Tashkent, Uzbekistan (UzDaily.com) -- The Uzbek banking sector faces increasing asset-quality risks due to rapid lending growth, high balance-sheet dollarisation and an increased reliance on external funding, Fitch Ratings says. 

Uzbek banks have a significant proportion of unseasoned exposures as a result of lending growth as well as loan moratoriums granted in 2020 to alleviate pressure on borrowers caused by the pandemic. The sector’s longer-term performance will depend on asset-quality trends, operating environment stability and how successfully the state-owned banks targeted for privatisation can shift from directed lending to a more commercial focus.

The sector’s asset-quality risks mainly stem from rapid loan growth at most state-owned banks in recent years and a high share of foreign-currency loans, particularly at larger banks. In addition, material amounts of loans are still being issued under government development programmes that require banks to target issuance volumes, in some cases resulting in relaxation of underwriting standards.

Uzbek banks often provide long grace periods of up to three years on loans, especially in cases where financing was used to set up businesses or expand production. Asset-quality metrics weakened in 2020 and we expect further deterioration in 2021-2022 now that moratoria have expired and as more grace periods come to an end. The banks’ pre-impairment profit provides only a limited buffer against a potential increase in loan impairment charges, given thin net interest margins.

Impaired loans (Stage 3 loans under IFRS) increased at most banks in 2020, except for Asaka, which reclassified a large amount of Stage 3 loans. Although Fitch-rated banks’ impaired loans ratios were below 10% at end-2020, we do not believe this fully captures the asset-quality picture. The ratios are distorted by rapid loan growth and moratoriums and we expect Stage 3 loans to increase further as more Stage 2 and restructured loans become impaired. However, according to our discussions with rated banks, most of the exposures that underwent pandemic-related restructuring had returned to their payment schedules by end-1H21, which suggests that the pandemic has had a limited impact on asset-quality metrics.

Coverage of Stage 3 loans by total loan loss allowances was 0.5x-1.0x at large Uzbek banks at end-2020. We consider this to be adequate given the collateral and state guarantees available on some impaired exposures. However, we consider most banks’ capitalisation as only moderate in view of increasing asset-quality risks, limited pre-impairment profit and a high appetite for loan growth.

State-owned Uzbek banks have financed recent loan expansion mainly with state funding or external funding from international financial institutions and development banks. This reflects the moderate level of customer deposits in the local banking system. Refinancing needs are modest in the medium term as maturities of external facilities are mostly linked to funded loans, and most banks have sufficient liquidity to service external liabilities in 4Q21-2022. However, long-term repayments will depend on the performance of loan books and state-owned banks could face foreign-currency liquidity gaps if there is asset-quality deterioration.

Six state-owned banks have been targeted for privatisation by end-2025. International financial institutions may initially acquire minority stakes in the banks while they undergo business transformations, after which the government expects to sell controlling stakes to strategic investors. All banks targeted for privatisation are shifting business models from directed lending to becoming more commercially based, with a focus on improving margins and profitability metrics.