The key driver of the outlook -- which has remained stable since August 2010 -- is the country’s robust economic growth, which provides favourable operating conditions for the country’s banks.

Other key drivers include healthy profits and a slight improvement in asset quality, as well as stable liquidity that benefits from growing customer deposits, continued channelling of government financing through the largest banking institutions, and limited reliance on wholesale funding.

The credit positive elements are partly offset by some fundamental weaknesses in Uzbekistan’s banking system such as weak corporate governance, lax credit underwriting standards, the banks’ high exposures to single borrowers and single industries, as well as their significant reliance on large corporate depositors. Other weaknesses include a somewhat high level of problem loans and banks’ rapid lending growth, which necessitates regular capital increases.

Overall, Moody’s says that Uzbekistan’s robust economic growth will provide favourable operating conditions for banks over the 12-18 month outlook period, as the country’s gross domestic product (GDP) will increase by 7.0% in 2013 (in real terms), according to the International Monetary Fund (IMF). However, downside risks to strong GDP growth stem from a potential fall in demand for Uzbekistan’s key export commodities (cotton, natural gas and wheat) because of the sluggish growth of the global economy.

"Asset quality has improved slightly in the Uzbek banking system over the past 12 months, and we expect the average level of problem loans in the sector to remain stable over the outlook period, hovering below 10% of total gross loans, testament to the growing economy," explains Olga Ulyanova, a Moody’s Vice President Senior Analyst, and author of the report. "However, our scenario analysis reveals low coverage of the reported problem loans by loan-loss reserves and we estimate that Uzbek banks will need to increase these reserves to around 7.8% of gross loans (from 4.4% at year-end 2012) in order to fully cover expected losses," adds Ms. Ulyanova.

Moody’s also forecasts 20% annual lending growth which -- together with more prudent provisioning policies -- will push the Uzbek system’s total capital adequacy ratio (CAR) down to a still acceptable 12.3% over the next 12-18 months, from the 16.7% average reported by rated Uzbek banks at year-end 2012. However, the rating agency estimates that in order to preserve the current total CAR in line with loan growth, the Uzbek banking sector will need to raise an additional $650 million of fresh capital in 2013-14. In particular, as regards the recapitalisation of systemically important (predominantly state-controlled) banks, Moody’s notes that the government has favoured regulatory forbearance rather than providing capital injections.

In Moody’s view, a key downside risk for profitability is the need for Uzbek banks to make additional loan loss provisions. Nonetheless, the rating agency generally expects banks to maintain profitability indicators -- such as return on assets and return on equity -- at current levels, supported by robust fees and commissions and stable, albeit narrow, net interest margins of just over 3%.