The outlook for the banking system in Uzbekistan remains stable, says Moody's Investors Service in a new Banking System Outlook published on 29 August 2012.

The key drivers of the outlook are (i) Uzbekistan's relatively favourable economic conditions; (ii) the active spending and investments of a cash-rich central government, which are channeled into the economy through local banks; and (iii) banks' high (albeit gradually weakening) capitalisation levels.

"In our view, macroeconomic conditions in Uzbekistan will support the overall operating environment for banks over the 12-18 month outlook period, with banks benefiting from both deposit inflows and growing loan demand," says Olga Ulyanova, a Moody's Vice President, senior analyst and author of the report.

The country's gross domestic product (GDP) has grown rapidly over the last decade and is expected to increase by 7% in 2012 and 6.5% in 2013 [IMF forecast]. Moody's expects that a large number of government-sponsored projects will continue to spur the economy, and for "under-banked" retail and SME sectors to provide new lending opportunities. At the same time, the government's financial flexibility is dependent on macroeconomic developments in the country's major trade partners, such as China, the CIS, and Europe. A further weakening in global demand is a key downside risk to the country's growth outlook.

"We expect that Uzbek banks' asset-quality metrics will be stable, supported by the relatively benign operating environment, with the problem loans-to-gross loans ratio likely to remain close to its 11.7% year-end 2011 level over the outlook period. That said, we note that rapid lending growth is masking the level of problem loans, and that their stock is rising. This could lead to a sharp rise in the problem loans ratio in the advent of deteriorating macro-economic conditions as a result of adverse developments in external demand. We believe that Uzbek banks' loan-loss reserves, which stood at 5.6% of gross loans as of year-end 2011, are insufficient to cover potential credit losses and need to be accumulated further," adds Ms Ulyanova.

Moody's notes that with its reported Basel I Capital Adequacy Ratio (CAR) of 18% as of year-end 2011, the sector's overall capitalisation provides a sufficient buffer to absorb higher expected losses anticipated by the rating agency's central scenario, which assumes GDP growth of 7% and a 10% local-currency depreciation. Under these assumptions, the sector's total aggregated Basel I CAR would decrease to 14.9% over the outlook period. Under the adverse scenario, which anticipates less favourable global market conditions for major Uzbek export commodities, the sector' total CAR would drop to 10.3%, only slightly above the 10% regulatory minimum requirement. Furthermore, the capitalisation of some systemically important banks is significantly below the system's average, rendering them more vulnerable to adverse operating conditions.

The rating agency expects that Uzbek banks' liquidity will remain stable over the outlook period, supported by growing customer funds, sustainable government financing channeled to the largest banking institutions and limited reliance on wholesale funding, which partly shields the system from the global financial crisis and external shocks.

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