Banks’ Non-Financial Appetite Should Be Curbed
15 November, 2012
Banks’ Non-Financial Appetite Should Be Curbed

The ravenous appetite and excessive aspiration of Georgian banking sector toward non-banking businesses must be curbed.  

The loose cap limit fixed for Georgian banking sector in non-financial activity laid ground to unfair market competition, monopolization and expensive credits. To keep the market off malfunctions, stronger regulation is prescribed.

Too excessive inclination of Georgian banking sector for acquiring non-financial assets is one of the key reasons responsible for expensive credits and the spoilt market competition in Georgia. Apart of banking activity by

today Georgian banks run a large scale of businesses of both financial and non-financial profile ranging from leasing, brokerage, investment, real estate management, and construction  to medical sector, sport, entertainment and trade.

Eight top ten Georgian banks out of 19 operating at the market have controlling packages at non-profile companies. But the most impressive list belongs to Bank of Georgia, the single Georgian bank enlisted at London Stock Exchange. It leads the sector by owning around 50 sundry businesses including three hospitals   and a surgery center in regions, a winery, a brandy company, two travel agencies, fitness center, newspaper distribution company, real estate company, a brokerage, a construction company and so forth. TBC Bank, another leading Georgian bank, is a runner up by managing just 10 non-profile businesses mainly in financial and real estate sectors. Basis Bank, VTB, Cartu, PrivateBank, Bank Republic, and Basis Bank have comparatively moderate appetite: they have around-2-3 non-banking businesses. However the list of non-profile businesses of banks is quite difficult to define as their affiliated companies have also got daughter companies and so forth.

What makes financial market connoisseurs worry is not holding non-financial assets by banks but unreasonably high shares of the said [non-banking] shares in the banking portfolios.

According to the Georgian law on commercial bank, share of non-financial assets should not exceed 50% of the total equity capital of the bank and shares acquired in any other company should be under 20% [although banks contrive to have controlling packages at other companies through setting up daughter companies and affiliations as the legislative loopholes leave room for this].

Almost all experts find the limits too loose. Actually until liberal financial reforms launched in 2005 by ex-ruling rose-government, limits were lower and stricter: the cap for the share of non-financial assets in the total equity capital of the bank was fixed at 20% and the limit for admitted shares at legal company stood at 10%.

Dietrich Muller, an economic and legal expert with Georgian Investment Group, believes the liberalized limits encouraged Georgian banks to chase after non-financial assets that led to unfair market competition and monopolization of certain sectors that ultimately make credits expensive – the reality that Georgia tries to discharge now.

“There is a clash of interests. Banks that hold controlling shares at non-profile business lend credits to their own businesses thus controlling price through their credit lines. And since money is cheaper to bank-owned businesses they [along with banks] enjoy super-profit dictating their prices to the market and setting monopolies,” Muller elaborated.

Besides, risks taken by bank through entrance in equity capital of non-banking business is an equity risk unlike of credit risks that banks usually assume when they simply disburse credits. But the equity risk is much bigger responsibility than the credit risk and may have a fatal outcome to banks and its clients. If banks’ non-profile businesses face equity problems banks would be compelled to solve this problem most probably by allocation financial resources from banking revenue or deposits. Thus, exposing deposits to bigger risks while there is no deposit insurance system in Georgia as of yet.

As the best world practice shows banks are allowed to have non-banking assets of insolvent company under temporary management but as soon as banks compensate their loss they have to sell out the non-financial assets. But this practice was distorted in Georgia.

“Georgia is a small market offering small profits therefore banks need to manage non-financial assets temporarily when they need to reimburse the losses of insolvent clients but this practice became vicious lately and banks own anything starting from petrol stations to whatever man can fancy,” Lia Eliava, a financial analyst, said. “One should always remember that any business is risky and when a bank enters non-profile business it poses threats to depositors as far as if that business faces problems bank will aid it through banking incomes particularly deposits.”

According to Nodar Javakhishvili, a candidate for the post of president at Georgian central bank, non-profile businesses distract banks from proper risk management. When it comes to financing their non-banking companies banks are prone to underestimate risks [once they manage with the assets] that may have fatal outcome to banks.

Experts fear that excessive interest in non-banking businesses may stray banks off their core function to credit economy. Therefore they think the regulation must become stronger and restrict non-banking activity of commercial banks in line with the international tendency.

Levan Surguladze, managing director of CFS [Caucasus Financial Services] Investment Bank, reminds that the loosened regulation and excessive involvement in non-banking activity was the reason triggering financial crisis of 2008. And now the entire world is focused to make the banking regulation stronger. The latest Basel’s recommendations suggest restricting even investment activity to banks let alone non-financial businesses.

Surguladze thinks even the old 20% limit of non-banking assets in total equity resources of banks is quite large and recommends to keep closer with Basel recommendations ignored so far in Georgia.

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