Uzbekistan's most profitable bank, UzPromStroyBank (known locally by the Uzbek language abbreviation SQB), is going to be the first big bank to be sold off as the country’s banking sector privatisation gets under way. Two smaller banks have already been sold this autumn, but the sale of the big banks is just starting and SQB will probably have new shareholders sometime next year.

The Uzbekistan state is committed to getting out of the economy. The cotton sector has already been sold and a raft of hotels and real estate assets as well. Most of the largest industrial family jewels will be sold in the coming years, but banks have been the focus of an intense restructuring programme and most are now ready to go.

As bne IntelliNews reported, the effort moved to a practical level in March this year as the State Assets Management Agency (SAMA) began to implement a presidential decree that mandates the privatisation of banks with a new zeal.

The decree included lists of banks to be sold but work on getting the banks ready started earlier with the acceptance of a roadmap for reform prepared by the IFC and EBRD.

In all, six banks are being prepared for privatisation and SQB is the biggest and most profitable. The banks that have been prepared for privatisation are: SQB, Asakabank, Aloqa Bank, QQB, Ipoteka Bank and Turonbank.

The international financial institutions (IFIs) have been actively involved in the process and as part of the changes all Uzbek banks must have switched to IFRS reporting by the end of 2022 and the government hopes to have the whole programme completed by 2025.

Uzbek media outlet Spot compiled a list of Uzbekistan's domestic banks in terms of their profitability following the release of 3Q results, and SQB tops the list. Its analysis showed that almost all of the financial institutions ended the reporting period in profit. The profit posted by the top ten banks is fivefold that of the other 17 banks in the sector, according to Spot.

Profits of the top ten most profitable banks in Uzbekistan in 3Q21
Uzpromstroybank	UZS 787.3bn	$73.3mn
NBU	UZS 676.8bn	$63mn
Ipoteka-bank	UZS 587.7bn	$54.7mn
Trastbank	UZS 323.9bn	$30.7mn
Hamkorbank	UZS 303.6bn	$28.3mn
Ipak Yo'li	UZS 299.9bn	$28mn
Qishloq qurilish bank	UZS 272bn	$25.3mn
Kapitalbank	UZS 267.8bn	$24.9mn
Asakabank	UZS 258bn	$24mn
Orient Finance Bank	UZS 213.7bn	$19.9mn
source: Spot

The banking business

As part of the preparations the bank has been refocusing its business. Under the previous Karimov administration the country’s banks were split up by activity and used to provide directed credits to finance the various aspects of the economy. SQB was primarily focused on industry and infrastructure, a focus it retains, but now all its business decisions are made on a commercial basis, not state orders from on high.

“Our funding is from the local market deposits and the Ministry of Finance funds. The bank’s focus is investment and development of Uzbekistan infrastructure and industrial development. We can fund these projects on a commercial basis, drawing on our deposits as well as synthetic loans from international financial institutions,” Ilkhom Khudayberganov, SQB chief funding officer, told bne IntelliNews in an exclusive interview.

SQB’s loan portfolio is largely made up by corporate clients (60%), with SMEs comprising another third (30%), and the rest is retail customers (10%), according to Khudayberganov. The bulk of the corporate clients remain state-owned enterprises (SOEs), but that share should fall as the privatisation in the rest of the economy gets under way.

“We are aiming to reduce the number of SOEs in our mix and increase the number of private sector customers,” says Khudayberganov. “But the pandemic has not helped, as the private sector clients have fallen in the last year after the borders closed and raw materials trade fell. In the meantime, we have been concentrating on improving the quality of our service.”

The bank has abandoned the directed credits and now makes loan decisions on the basis of market conditions and how they will affect the bank’s risk profile and return on assets, says Khudayberganov.

Two step privatisation

SQB’s privatisation will be conducted in two steps. In the first it will take a convertible loan from the IFC and EBRD to fund its work, but that loan will be eventually converted into an equity stake as the two development banks join the bank’s board of directors. With this help the bank will continue its transformation but then either a strategic investor can be found or the bank can be listed on an exchange. The presence of the development banks in the bank’s shareholder structure will give investors extra confidence in the bank’s reliability and should make it easier to sell. The same model has been used by the IFIs to help in the privatisations of many banks in other countries such as Russia, Georgia and Moldova. It is a path worn smooth by use.

SQB’s co-operation with the IFC began in 2018 when the development bank conducted its first due diligence on the bank, after which it gave the management a “to do” list that was implemented over the next two years, says Khudayberganov.

Now the co-operation is coming to a cusp where the IFC is preparing to take a stake in SQB. The bank is in the middle of organising the convertible loan worth $75mn that will be invested into giving credits to small and medium-sized enterprises (SMEs) to help grow that sector, of which half are also green projects such as improving energy efficiency in small firms.

The EBRD is also involved in this project and will also offer another credit worth $50mn in local currency which is almost all dedicated to funding energy efficiency investments. And the Asian Development Bank (ADB) is also participating in a convertible loan to the tune of $50mn too.

Khudayberganov says that the current IFI lending has a strong green focus and SQB has set up Uzbekistan’s first green loan department specifically to promote this type of lending.

“We have the first green headquarters in the country and the building is built with energy-efficient materials, which we are about to move into,” says Khudayberganov.

The IFC loan is denominated in dollars, but paid out in Uzbek soum. The loan has to be repaid in foreign exchange at the market rate of the time of repayment, which means that the FX risk from a devaluation all falls on the IFC, not SQB. “If there is a devaluation then the IFC will simply get [fewer] dollars back,” says Khudayberganov. “But we are hedging the risk too.”

The IFIs have been very active in offering credit lines to Uzbek banks and have become a major source of funding for the banks, with the EBRD having granted over $200mn of credits alone.

The current convertible loan deal is subject to the IFIs' due diligence process at the moment but it is expected to get the all clear in the first half of next year.

“Once the deal is closed then we will issue new shares and the loan will be converted to equity. The IFC will get up to 20% in the bank depending on the exchange rate then, but it could be a bigger stake,” says Khudayberganov.

In the next stage the IFIs and the Ministry of Finance will start the hunt for a strategic investor and intend to sell at least 51% of the bank, says Khudayberganov. Then the IFIs can exit the bank’s shareholding at any time.

Bank deals

Two banking deals have already been done, but both were smaller and had more specialist goals.

In October the IFC and the EBRD announced their intention to buy equity stakes of up to 20% in TBC Bank Uzbekistan, a subsidiary of Georgia’s TBC Bank, also using a convertible loan. The two banks will pay $9.4bn each this year and may increase their share in the coming three years. As bne IntelliNews reported, TBC was the first foreign bank to enter the Uzbek market in April 2019 that offered digital banking and fintech services. Since then it has already built up a 630,000-strong customer base.

"This is the first equity investment in the banking sector of Uzbekistan since the resumption of EBRD co-operation with the country in 2017. We welcome competition and expect that it will benefit everyone," Alkis Drakinos, head of the EBRD representative office in Uzbekistan, told bne IntelliNews.

TBC is now the biggest bank in Georgia and knows the EBRD well, as it went through similar reforms when the EBRD bought a stake in it several years ago and helped it with its reforms before it was eventually listed on the London Stock Exchange (LSE). Since then, EBRD has exited the bank’s shareholder structure, but now is proposing to get involved again, this time with TBC’s Uzbek daughter bank.

“We are going to offer our digital offering. We are the largest financial institution in the Caucasus and differentiate ourselves through our digital offering,” Giorgi Shagidze, TBC Bank’s CFO and deputy CEO, told bne IntelliNews in an exclusive interview at the time.

The Uzbek government has also sold off the mortgage specialist Ipoteka Bank in September to  Hungarian banking powerhouse OTP. The deal was announced in September at an economic forum organised by the Ministry of Finance to showcase the progress the privatisation drive was making. The sale of Ipoteka was significant, as it is the third most profitable bank in the country, according to Spot. The acquisition marks the first foreign takeover by Hungarian banking powerhouse OTP outside Europe.

Like the other deals, the IFC played an important role brokering the deal. Ipoteka Bank is the fifth-largest bank in Uzbekistan, with a market share of 8.5% based on total assets at the end of July 2021, with more than 1.2mn retail customers and a large corporate clientele. The bank had a balance sheet total of UZS32.6 trillion (€2.64bn) and equity of UZS4 trillion last year.

"The underdeveloped banking market in the highly populated Uzbekistan may provide an excellent growth opportunity for OTP Group, where economic reforms have already begun and the banking sector is before privatisation," OTP said in a statement at the time the deal was announced.

Reforms still not over

But the Uzbek banking sector is not without its problems. The coronacrisis hurt the banking sector and slowed its growth. Bank services were the only part of the Uzbek economy to see a contraction in 2020, although economic growth slowed dramatically that year.

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 warned in a report released on October 8.

One of the problems is the large spread in interest rates for dollar vs local currency loans. As foreign exchange loans are so much cheaper, lending is heavily skewed towards borrowing in dollars, which exposes industry to the risk of a devaluation. This is partly because inflation expectations in Uzbekistan have never been anchored by the regulator, but as the Central Bank of Uzbekistan (CBU) told bne IntelliNews in an interview, it has now introduced a policy of inflation targeting and hopes to close the gap in the coming years.

Last year the non-performing loan (NLPs) ratio tripled to 6.2%, which is uncomfortable but not dangerously high, after which the ratio began to fall again as the economic growth gathered some momentum in the third quarter of this year. The NPL ratio was down to 5.8% as of October and is expected to continue to shrink up until the end of the year as the banking sector clean-up and privatisation continues.

“The decline in problem loans is primarily driven by state-owned banks,” Bluestone investment bank said in a note, whose NPL ratio fell from 6.4% in August to 5.9% in October. Major state-owned banks such as National Bank of Uzbekistan, [saving bank] Xalq Bank and Qishloq Quriish Bank improved their asset qualities. Privately owned banks saw their NPL ratios rise slightly in October, with Turkiston Bank (69.2%) and Ravnak Bank (31.9%) registering the highest levels amongst the large private banks.”

Nevertheless, the sharp rise in NPLs this year has focused attention on the banking sector’s health. The liquidity coverage ratio of banks also declined in the three quarters of this year, falling from 224.5% in January to 152.4% in September, with the highly liquid assets shrinking 10% in the same period.

Pressure on the balance sheets will ease as profits grow. The banking business was picking up in October when the volumes of loans extended were up by 33% over the first nine months of 2021 and microloans in particular increased 2.3-fold. Auto-loans is another category that is growing, up 1.3-times as consumption takes off on the back of rising incomes.

Funding remains an issue, as banks had to dig into their capital to fund these loans. Banks’ tier one capital adequacy fell slightly from 15.2% in January to a still comfortable 14.8% in October and well above the 10% considered to be a safe minimum.

It's still early days in reforming Uzbekistan’s banks, but several years of work that has already been put in are starting to bear fruit. As more banks go under the gavel in the next two years these will play an increasingly important role in driving economic growth and should flourish in the process.