The credit outlook for rated Armenian banks is stable, reflecting an evolving regulatory framework, buoyant credit growth, low banking penetration, robust aggregate capitalisation and good asset quality, Moody’s Investors Service said in its new Banking System Outlook for Armenia.
These strengths are offset, however, by the challenging operating environment, potential for accelerated asset quality deterioration due to the unseasoned nature of loan portfolios, as well as real concerns regarding operating risk due to under-developed infrastructure.
The Armenian banking sector has undergone considerable consolidation in the past decade following the banking sector turmoil of the mid-1990s and subsequent tightening of prudential regulations.
Moody’s noted that the system, comprising twenty-one banks, remains highly fragmented, however, the four largest banks control 45.54% of total banking system assets and the ten largest banks 79.61%. In its current structure, the Armenian banking sector lacks economies of scale, resulting in low productivity and thereby raising the potential for further market consolidation.
To better perform its new duties, CBA has been reorganised along both operational and functional lines. CBA enforces stringent liquidity requirements, and will introduce Pillar I requirements for Basel II from 2008. Moody’s notes that regulation is improving from a historically low base, however, and could benefit from further refinement and better infrastructure and risk controls.
Favourable conditions have driven buoyant credit growth over the past year. In particular, according to CBA data, consumer credit grew by 35% while mortgage lending registered a growth of 114%.
Moody’s maintains a generally positive view regarding banks’ efforts to expand their retail and mortgage lending operations, although the rating agency emphasises that fast credit expansion could result in elevated non-performing loans (NPLs) for the system in an economic downturn, particularly as loan portfolios are not seasoned. As the country’s nascent banking sector evolves and the sector’s loan book term structure lengthens, Moody’s expect NPLs to grow to levels observed in other countries at similar stages of development.
Banking penetration in the country remains low, however, despite the good credit growth of recent years.
“As a transitional economy, the country continues to grapple with a historical lack of public confidence in banks and a largely cash-based system,” said Stathis Kyriakides, a Moody’s analyst and author of the report. Nevertheless, this offers great potential for further growth, particularly in the SME and retail sectors.
To date, HSBC-Armenia is the only domestic bank majority-owned by a large, highly rated international banking group, but recent years’ relative geopolitical stability, economic growth, low banking sector competition and high spreads are starting to attract other international banks. In such circumstances, locally owned, smaller banks may find it increasingly difficult to compete, leading to sector consolidation. “To the extent that consolidation leads to stronger franchises for rated Armenian banks, this is likely to have positive rating implications in the medium term,” said Kyriakides.
Meanwhile, extensive borrowing in foreign currency, mainly US dollars, has exposed customers to foreign-exchange (forex) risk. Although this has been mainly driven by the population’s historical mistrust of the local currency, as well as lower US dollar interest rates and the dollar’s weakness in recent years, foreign currency lending has been facilitated by Armenian banks ostensibly hedging their own forex open positions arising from foreign-currency credit lines from international institutions.
Moody’s cautions that a potential depreciation of the Armenian dram could result in customers facing difficulties in servicing their obligations, leading to currency-induced credit risk for banks.
Nevertheless, the weight of foreign-currency loans as a proportion of total loans has decreased significantly in recent years, from a high of 78% of total loans in 2002 to around 42% towards the end of 2007. “If the weight of foreign currency-denominated loans continues to contract at current rates, our concerns are likely to be alleviated,” said Fimi Gostanian, a Moody’s Senior Associate and co-author of the report.
