Armenia’s banking sector — the region’s strong man

Armenia’s restrictions on lending are starting to pay off, as its banks are able to lend effectively to the country’s burgeoning private sector and so help drive economic growth

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Regulation of Armenia’s banks is among the toughest in the Commonwealth of Independent States region, and Central and Eastern Europe, and it’s only getting tougher. The central bank is set to introduce Basel III, requiring the nation’s banks to maintain the capital buffers the regulation mandates.

While the 2014 economic slowdown hit Armenia as it did everyone else in the region — credit quality has still not yet recovered according to the IMF — the response in Armenia was more muted than elsewhere.

“Overall, the Armenian banking sector has been extremely stable over the last 20 years and is rather overcapitalised,” says Artashes Shaboyan, chief researcher at Ameria CJSC, one of Armenia’s top consultancy and advisory companies. “Most of the banks apply best practice corporate governance and high level of transparency in reporting per IFRS standards.”

With 17% total capital to risk weighted assets and 15% as common equity tier one, Armenia is well ahead of the capital requirements imposed by most regulators. Even with the planned phase-in of the Basel III capital requirements, and the IMF’s counter-cyclical buffer, the average Armenian bank is holding more than enough capital.

Banks have had to struggle against regulation to make risky loans and preserve profitability. However, the restraint has stood Armenia in good stead, setting it up with a stable financial system.

“The Central Bank of Armenia was swift in implementing international regulatory standards in the early 2000s, and up until now they are in many cases even ahead of Western countries with applying Basel and other relevant standards,” says Shaboyan.

That has led Armenia to hold a smaller proportion of non-performing loans than most of its peers in Eastern Europe. Christian Fang, senior analyst for Armenia at Moody’s says: “NPLs rose over 2015 and 2016 on the back of the large economic shock that hit the region in 2014, but only to around 10% or so. Many of the other countries in the Eurasia region had much higher levels of impaired assets.”

Now, with the economy enjoying growth of more than 5%, and banks holding generous capital buffers, credit has been growing robustly in Armenia over the past few years — a period in which banking systems with less proactive supervisory policies have contracted, according to Fang.

“Investment accounted for a significant share of lending in 2018,” he says. “Such investment in productive capital will contribute to future growth.

“There’s growth in demand for loans, thanks to the growing economy, and growth in financial liquidity among customers,” he adds. “I expect credit to expand quite dramatically over the next few years.”

Of course, there remains room for improvement in any banking system. Despite strong capitalisation, around 50% of deposits in Armenian banks are in foreign currencies. The high dollarisation of the Armenian economy is a structural challenge for the banking system.

With growth in the global economy slowing, many will opt for the safe haven trade and keep their funds in dollars. Should the dollar strengthen against the Armenian dram, Armenia’s liabilities will increase dangerously.

The Armenian central bank has taken steps to mitigate these risks, imposing higher risk weights on dollar assets, for which it received the IMF’s commendation. The IMF has also suggested more measures to address the risk of Armenia’s FX exposure: a stressed debt service to income ratio limit and a requirement for banks to maintain foreign currency reserves against foreign currency liabilities. 


Digitalisation to drive consolidation

The Armenian banking sector is undergoing changes from within, as well as reacting to impositions from regulators.

Armenia’s banks are pursuing an aggressive digitalisation strategy, updating their processes both internally and externally. The moves should lower costs of running business and increase sales, according to Armenian analysts.

But the drive to digitalise is not just going to make Armenian banks more efficient and competitive internationally; it will change the make-up of the industry.

“Over the next couple of years, I expect to see another round of consolidations in the Armenian banking system,” says Tigran Jrbashyan, head of management advisory services at Armenia CJSC. “I would be surprised to see small and low efficiency banks that have not adopted a digital transformation strategy survive in Armenia past the next few years.”

Although the IMF will always have suggestions for improvements to Armenia’s banking regulation, the country’s central bank deserves praise for managing a stable and secure banking system, which will help power Armenia’s growing economy.