Tigran Jrbashyan: We will have a fundamentally different banking system by 2017

As the Central Bank of Armenia increases the minimum capital requirement for banks to 30 billion drams for late 2017, the opinion of economic experts on this matter appears divided. Part of analysts welcome the decision, while others say it will suffocate perhaps the only competitive sector in the country experiencing economic crisis.  Such a measure of the regulator will leave only big actors in the market, making the sector less competitive and less accessible to the economic entities and the population, at large. ArmInfo Director-Columnist Emmanuil Mkrtchyan had a talk with Tigran Jrbashyan, Development Director at Ameria Group, head of Ameria Management Advisory Services, over the situation in the banking system, its prospects and the country’s economic problems.

I can’t help but notice that my worst forecasts for the banking system of Armenia have, unfortunately, come true. The system experienced serious difficulties over the last two-three years due to the falling lending rates, growing number of NPLs, and lack of financing. Once running ahead of economy, the banking system has now fallen victim to that economy – something I have repeatedly written about. The mediation mission of the banks has fallen dramatically and for the first time since its establishment and development, the banking system completed the year with losses. What was the main reason for that?

I strongly disagree with the views suggesting that the banking system has decreased its mediation mission in the economy over the last year. Quite the contrary, the banking system’s role in financing of economy sectors has significantly grown. Actually, it was one of the reasons why the aggregate loss of the system has grown that dramatically. In 2012 the ratio of the bank loans to GDP was around 40%, while in 2014, this indicator increased to 47.7%. The aggregate assets to GDP ratio also grew from 62% in 2012 to 75.8% in 2014. Comparing to the similar indicators of our closest neighbor Georgia – the country has similar economic indicators – the growth for 2012-2014 was 55%-70%. These indicators show that the banking system of Armenia has a greater role in financing economy than that of Georgia. Our assets-to-GDP ratio has reached the average level in the CIS. 

That is, the real growth of economy for the last three years was a result of the increased bank lending. Another matter that all this was happening amid stiff competition in the market of banking services, a competition based on extensive development. The last circumstance requires special attention. Using their equity reserves that accumulated after the crisis, banks began to use it trying to ‘act on’ leverage. Actually, the banking system largely took the path on extensive not intensive development, using just what they had at hand, and making no investment in new technologies or products.  Many banks had worked in that way for the past three years. Many, but not all. Unlike Georgia, the efficiency of our banking system was low, as the margin fell amid stiff price competition.  

Specialists in the sector are well aware that there are three basic indicators of efficiency of banks:  ROA (return on assets), CIR (Cost/Income Ratio), and ROE (return on equity). ROA of the banking system of Armenia is 2-3fold lower than in the CIS countries. Cost/Income Ratio in the banking system of Armenia is 54.4%, while in CIS it is around 45%-47% and at best global banks – 35%-37%. As for ROE - a very important indicator – everything is clear here. Our ROE has been falling since 2012 – from 14% to 7%. Although ROE of some big banks in the country is higher (for instance, 17.8% at Ameriabank), this indicator of the banking system is generally low.  All this means that extensive growth at the expense of capital is not possible any longer.

Let me protect our banks. Competition in the banking system of Armenia is stiff, of course. They count on every solvent customer. But I think the reason of such a situation is that there is no enough solvent, healthy demand for credit resources and for banking services in general. Therefore, most banks are unable to generate profit today. 

We will touch on it, but now I would like to draw your attention to this. InGeorgiaabout82% ofassetsfallontwomajorbanks, whileinArmeniathetopfiveleadersownnearly46% ofassets. For instance, Ameriabank, which took the lead in the key indices in 2014 – assets, liabilities, lending – has only a 14-15% share in the market, while the Georgian market leader’s share is thrice as big as ours. There is less competition there and more opportunities to invest in new technologies and new infrastructures. The margin is also bigger there. Now we face a stalemate – on the one hand, the banking system has grown and become a serious GDP driver, on the other hand this has been done at the expense of efficiency reduction and mostly losses. So, the new 2015 year started with a big question – what to do next? We face a serious Capital Adequacy Requirement (CAR) problem. In quite many banks the CAR has dropped to the lowest level due to the low efficiency and additional capital can be raised from nowhere, certainly given our serious current economic risks. 2 groups of banks have unambiguously emerged in the market with relevant efficiency indices.

You are strict. Our agency, for instance, has singled out 4 groups.

But you have singled out these groups with due regard for the opportunities to raise capital, not by the efficiency indices. The thing is that a bank can raise capital only when it secures relevant financial return. If we analyze all the efficiency ratios, including such indices as the amount of loans per employee, amount of deposits per employee, amount of investments per fixed capital and when we group all this, it becomes clear that it is the amount that matters. In fact, the small banks are currently trying to compete with the large banks in the universal market. Most of them have much lower efficiency indices and the key losses are fixed in those very banks. Some of the small banks ensure good efficiency indices but those are specialized banks. In general, the small banks are trying to compete with large ones in a wider field, however, due to their small size, even if they invest in the new technologies and operating systems (as a rule, investments here are almost similar for all banks), the efficiency of operations leaves much to be desired. Thescaleeffectdoesnotwork. Thereissimplynoscaleeffect. So, the current situation is that due to their low efficiency the small banks have started “eating away” the capital on the one hand and suffering a bad shortage of funding on the other hand.

The CB mentioned that circumstance when substantiating the increase of the minimum capital requirement for the banks to 30 billion drams for late 2017.  

Naturally, the CB perfectly realizes that the situation is not easy and it encourages the banks to undergo synergy, merger, and enlargement to make the use of their own funds more effective. Let’s look at the current situation in such a technologically important banking segment as payment cards. By the number of ATMs per 100,000 people, Armenia is actually at the same level as Slovakia, Belarus, Georgia and Macedonia. The indicator seems to be good. But when you see the number of the cards per ATM, you understand that Armenia is at the lowest level. We have an infrastructure but we cannot effectively use it. By the number of cards per capita we only leave Moldova behind, which is the last one. Or let’s have a look at the share of noncash transactions in the total amount of card transactions. The amount is not small, but Armenia is the last among the CIS countries in terms of the amount per capita. This demonstrates how ineffectively our banking system’s investments in technologies are being used. NoonethoughtofefficiencywhentheCARwasataquitehighlevel. As long as a company generates profit at the expense of its CAR, i.e. by increasing its loan books, few people think of efficiency and non-interest expenses.

Yes, but lending in the country is at the worldwide average level now. Armenia is neither lower nor higher than the other CIS countries.

I would reiterate that when you analyze the interest income and interest expenses, everything related to the CAR is good. But when you analyze the non-interest expenses and non-interest income, the problems become obvious because we have very few non-interest incomes. 

Just the opposite. Over the past 2-3 years they have been intensively growing and the growth rates of non-interest incomes outstrip those of interest incomes due to the stagnation in the credit market. 

I would disagree with that general assessment. To speak of a pure non-interest income, one should group the banks. In fact, as I have already said, the banking system was growing but the growth was focused on the group of large banks. The small banks saw no such growth and this demonstrates that the banking system is experiencing the following situation: there is a group of banks which have gained the lead in terms of capital, efficiency ratios and non-interest income. Unfortunately, the small banks have chosen a wrong strategy – they had a small capital but tried to compete with the larger banks. In addition, the banks resort to tangible non-interest expenses, even for promotion of services, and these expenses are not grounded and do not boost development. The non-interest expenses were too many.

What mistake have they made when investing in the infrastructure, promotion, development of branches, and human resources?

They have failed to realize that the Armenian banking system is too competitive. Hence the problem of inefficient activities of the small banks, which cannot compete with the large ones. The inefficient small banks do not know what to do. To keep working in that way is to operate at a loss. So, they should either merge with others or be sold to others. Ameriabank thought such deals would start much earlier and the Bank is ready to take part in them. We believe that the banking system should find ways for consolidation. Now that the situation in economy is rather complicated, one has to wait for considerable growth in NPLs. 

Over the past 2-3 years, loans have experienced large-scale refinancing. But this cannot last forever, and at the yearend of 2014 the banks launched the writing-off process and many of them suffered losses, as a result.

Yes, this process is underway. The owners of the banks start seriously thinking what is better – to merge, to sell the bank or to keep operating at a loss and lose everything. I think this was a long-simmering process regardless of the CB’s decision.    

I think the CB has taken that decision because there was no progress in the process, the shareholders of the weak banks did not want to merge and the risks were growing. So, the regulator had to promote that process with its own decision.

Certainly, we realize that this cannot last any longer. Amid the crisis phenomena and growing NPLs, the capitals start suffering negative indices. Therefore, the CB’s decision is quite justified, even if such decisions seem to break the liberal structure of the market. On the other hand, we will have a different banking system by late 2017 and a different structure of the banking market. I think some 10-12 banks will remain in the market and the market will experience segmentization. There will be at least four large, universal banks and the rest will have to look for their niches. Maybe, my words sound somewhat cynical, because I am a representative of the largest bank today and I expect Ameriabank to be in that group of large universal banks. This stand is somewhat insolent, but on the other hand it is based on the analysis of the real indices. We thoroughly analyze the condition of the system and the condition of each of its participants, as well as the dynamics of changes, and we also predict the behavior of each bank and the possible developments.

I think much depends on the shareholders themselves, on their strategic vision of development of our market.  

Yes, but if there is no enough attractive ROE, there will be no investment in the capital. There are some examples of serious investments in technologies, but the return on investment was low due to the lack of the scale effect. Investment in technologies is justified only when the bank size is quite big. Therefore, we will experience a consolidation process, which will be followed by technological development. We are rising to a qualitatively new level – we should address problems of branchless banking, problems of operating systems, processing, relations with the international card systems, etc. Even our large bank cannot always afford big investments in technological projects.        

Let’s get back to the niches. I see no niches yet. To be more precise, there are niches here, but they are too risky and narrow.

There are niches in any economy. These are certain segments to be focused on, e.g. the market of micro-lending lies between the functions of credit companies and universal banks.

In this segment, amid the lack of healthy demand, scale effect is needed. The losses, NPLs are very big here, especially given the economic stagnation. The predicted zero economic growth is not even stagnation; it is a real recession for small Armenia, I would say.  

Yes, a scale effect is needed, because it is due to that effect that the micro-finance banks are able to cover their losses. This segment may also include credit organizations, which will be enlarged. I would not be surprised to see some of them merging with the banks and creating new specialized niches. The second segment is consumer lending. It is a segment with its own risks and its own technologies and it also needs a scale effect. But it is a niche segment. There will be companies engaged in investment – investment banks. Our market already knows such a positive example. It is unambiguous that our banking system will be much more complicated by its structure. There will be fewer banks but the system will be more complicated. Except 3-4 “omnivorous” banks to be engaged in all segments, the rest will compete with them in specific segments. Emergence of regional specialized banks is not ruled out either. As a result, by late 2016 we will have different indices by efficiency. The banks will launch active capitalization in 2016. By 2018 I expect the interest in investing in the Armenian banking system to tangibly increase due to the efficiency growth, which will mark the start of a new cycle of economy financing.

There is already a small group of small banks that have lost their competitiveness in all banking segments. Can you forecast a process of resolution for such banks?

I do not think it will come to resolution. No assets are unattractive for purchase. The problem is the price. The CB's decision will encourage the shareholders to consider the expediency of selling their bank assets at normal prices today.   

Though our banking supervision is at a high level, nevertheless, the quality of many banks’ assets leaves much to be desired. Therefore, some large banks are afraid to acquire assets that are worthless, as a matter of fact.

Today’s market is a market of buyers. It is the buyers, not the sellers that dictate the terms. Moreover, those of the shareholders trying to put off the decision to sell their assets today may have to sell them at a lower price tomorrow than those doing it now. It is natural that the prices, which were reasonable for us, buyers, 3 years ago no longer exist today. The buyers will have even more advantages due to the deterioration of portfolios and the general situation. So, it is not ruled out that today the shareholders will receive less than they wanted to. They will have to agree to the current terms, but no one will leave the market with losses anyway. If the macroeconomic environment complicates and the uncertainty grows, this is reflected in the price of bank assets.

 (To be continued)