Sector stability is currently supported by rapid economic growth, low exposure to external financial markets and the strong external and fiscal position of the sovereign. However, the sector remains vulnerable to possible economic shocks due to weak corporate governance and risk management, fast recent asset growth, significant directed lending and acquisitions of problem assets. Banks' foreign currency obligations, specifically those arising from trade finance, are particularly vulnerable due to existing foreign exchange constraints.

Uzbekistan has recorded rapid five-year average annual GDP growth of 8.7%, driven by rising revenues from its main export products (including base and precious metals, gas, cotton and other agricultural goods), strong industrial growth led by sovereign investments, infrastructure construction and foreign investments in energy sectors, and solid domestic demand, boosted in particular by foreign remittances.

The sovereign balance sheet benefits from the low level of debt (estimated at 9% of GDP at end-2011), fiscal surplus (7.5% of GDP), positive current account (5.8% of GDP) and its strong external position, with accumulated foreign currency reserves estimated by the IMF at USD19.8bn (45% of GDP) at end-2011. However, the sovereign credit profile remains undermined by structural weaknesses, including a difficult business climate, poor institutional development and weak economic diversification.

The economy is largely state-influenced, with the government retaining direct operational supervision in the main industries. In line with this, the banking sector is also dominated by several state-controlled banks, which in total account for almost three quarters of sector assets. Their performance is generally modest, constrained by significant directed lending and investments in non-core assets under the government's financial recovery programme. Private banks benefit from higher margins, but have low financial flexibility due to lack of scale efficiencies.

Credit penetration (loans/GDP at 20% at end-2011) is one of the lowest among banking systems covered by Fitch globally, which mitigates the risks of the rapid growth in the sector. Published asset quality metrics remain adequate; however, there are notable risks of asset quality deterioration in case of a reversal in economic trends, as the banks' risk management systems have not been tested through a crisis.

The funding base is mainly short-term, largely sourced from corporate current accounts, while retail funds, despite their recent fast growth, still account for only a small 25% of total deposits. Longer-term funding is provided by the Ministry of Finance and other state agencies, which comprise a notable proportion of sector liabilities. Foreign funding is small, estimated at about 10% of the total liabilities, and plans for further borrowings are so far moderate. Liquidity management is constrained be the lack of deep capital markets, and banks generally tend to hold substantial cash reserves on their balance sheets.

The quality of capital is sometimes compromised by less conservative regulatory requirements for recognition of credit impairment and by investments in non-core assets. For a sample of banks (which account for about 40% of sector assets), Fitch calculated the maximum loan loss absorption capacity at about 10% of the total portfolio, which represents a resilience to only a relatively mild stress scenario for an emerging market. State-controlled banks have generally received regular equity injections, particularly post-2008. However, state support was slow and so far only partial in the case of state-owned Agrobank ('B-'/Rating Watch Negative), which received only delayed and so far insufficient equity following the discovery in 2011 of UZS250bn losses from fraud (exceeding the size of the bank's capital).

The foreign-currency Issuer Default Ratings (IDR) of Fitch-rated banks in Uzbekistan are currently constrained at the 'B-' level, and their upgrade would require liberalisation of foreign exchange regulations. State-owned banks' local currency Long-term IDRs are a notch higher, at 'B', reflecting the greater probability of state support in UZS, and could be upgraded or downgraded if there is improvements or deterioration in the sovereign credit profile. The potential for upgrades of banks' Viability Ratings (which are also mostly at 'b-') is currently limited, while downward pressure could arise from a deterioration in banks' asset quality, realisation of operational risks or continuing build-up of non-core assets on their balance sheets, if this was not offset by equity injections.