Mark Davis: 21 banks is too many for Armenia

03.03.2015 | 10:19 Home / News / Interviews / exclusive interview with the Head of EBRD Yerevan Resident Office Mark Davis.

-Mr. Davis, EBRD changed its September forecast (estimated at 3.5%) for Armenia’s 2015 economic growth and replaced it with a forecast of zero growth. What was it conditioned by and what new risks emerge for our economy?

-It is true that currently we are forecasting zero percent GDP growth in Armenia for 2015.  At first it appears that EBRD is less optimistic than other forecasters, but I suspect that may just be a reflection of the timing of our forecast release.  I would expect other agencies to also downgrade their forecasts over time, but let’s see.

Armenia, as a small open economy, is subject to the regional economic challenges which it may face in 2015.  But that said, its macro, monetary and fiscal framework is well-positioned to manage economic stress.

First, over the last few years we have seen healthy fiscal policy with relatively low deficits in Armenia. Also, reserves are adequate at about 3 months of imports, and the banking system is well-capitalized.  Armenia continues to make strides to strengthen its institutions and policy framework, and thus has access to continued international financial support from International Financial Institutions. Also, in November 2013, Armenia issued Euro bonds of USD700 mln, which received very positive feedback from the international markets. The investors who bought those bonds profited soon after due to the simultaneous price increase and decrease of yields on these bonds.  So those bond buyers must have felt quite good about their decision to invest in Armenia.  More recently, while the crisis has had a negative impact on the price of all sovereign bonds in the region, Armenia’s bonds have performed relatively well.  So now, should the Ministry of Finance wish to, there is a level of confidence that they could go out and tap international markets further. That is a nice tool and cushion to have at your disposal, as these capital inflows would provide both an extra source of budget financing while potentially contributing to the increase in the reserves of the Central Bank.

- Let’s talk about banks. In which Armenian banks EBRD is currently a shareholder? According to the information we have, EBRD is no longer a shareholder in Pro-Credit Bank.

-We are currently shareholders in 3 banks- Araratbank, Armeconombank and Byblos Bank Armenia.  First, I can say that the banking sector overall is relatively healthy and able to stand stresses. Banks in general were well capitalized to manage stresses that come from exchange rate pressures and credit risks.  With regard to Pro-Credit Bank, it is true that we are no longer a shareholder.  I want to be very clear on this however, that that decision was between the global holding company and EBRD and is not related to current exchange rate pressures and should not be interpreted as a sign of some kind of deterioration of the quality of ProCredit Bank in Armenia. It was a strategic decision of the global holding company in cooperation with EBRD Headquarters. The Armenia shareholding of EBRD was just a part of that global decision.

-How would you comment on CBA’s recent decision by which the Armenian banks should have six-fold increase in their total capital within two years?

-Let me try to first demystify this decision, because there are two concerns I have heard that just don’t make sense to me. This first concern is that this will create reduced competition because there will be fewer banks. It should be the opposite in fact.  Bank consolidation will lead to fewer, stronger, more efficient and more sophisticated banks. Because they are stronger and more efficient, they will be able to attract cheaper funds, will have less administrative costs as compared to their capital, and they will thus be able to offer lower interest rate loans with longer maturity to their clients.  Second, sophistication will lead to a better quality loan book, better monitoring of their positions, and new lending products that should broaden the client base overall and reduce risks. And these banks will certainly compete. You don’t need 21 banks to create competition, and certainly not for a country the size of Armenia. Bigger, better banks will compete with each other and drive down borrowing costs.  

The second concern I have heard is that somehow the CBA’s decision is an admission that Armenia’s banks are “under-capitalized”. That concern is an unfortunate misunderstanding. The CBA is saying that banks will have to have a minimum amount of capital to continue to operate. That means they need to get bigger. So bank owners with less than the minimum will either have to invest more equity to grow organically, buy other banks, merge with another bank, sell to another bank, or leave the market. This is about minimum overall size of capital, but in all of the cases above, except of course the decision to close down, the liability side of the balance sheet will also increase! The “minimum capital reserve requirement as compared to risk weighted assets” is a whole different concept, and banks in Armenia are already compliant, and will of course be required by the CBA to continue to be compliant in any case.

In short, consolidation of the banking system is long overdue.  21 banks is too many for Armenia: it creates less efficiency, and doesn’t encourage sophistication, it means high administrative costs relative to the loan portfolio, and tends to keep interest rates higher than they could be with a smaller number of bigger, better banks, who will be able to raise cheaper funding (domestically and internationally) and compete to grow higher quality loan books. You would also naturally expect them to be better credit risks for depositors.   

-Do you think our economy can absorb the resources that might enter Armenia as a result of replenishing bank capital? In particular, there is a misgiving that those resources might be either frozen or might lead to higher bank product prices.

Increased capital inflow into the banking sector should create more resources for the banks to lend at lower overall costs, so actually you would expect bank product prices to decline.   In general, capital inflow into the banking sector of Armenia is almost certainly a good thing. It reflects the fact that Armenia is attractive for the international capital. Capital inflow should be welcomed because it offsets some of the stresses the country may be facing.  Importantly, foreign bank capital is by its nature a long-term type of investment. We all can be concerned about “hot” money into short term fixed income instruments which can quickly be quickly pulled out in the face of financial stress. Armenia so far has not seen inflow of hot money which is another factor that contributes to stability in the face of financial stress.

The 2013 Euro bond is a good example of what I would call the “information transmission mechanism”.  Armenia is now on the “radar screen” of a large number of international investors, and each of them needs an analyst covering Armenia.  If an investor, whether a bank or a hedge fund, understands the macro-fiscal picture and becomes comfortable, they will be more likely to make other types of inward investments as well, and they will tend to talk about Armenia to other investors that then may take a look.

- In this context, to what extent is the cooperation between the financial and real sectors sufficient?

-One of the pressures faced by the regional crisis is that borrowers and lenders are more uncertain about the future and therefore we should expect to see a reduced amount of crediting taking place in the economy. That will clearly have a negative impact on GDP.

The positive aspect is that once the situation becomes clearer for both lenders and borrowers there should be an increase of demand of loan products so we can see a quick natural increase in lending to make up the slowdown that I think we will be experiencing in the 1st quarter of 2015. Let’s see what happens to oil prices, Russia and the region, but as the situation stabilizes we will see rapid pick up in the investments. And as I have noted, Armenia is in a good position to manage through the stresses in the meantime.

-How do you assess EBRD’s current involvement in the real sector of economy and are there any ideas to this end?

-2014 was a very good year for us. We have made EUR114 mln worth of lending which includes 18 deals.  That’s a record for EBRD in Armenia bringing our total commitments today over EUR 872 mln and about EUR320 mln outstanding portfolio.

We have dramatic increase in trade finance, having done lots of training and work with partner banks and also look for domestic trade finance to grow.

We continue to work on municipal and environmental infrastructure investments which typically are supported by sovereign guarantees and include significant grant resources from EU and other international donors. At the end of 2014, we signed the first solid waste management loan for Kotayk region.

With respect to the private sector investments, we have made progress in our co-finance arrangements with partner banks to provide parallel loans to clients. We also continue to make direct loans to the companies in manufacturing sector and have some deals in agricultural and food processing.  

We are a bank, we do make profit and will continue that process, but we do look at every deal as both an opportunity and requirement to bring innovation and generate development impact.  Our doors are open for new clients and we look forward to look at any deal and help particularly the private sector to grow and become more diversified.

By design, we are complementary to the private sector and bring technical assistance and support to our clients. I think companies like Liqvor are perfect example of that. We started a relationship with them 10 years ago. It’s a vibrant small pharmaceutical manufacturer which is the first recipient of Armenian Good Manufacturing Practices (GMP) certification. This means they are close to receiving GMP of other countries, and particularly from Europe. This is a big deal, because it will allow them to produce and export pharmaceutical products to Europe and beyond, and frankly with a nice cost advantage and good margins.  This is a perfect example of what do we want to achieve in Armenia.

-And finally, could you disclose details concerning the statement made back in 2014 which had it that “the EBRD will soon confirm new strategy for cooperation with Armenia?”

-We look forward to starting our new strategy for 2015-2019 which as we expect will be approved by Board of EBRD in July 2015. We have benefited from a healthy dialogue with government of Armenia, Central Bank, clients, other donors as well as civil society organizations to help us define our strategy for this period. The strategy itself is still in discussion but we expect focus in 3 main areas:   The first priority area is to deepen Armenia’s financial and private sector while continuing to improve the business climate.  

A second important area of our focus is to continue supporting the development of the local capital markets. This is unique, as for EBRD it is only for second time that “local capital market development” is to be a stand-alone theme in the country strategy, and it’s the first time that it is to be a special focus in a small country like Armenia.

The third main area of focus is to be on improved public service provision through socially sustainable infrastructure investment with increased private sector participation.  We have a good pipeline of high quality projects in coordination with multiple government agencies and municipalities targeted at areas such as energy efficiency and improved service delivery in water, solid waste, transport and energy.

Narine Daneghyan talked to Mark Davis.

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