since 1995: introduction of international prudential standards, transparency and auditing requirements, IFRS harmonization, mandatory internal risk management systems since 2003; periodic reporting and inspection guidelines. ### Crisis management, recovery, and resolution framework - Legal powers under Law on Banking N2444: - Conservatorship: “temporary bank closing” and appointment of a temporary administrator (Articles 62 to 67-1). - Purchase and assumption (P&A): temporary administrator may sell/transfer assets and liabilities to another bank with NBK approval (Article 61-2). - Stabilization/Bridge bank: restructuring into a stabilization bank to hold “good” assets; stabilization banks not subject to capital adequacy requirements and other prudential norms (Article 61-3). - Forced takeover of bank shares by the NBK or the national management holding company with Government approval (Article 16, paragraph 6). - Voluntary bail-ins: under Bank Restructuring Law N185-IV (post-2009), banks (BTA, Alliance Bank, Temir Bank) underwent voluntary debt restructurings with creditor haircuts; sovereign wealth fund converted some $1.2 billion of its deposits in BTA bank into equity. ### Deposit insurance and market discipline - Deposit insurance: Kazakhstan Deposit Insurance Fund (KDIF), owned by the NBK, established December, 1999; participation mandatory for banks taking deposits from private individuals. - Guarantee limit: KDIF guarantees and reimburses deposits of individuals up to KZT 5 million (about USD 33,000). - Trigger: revocation of a bank’s license triggers deposit guarantee system and compulsory liquidation. - Transparency and corporate governance: Laws (JSC N415; Law on banking N2444; Law on accounting and financial reporting N 234-III) establish rules on corporate governance, transparency, audited financial disclosure, and publication of annual consolidated financial statements. ### Main findings (supervisory capacity and shortcomings) - Legislative framework: comprehensive framework implemented; work ongoing to address areas not meeting international standards (AML/CFT amendments; Instruction 359 amendments to incorporate operational, liquidity and market risk management). - Implementation gaps: effectiveness affected by insufficiently detailed guidance for banks and FSC staff; training needed on market risk, interest rate risk management, and loan loss provisioning to reduce excessive reliance on compliance. - Governance concerns: Executive Board composition may expose supervisory decisions to non-prudential considerations (includes Minister of Finance, Minister of Economy, representative of the President as voting members); lack of transparent conditions for removal of NBK Head and Executive Board members (no specified requirements such as misconduct nor requirement to publish decision and reason). - Resource needs: increased regulation and enhanced risk management requirements support a need to review adequacy of FSC staff numbers and skills, particularly for off-site supervision of banking conglomerates. - Staff legal protection: legal protection under the Civil Code should be clarified by internal NBK guidelines (clarify payment of legal expenses and establish threshold for guilt, e.g., responsibility only for gross negligence and intentional acts). *Italic: Excerpt from IMF staff report chapter on Kazakhstan banking sector (provided content).* ### 37. The focus of the supervisory activity is primarily oriented towards a granular ### _cr14258 - 37. The focus of the supervisory activity is primarily oriented towards a granular ### Supervisory approach and techniques - Supervisory activity is primarily oriented towards a granular verification of compliance with rules, with less room left for more advanced risk-based analysis. - The forward-looking aspect of risks is present, but it is captured in a somewhat mechanistic way. - The credit registry is largely underused. - The FSC periodically receives results of mandatory internal stress-tests from banks, but their quality and integration into banks’ decision-making is far from satisfactory. - Bottom-up stress-tests are used mainly for reporting and compliance-check purposes rather than deeper risk analysis. - Top-down stress-tests run by the financial stability department are substantially not integrated into supervisory analysis. - The distribution of off-site analysts across supervised entities is not commensurate to their relative importance and systemic relevance: banking conglomerates are typically assigned to a single analyst, creating disproportionate operational burden. ### Corrective and sanctioning powers of supervisors (CP 11) - The NBK is equipped with broad discretionary enforcement powers to address weaknesses in banks or non-compliance with laws, regulations, or supervisory instructions. - The banking law authorizes the NBK to require preventive and corrective action over a broad range of activities. - A well-designed enforcement process is in place and linked to the bank’s condition to ensure prompt supervisory action. - Remedial measures include: - letter of commitment from the bank’s Board of Directors, - written agreement with the bank concurring on action plans, - written order to implement corrective action, - written warning on the imposition of sanctions. - Possible sanctions include: fines, suspension or revocation of a license, placing the bank in conservatorship, and transfer of the bank’s ownership. ### Consolidated and cross-border supervision (CPs 12–13) - The Banking Law provides a definition of banking conglomerate that includes significant participations of the bank and its bank holding company. - The FSC supervises such conglomerates on a consolidated basis and regularly reviews compliance with prudential standards and other regulatory requirements. - The NBK is open to cooperation with foreign supervisory authorities, but further steps are needed to guarantee effective cross-border supervision of Kazakh banking conglomerates. - At the bilateral level, the NBK has signed MoUs with most foreign supervisory authorities it contacts, but it has not signed a MoU with a foreign authority of a country where a Kazakh bank holds a significant participation of a certain relevance. - At the multilateral level, FSC experience as host supervisor is in initial stages (participation in supervisory colleges headed by two foreign authorities); experience as home supervisor has yet to be planned. - Gaps in consolidated supervision of cross-border banking groups were identified. - The NBK has not signed a MoU with a foreign authority of a country where a Kazakh bank holds a significant participation of certain relevance. - The FSC has not established supervisory colleges for Kazakh banks with significant foreign operations. ### Corporate governance (CP 14) - Extensive legislative and regulatory requirements on internal governance exist and are routinely verified by the supervisor. - Main missing elements: - no prescription for banks (or at least systemic ones) to establish a committee for risk oversight, - no experience requirements for non-executive Board members, - no requirements for the Board to determine risk appetite, establish and communicate corporate culture and values, or maintain succession plans. - The NBK plans to introduce requirements in an upcoming amendment of the Instruction on risk (e.g., committee for risk oversight, Board to set acceptable level of risk and report on performance and risk profile). ### Prudential requirements, regulatory framework, accounting and disclosure (CPs 15–29) - Risk management provisions are almost completely contained in Instruction N. 359, which the NBK plans to replace with a new regulatory document. - Missing elements in current Instruction N. 359 include: - attention to model risk (requirement for Board to ensure uncertainties are attached to risk measurements, standards on model use and regular independent validation), - guidance about management of exceptions to policies, processes and limits (including prompt attention and authorization by appropriate management or Board where necessary), - requirement to establish the function of CRO or equivalent. - Capital adequacy: - Modeled on Basel II standards with capital charges for credit, operational, and market risk. - For credit risk, the standardized approach was implemented. - Operational risk is calculated using the basic indicator approach. - Market risk is measured under the standardized approach. - The NBK is currently developing guidance for banks regarding expectations for the internal capital adequacy assessment process (ICAAP). - Implementation of Basel III is scheduled to commence in 2015 with full implementation by 2019. - Provisioning: - Provisioning requirements moved from fully prudential/regulatory approach established by the NBK to adoption of IFRS. - In 2013 the NBK adopted IFRS loss impairment as the standard for provisioning. - Transition did not include attendant definitions and guidelines to frame identification of impairment indicators. - FSC did not undertake certain activities needed to preserve staff ability to judge adequacy of provisions (training, access to real estate statistics, hiring appraisal expertise, standards for restructuring loans, requirements for upgrading loans after restructuring). - Country risk monitoring is limited to ensuring banks adequately weigh the risk in capital adequacy computations and that exposure limits are not exceeded; FSC has not issued guidelines on provision of country/transfer risk and does not focus on country risk in monitoring. - Market risk coverage is extensive but insufficient: - Commodity risk is not included in definition of market risk. - No requirements for banks to establish policies/processes for calculation of valuation adjustments when needed. - Missing elements include management of exceptions, model validation, and controls on their use. - Interest rate risk: - Main requirements for an adequate interest risk management framework are in place, but with no distinction between trading and banking books and no guidance on interest rate shocks to adopt. - Interest rate risk is treated as part of market risk; lack of distinction may reduce consideration for specificities of interest rate risk (e.g., optionality). - NBK does not provide banks with indications about the standardized interest rate shock and supervisor’s expectations on internal measurement systems. - Liquidity risk: - Regulation provides for a wide range of requirements for a prudent and appropriate liquidity risk framework. - NBK plans to evolve liquidity requirement regime along latest regulatory developments with consideration for local market characteristics. - Operational risk: - Regulatory standards issued, but guidelines do not fully address outsourcing risks and business continuity plans. - Revisions to existing guidance have been drafted to incorporate quarterly reporting by banks on operational risk and provide guidance on business continuity plans. - Currently no ex-ante review by FSC of outsourcing arrangements; existing guidance does not address baseline due diligence elements, contingency planning, or FSC access to assess service providers. - Financial reporting and external audit: - Banks required to prepare financial statements according to IFRS; NBK does not impose differing requirements to valuation of financial instruments. - Laws and regulation set requirements for external audit; no requirement for banks to rotate external auditors from time to time. - Disclosure and transparency: - Requirements exist for banks to disclose information on solo and consolidated bases, but with limited coverage of risk-related issues (exposures, strategies). - No specific requirements for disclosure of risk exposures (apart from loans exceeding a certain threshold and major transactions), risk management strategies, and corporate governance policies and processes. ### Anti-Money Laundering / Combatting Financing of Terrorism (AML/CFT) - AML regulation is deficient; significant amendments are being contemplated. - FSC has been active in implementation and supervision of existing AML/CFT Law through onsite inspections. - Existing Law fails to meet international standards, primarily in areas of correspondent banking and customer due diligence, limiting effectiveness of supervision and enforcement. - Amendments are pending in Parliament to address deficiencies; approval is expected by summer 2014. - Recommended prompt implementation once AML/CFT law is approved and review adequacy of cash transaction reporting thresholds. ### Table summary findings (selected items) - Independence concerns: composition of NBK Executive Board jeopardizes independence by voting presence of significant executive branch representation (Deputy Head of the Presidential Administration, the Minister of Finance and Minister of Economy). - NBK Chairman and Deputy Chairmen are appointed for a minimum term by the President; law does not specify reasons for removal during term. - Demands on FSC staff will increase with implementation of revisions to Resolution 359, anti-Money Laundering legislation, and implementation of IFRS provisioning practice. - NBK has not developed internal operational guidelines and statutes to clarify implementation of Article 922 of the Civil Code on legal protection for NBK staff. - Resolvability is not taken into consideration in analysis of systemic banks. ### Recommended actions (F. Recommended Actions — selected and grouped) - Principle 2: - Augment independence of bank supervision decision-making by delegation from the Executive Board to the FSC prudential decisions. - Propose legislation to have the NBK Law identify proper reasons for dismissal of the Executive Board and its publication. - Ensure FSC staff has the skills and training to monitor compliance with the revised Instruction 359 and Impaired Asset provisioning. - Develop regulations on application of Civil Code legal protection to NBK staff. - Principle 8: - Shift emphasis of supervisory activity from compliance verification towards more risk-based oversight, through adoption of more advanced risk assessment tools (e.g., better use of credit register data) and from mechanistic early warning indicators towards more intense use of stress testing results (e.g., as input for CAMELS rating system and decisions on specific capital requirements / capital buffers). - Incorporate resolvability into analysis of systemic banks and establish powers and processes to adopt measures to remove bank-specific barriers to orderly resolution (e.g., changes to business strategies, managerial, operational and ownership structures, internal procedures). - Principle 9: - Reinforce use of bottom-up stress-test results as input for deeper analyses of banks’ risks. - Better integrate top-down stress-test results into supervisory analysis. - Increase staffing of off-site supervision on banking conglomerates. - Principle 12–13: - Introduce explicit provisions linking restriction of admissible activities to adequacy of foreign authorities’ supervision and/or to perceived obstacles to effective consolidated supervision. - Agree and sign MoUs with foreign authorities of countries where Kazakh banks have subsidiaries or significant participations. - Impose restrictions on presence of Kazakh banks in countries whose supervisory authorities prove non-collaborative. - Establish supervisory colleges for Kazakh banks with significant foreign operations. - Principle 14–15: - Require banks to establish a committee for risk oversight. - Establish requirements for Board to determine risk appetite, establish and communicate corporate culture and values, and maintain succession plans. - Introduce requirements for Board to ensure uncertainties are attached to risk measurements, supervisory standards for model use and independent validation, and requirements for management of exceptions and appropriate escalation mechanisms. - Require banks to establish the function of CRO or equivalent. - Principle 16: - Provide guidelines on establishing an ICAAP in line with Basel II as NBK continues implementing Basel II and III. - Principle 17–18: - Prompt implementation of revised Instruction 359. - Provide training and develop guidelines/procedures for FSC staff on evaluation of adequacy of provisions in an IFRS environment. - Get access to statistics on real estate and consider hiring staff with expertise in professional appraisals. - Establish definitions for restructured, cured and nonperforming loans. - Principle 21–23: - Develop procedures for FSC staff on assessment of country risk and analysis of provisions/enforcement actions to address country/transfer risk based on a country’s trends in reserve levels and balance of trade. - Include commodity risk in treatment of market risk. - Introduce requirements for banks to establish policies/processes for calculation of valuation adjustments when needed. - Remove requirement for Board to assess management performance in achievement of bank goals in a way that conflicts with sound risk management principles. - Introduce separate treatment of interest rate risk in the banking book and provide standardized interest rate shock guidance and supervisor expectations for internal measurement systems. - Principle 25: - Broaden outsourcing risk guidelines in revised Instruction 359 to ensure proper due diligence before entering into relationships and ensure FSC access to service providers. - Principle 27: - Establish a requirement for banks to rotate their external auditors from time to time. - Principle 28: - Introduce disclosure requirements regarding risk exposures, risk management strategies and corporate governance policies and processes. - Principle 29: - Prompt implementation once AML/CFT law is approved by Parliament; review adequacy of cash transaction reporting thresholds. *IMF assessment excerpt from the consolidated Basel Core Principles review contained in the provided source content.* ### 54. The National Bank of Kazakhstan (the NBK) welcomes the assessment of the Kazakhstan’s ### _cr14258 - 54. The National Bank of Kazakhstan (the NBK) welcomes the assessment of the Kazakhstan’s ### NBK reaction to the assessment - "The National Bank of Kazakhstan (the NBK) welcomes the assessment of the Kazakhstan’s banking regulatory and supervisory framework and acknowledges the extensive work done by the assessment team." - "Generally, the NBK appreciates the recognition of the resilience and stability of the Kazakhstan’s financial system." - "The NBK agrees that there are some deficiencies and gaps in the bank regulations in Kazakhstan and accepts the BCP recommendations." ### NBK commitments and next steps - "We intend to implement recommendations provided in detailed assessment of observance Basel core principles for effective banking supervision in a reasonable time frame." *https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14258.pdf* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14258.pdf_