Interview for Forbes.kz.

         The new Law on Banks and Banking Activities introduces a modern system for regulation of insolvent banks that complies with international standards and takes into account national characteristics of Kazakhstan's financial market. This reform is designed to protect interests of depositors, reduce systemic risks and minimize use of budgetary funds in crisis situations.

         Timur Abilkassymov, First Deputy Chairman of the Agency for Regulation and Development of the Financial Market, explains what the new regulation mechanism will be, how it will work in practice, and why it is important for long-term stability of the country's financial sector.

– Timur Bokeikhanovich, Kazakhstan has experienced several cases of troubled banks in the past. How will the new law help prevent recurrence of such situations?

– In the past, our financial system faced situations where individual banks lost their stability and became insolvent. To maintain market stability, the state was forced to allocate budgetary funds to support them. I believe this approach was a temporary measure, and I am confident that responsibility for mistakes of bank owners and management should not be shifted to the society. The new law fixes a different principle. Primary strain of bank's recovery is put on its shareholders, creating a fairer and more sustainable model.

To ensure operation of these principles in practice, the law improves the early response system. This means the regulator has more tools to work with the bank even at the stage of initial challenges. If indicators begin to deteriorate, supervision is enhanced and the bank is obligated to take measures to rectify the situation. Each bank is required to have a recovery plan agreed upon with the regulator, clearly outlining the measures which its shareholders and management will take to improve financial stability. If they default on their obligations to restore stability, a regulation mechanism will be kicked off to protect interests of depositors. In other words, the new law fixes the principle that shareholders bear primary responsibility for recovery of a bank. This mechanism mitigates the risk of sudden crises and increases predictability for the entire market.

– You have mentioned enhancement of shareholder responsibility. How does the new law strengthen responsibility of bank shareholders and management?

– In my opinion, the key change is in the philosophy of the approach itself. While previously, when problems arose, the main strain was put on the state, now shareholders must change their approach to potential crises. They must not only maintain capitalization, but also constantly confirm their readiness to maintain stability under any circumstances. This means that shareholders must have a realistic financial and management action plan, rather than limiting themselves to formal promises.

For large, backbone banks, we have reinforced capital requirements. This is what is known as the loss-absorbing capacity or TLAC. To put it more simply, such banks must have a safety margin that will allow them to survive tough time without government assistance.

We have also significantly revised our approach to corporate governance. From members of the board of directors, we now expect less formal participation and more genuine engagement and professionalism. It is important that the board be comprised of independent and competent people who know how to ask tough questions and make informed decisions. Additional requirements to the senior management as regards their experience, qualifications and risk awareness have also been established.

I would like to specifically mention supervisory practices. We are expanding the use of motivated judgment as a key tool in risk-based supervision. This approach will make supervision more meaningful and focused on problem prevention.

Taken together, these measures create a more mature system in which each participant understands his responsibilities, and key decisions are made given actual risks and interests of depositors.

– One of the most discussed elements of the law is the mechanism for collective bank contributions to a fund to be used in regulation of backbone banks. Market participants fear that this could serve as an "insurance policy" for unscrupulous owners. Why was it necessary to create such fund?

– It's important to understand that we're not talking about establishment of a new fund in the traditional sense. The idea is completely different. We want to establish a mechanism whereby banks contribute to covering the losses only if the state incurs actual losses during the regulation process.

This is necessary to establish a transparent and fair procedure in case of a crisis. Previously, such situations were regulated on an one-off basis, often with the use of the budget. Now the state only intervenes in relation to backbone banks and only in exceptional circumstances. The remaining banks will have to rely on themselves and their shareholders.

If losses arise during regulation of backbone banks, they are compensated by the market, that is, by the banks themselves, proportionally to their shareholding. In practice, such scenario is extremely unlikely because the new law rests on the principles of early response, enhanced capital requirements and shareholder responsibility. All these make a situation in which the country's budget suffers losses extremely unlikely.

Along with that, it is important to understand that such mechanism allows for maintaining a balance between sustainability and development. To cover all risks, it would be possible to continually increase capital and liquidity requirements, but this would entail excessively stringent regulation and restrict lending. For example, to support lending to small and medium-sized businesses, we have now introduced a reduced risk-weighting of assets, although calculations indicated the need for an increase. Such decisions may be possible precisely because in the future a mechanism will be in place that allows the system to compensate for risks without the use of budget funds. This creates space for more flexible regulatory policy.

– Is this approach to bank regulation unique to us, or are there similar mechanisms worldwide? What international practices have you relied on when developing the law, and what have you taken into account from your own experience in previous years?

– This approach is not unique. Similar mechanisms are in place in many countries, for example, the European Union, the United Kingdom, South Korea, Canada and other jurisdictions. They rest on common international principles fixed in G20 and Basel Committee documents.

For several years, we have consulted with international experts, including representatives of the IMF, ECB, World Bank, EBRD and national regulators who have undergone similar reforms. We also closely studied our own experience and bank regulation cases in recent years with international experts. Combined efforts have helped us determine which elements of the international models are truly applicable in Kazakhstan and which require adaptation to our market structure and the scale of our banking system. As a result, the new regulation mechanism combines best international practices and lessons learned from our experience.

Overall, the new law reflects our vision for consistent development and enhancement of the financial sector. International organizations and rating agencies agree that quality of banking supervision in Kazakhstan has significantly improved in recent years. This suggests that the banking system is ready to enter a new stage of development and become even more efficient, open to innovation, and, most importantly, resilient. Therefore, it is important to consolidate the achieved progress and move on to the next stage – development of a modern regulatory system that combines sustainability, development and trust.

Source : https://www.gov.kz/memleket/entities/ardfm/press/news/details/1081605?lang=kk