Special report: Mongolia: Banking system marks its 90th anniversary

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Mongolia’s banking sector has come a long way since its foundation, with Russian help, in 1924. The industry proved resilient during the financial crisis and competition has stimulated expansion and innovation, although there are worries about over-dependence on the resource sector

Mongolia's banking system has changed out of all recognition from its humble beginnings in the 1920s, helping to transform the country along the way into the pocket economic powerhouse it is today.

When the country’s first bank, the Trade and Industry Bank of Mongolia, opened with a single branch in June 1924 it was with the help of its Soviet neighbour and staffed mostly by Russians. Mongolia also had no national currency, presenting the bank with the headache of trying to fulfil financial and monetary policy with the foreign currencies then in circulation. 

The togrog (MNT1,823 = $1) was introduced the following year and by 1954 Mongolia had gained sole ownership and control of the bank, which was renamed State Bank of Mongolia (now the Bank of Mongolia – the central bank).

Transition to market economy

But the most significant milestone in the sector’s 90-year history came in 1990 with the start of the transition from Soviet-style communist rule, with its centrally-planned economy, to a multi-party democracy with a market economy.

The country’s first commercial bank, Trade and Development Bank (TDB), was founded in October of that year, followed by Khan Bank three months later. The 1991 Banking Law established the central bank and a statutory minimum paid-in capital requirement for banks. All banks, however, remained under state ownership. That year also saw the establishment of the Mongolian Stock Exchange in Ulaanbaatar.

However, early promise soon evaporated in the face of an economic crisis resulting from the collapse of the Soviet Union, on which Mongolia had relied for nearly all its trade as well as medicine, fuel, and machinery.

When reform efforts and private enterprise eventually fed through in the mid-1990s, economic growth resumed but banks over-extended credit. This left them poorly positioned to weather the Asian financial crisis that followed in the second half of the decade and a number of banks closed.

With Golomt Bank leading the way, by the early 2000s the sector had been transformed into a mostly privatized banking system, with 16 commercial banks regulated by the Bank of Mongolia. In 2006 the Financial Regulatory Commission was established to supervise the rest of the financial sector including insurers, securities houses, credit and savings unions, and non-banking financial institutions.

In 2007, TDB became the first bank to tap the international debt market with a $75 million bond issue. It repeated the exercise in 2010 and 2012, doubling the value of its issuance on each occasion. In January, TDB priced Mongolia’s first renminbi-denominated bonds. The bank’s so-called ‘dim sum’ bond offering, raising RMB700 million ($115 million), was twice over-subscribed.

Resilient in crisis

The global financial crisis did cause problems with two bank failures, two mergers and the formation from the liquidated banks’ assets of a new state-owned bank, State Bank, in 2009. Overall, the sector proved rather resilient, with growth dipping only briefly in the initial stages, helped in part by the introduction of an interim blanket bank deposit guarantee scheme in 2008.

That year saw the first foreign banking presence when Dutch bank ING set up a representative office. The UK’s Standard Chartered followed in 2011 and Bank of China in 2013. Japan’s number one and two banks – Bank of Tokyo-Mitsubishi and Sumitomo Mitsui Banking Corporation – opened representative offices in 2013. Goldman Sachs took a 4.8% stake in TDB in 2012.

In 2010, the Banking Law was strengthened, boosting minimum paid-in capital to MNT8 billion ($4.39 million) and limiting a bank’s exposure to any single borrower. The law also prohibits a single investor from ‘significant influence’ in more than one bank, requires banks to notify the regulator of major changes in the shareholder structure, and prioritizes prudential compliance over dividends. The minimum paid-in capital requirement was doubled again last year to MNT16 billion as part of counter-cyclical measures being pursued by the central bank.

The Development Bank of Mongolia was established in 2011 to extend medium- to long-term financing to strategically important sectors – loans for infrastructure and industrial and energy developments – to be funded through bond sales. The bank’s first issue of debt – government backed – in 2012 raised $580 million and was 10 times oversubscribed, followed last December by a Samurai bond issue. The $290 million of yen-denominated debt was guaranteed by Japan Bank for International Cooperation.

In January last year parliament passed the Deposit Insurance Law, replacing the earlier temporary measure that expired at the end of 2012. The industry-funded scheme guarantees deposits up to MNT20 million in the event of the failure of a member bank.

In July 2013, Savings Bank, the fifth largest lender, failed – pulled down by the non-performing loans of its affiliates and its insolvent parent company – and was taken over by State Bank.

Dynamic sector

This evolution over many decades means that, today, Mongolia has a dynamic banking sector comprising 13 banks ranging from dominant players like TDB, Khan and Golomt to community development and microfinance providers such as XacBank.

“Seeing the development of the banking system over the last decade, although there have been problems all they’ve done is helped highlight and weed out the weaker players,’’ says TDB president Randolph Koppa. “So we’re getting, I feel, an increasingly stronger system that’s providing a broader array of financial services to Mongolians in general than it was nine years ago when I arrived here.’’

Competition has spurred banks to expand, particularly their retail businesses, and created a strong innovation pipeline producing advances in payment systems and branchless banking that have made Mongolia a leader in financial inclusion.

But the banking system faces risks from Mongolia’s growing dependence on mining, resources exports and government stimulus which, while producing double-digit GDP growth, is also driving rapid loan growth of more than 50% a year.

“One of the central bank’s roles is to ensure the stability of the financial system and we have worked to make sure banks are sufficiently capitalized and work to international prudential standards,’’ says Sandagdorj Bold, adviser to the governor of the Bank of Mongolia. “The average core tier 1 ratio of Mongolian banks is 17% at the present time, against a minimum requirement of 12%. The average liquidity ratio is 41%, against a minimum of 25% and non-performing loans are stable at a moderate 5%.’’

But fund managers have doubts. Sturgeon Capital’s founder and CEO Clemente Cappello warns that while Mongolia is undergoing a transition for the good, over-investment in recent years will cause problems in future: “The only thing they’ve done outside natural resources has been real estate, and I think there’s been some over-investment there, certainly some capital misallocation. That is going to be linked to some volatility in the banking sector because real NPLs are increasing. The banks are limited in size and they just went through a huge boom and now, when capital is not there, I think they will face some troubles.’’

Total assets were up 59% year on year in April to MNT21.21 trillion, with loans up 51.5% to MNT11.69 trillion, BOM data shows. Total togrog deposits were up 46% year on year in April to MNT6.97 trillion, with personal savers accounting for almost two-thirds, but failed to keep pace with loans pushing up the loan-to-deposit ratio from 117% to 122%. The loan-to-GDP ratio stood at around 60% at the end of 2013.

TDB’s Koppa says that the headline figures are slightly overstated due the distorting effect of a weakening togrog, which depreciated by around 25% against the dollar in the same period. “Expressed in dollars, the asset growth in the banking sector was about 46% in 2013 which is significant but the figure was 28% in 2012, 35 % in 2011, and 62% in 2010, so asset growth has been quite strong in the past.

“Much of the growth last year was because of temporary BOM programmes to stimulate financing of small apartments through lending to banks to increase their mortgages and other funding to stimulate development of construction materials companies, and exports of cashmere and other sectors.

“This dedicated funding showed up as increased assets in the banking sector but as the economy continues to expand at a double-digit rate, the percentage increase each year will have to come down so instead of 28% we would be looking at 15-20%, then down to 15% annually.’’

Koppa says the elevated loan-to-GDP ratio is partly a consequence of the lack of capital markets, which means the funding load for business growth falls almost entirely to the banking sector, with domestic banks responsible for a significant proportion.

“The loan-to-GDP ratio will have to continue to increase so that means that banks will continue to grow a little bit faster than the rate of GDP growth in real terms for the next three years, at which point I think the loan-to-GDP ratio will stabilize at around 75-80%. We should then see bank growth pretty much in line with GDP growth.’’

Short-term headwinds

The sector does face some headwinds in the short term from rapid credit growth and imbalances injected by inflation above 12% and a substantial current account deficit combined with togrog depreciation. The foreign currency loan-to-deposit ratio jumped to a record high of 120% at the end of last year with foreign currency deposits accounting for more than a quarter of total loans.

Ratings agencies are concerned that, even through most FX lending is to corporations with hedged positions, the banking system faces credit risks given the degree of togrog depreciation. They also cite wider macro risks from the deteriorating environment for resources, the country’s key export, and that banks and the BOM may be underestimating the true extent of NPLs.

However, with the deficit set to fall, a weakening inflation trend, Mongolians’ fondness for saving and sustained economic expansion over the medium to long term, should ensure the sector prevails. GDP growth is forecast to spike to almost 13% this year according to the IMF, before slowing in 2015. However, growth is expected to stay well above 7.5% for the remainder of the decade, making it one of the world’s fastest-growing economies.