Policy Research Working Paper                             9984




                   Late Banking Transitions
           Comparing Uzbekistan to Earlier Reformers

                                  Davit Babasyan
                                   Yunfan Gu
                                  Martin Melecky




Finance, Competitiveness and Innovation Global Practice
March 2022
Policy Research Working Paper 9984


  Abstract
  Uzbekistan is one of the late transition economies. This                           much can a new transitioning country reasonably expect
  paper compares the early experience and challenges that                            to accomplish within the medium term? Which banking
  Uzbekistan confronts in transitioning its banking system                           reforms are the most essential and how should they best
  to market principles against the earlier experience with                           be sequenced? How can expectations about efficient cap-
  banking transitions from Poland, Russia, and Vietnam, and                          ital reallocation be managed, access to finance made more
  other relevant evidence from the literature. To that effect,                       equitable, and transition risks of financial instability be
  the paper uses new data on Uzbekistan’s banking sector,                            mitigated? What are the complementary reforms in the
  the data on past transition economies, and qualitative and                         real sector, especially of state-owned enterprises and the
  quantitative evidence from the literature. Uzbekistan’s latest                     competition framework, that need to happen in tandem
  experience with banking transition generates important les-                        for the new banking market to function properly?
  sons for countries that have yet to transition. Namely, how




 This paper is a product of the Finance, Competitiveness and Innovation Global Practice. It is part of a larger effort by the
 World Bank to provide open access to its research and make a contribution to development policy discussions around the
 world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may
 be contacted at mmelecky@worldbank.org, dbabasyan@worldbank.org, yunfangu@worldbank.org.




          The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development
          issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the
          names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those
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                                                        Produced by the Research Support Team
                             Late Banking Transitions:
          Comparing Uzbekistan to Earlier Reformers

                           Davit Babasyan, Yunfan Gu, and Martin Melecky∗




      Keywords: Banks, Transition to Market Economy, Uzbekistan, Former Transition
      Economies, Poland, Russia, Vietnam, Risks, Policy Lessons.
      JEL Classification: P34, P21, G21, G28




∗
  All authors are from the World Bank. This paper is a product of the World Bank’s Finance, Competitiveness, and
Innovation (FCI) Global Practice. The authors thank the Central Bank of Uzbekistan (CBU) for support, close
collaboration, and comments on earlier drafts of the paper, as well as Pasquale Di Benedetta, Pietro Calice, Ivailo
Izvorski, Vinayak Nagaraj, and Ilias Skamnelos for their useful comments on the earlier drafts of the paper.
1. Introduction

In 2017, Uzbekistan embarked on an ambitious economic transition focused on economic

liberalization and improving macroeconomic management. The reforms to date include trade and

foreign exchange liberalization; price liberalization; reforms reducing taxes on private enterprises

while broadening the tax base; public financial management reforms; and monetary and financial

sector reforms (IMF 2021). Such reforms have put Uzbekistan on the list of many other current or

former transition economies that have adopted market-based reforms, including some, such as

Poland, Russia, and Vietnam, that began as early as the mid-1980s (Svejnar 2002; Mako 2020). A

new central bank law and a banking law enacted in 2019 established the legal basis for a modern

bank regulation and supervision. The government has introduced corporate governance

requirements for state owned commercial banks (SOCBs) reforms and aims to privatize selected

SOCBs following its Banking Sector Strategy and associated implementation roadmap

(Presidential Decree 5992, dated May 12, 2020).



Taking stock of the transition experience in Uzbekistan’s banking system and SOCBs can yield

important lessons not only for the country itself, but also for many other developing countries

thinking of transitioning their banking sectors toward a more market-based system. Many countries

around the world have banking systems working within a centrally planned economy and/or

banking systems dominated by SOCBs. Uzbekistan’s latest experience with banking transition can

provide important lessons for countries that have yet to transition. Namely, how much can a new

transitioning country reasonably expect to accomplish within the medium term of four to seven

years? Which banking reforms are the most essential and how should they best be sequenced?

How can expectations about efficient capital reallocation be managed, access to finance made



                                                 2
more equitable, and transition risks of financial instability mitigated? What are the complementary

reforms in the real sector, especially of SOEs and the competition framework, that need to happen

in tandem for the new banking market to function properly?



This paper uses novel bank-level data from Uzbekistan to take stock of the ongoing transition of

the Uzbekistan banking sector and particularly SOCBs, compare the early transition outcomes to

those of former transition economies such as Poland, Russia, and Vietnam, as well as to the

qualitative and quantitative evidence from the existing literature. It contributes to our

understanding of the banking sector in Uzbekistan and how Uzbekistan’s path so far reflects the

experience of early reformers. To date, few studies have examined the role of state-owned banks

in Uzbekistan, and to the authors’ knowledge, there is no research that documents the ongoing

transition in the Uzbekistan banking sector and SOCBs. Existing studies on Uzbekistan’s financial

sector focus on describing past and ongoing reforms using aggregate data. Detailed studies on

banking sector development after the 2017 economic liberalization are missing and so are studies

that would relate Uzbekistan’s experience to date with that of former transition economies. This

paper aims to fill this gap.



The remainder of this paper is organized as follows. Section 2 provides an overview of the

literature on banking transitions and state bank ownership. Section 3 describes the data and

research methodology. Section 4 discusses the results of our comparative analysis between

Uzbekistan and the former transition economies of Poland, Russia, and Vietnam while linking the

issues to detailed review of relevant literature. Section 5 concludes and offers some policy

recommendations.



                                                3
2. Literature Overview

Transition economies are countries that are moving from government-controlled and centrally

planned economic systems to more market-based ones, driven by the private sector. The collapse

of the Soviet system has triggered a mass transition from central planning to a market economy.

For the transition economies, the old financial system typically entails high government ownership

in the banking sector, given the role of the government in allocating resources through central

planning. By contrast, a market-based economy calls for well-functioning financial intermediaries

that mobilize resources efficiently and allocate capital to the most productive uses. An

underdeveloped financial sector can misallocate resources (Pang and Wu 2009; Midrigan and Xu

2014), hamper firms’ ability to innovate and adopt new technology (Cole, Greenwood, and

Sanchez 2016), and significantly reduce national income (Wachtel 2001; Buera, Kaboski, and Shin

2015). Therefore, reforms of the banking sector and particularly state-owned banks take the center

stage in the transition toward a market-based economic system.



Until the late 1980s, many developing countries took state ownership of commercial banks for

granted because they considered banks, like many large state-owned enterprises, to be too

strategically important to be entrusted to private hands (Hawkins and Mihaljek 2001). During the

last quarter of the twentieth century and early twenty-first century, motivated by the “Washington

Consensus” (Williamson 2009), the world trended toward a more liberalized financial system and

less state ownership in the banking sector. Banking reforms focused on privatization and reducing

state intervention in the financial system (Megginson and Netter 2003; Kikeri and Kolo 2005;

Megginson 2017). While each developing country had its own motives for privatizing state-owned

banks, main factors driving virtually all privatization programs included: poor performance of



                                                4
state-owned commercial banks (SOCBs) and the need for frequent bailouts resulting from poor

governance, risk management, and lending decisions; significant dependence on state funding; as

well as a widely held perception that the presence of state-owned banks hinders development of

the financial sector (Hawkins and Mihaljek 2001). Moreover, several studies show that extensive

government ownership in the banking sector hinders financial development (and economic growth)

because it lowers access to the formal banking system, lessens depth in the credit market, and

decreases financial innovation (Barth, Caprio, and Levine 2000; La Porta et al. 2002; Cull,

Martinez Peria, and Verrier 2018).



While all transition economies have faced the need to restructure and privatize state-owned banks,

the transition has not always gone smoothly, and has been done at different speeds and under

different modalities. Widespread privatization programs are often controversial and difficult to

implement for a variety of reasons, such as political opposition—including resistance stemming

from the doubtful success of past privatizations; actual or perceived negative distributional

consequences; and political economy considerations (Bertay et al. 2020). Nevertheless, many

studies have shown that bank performance typically improves after privatization (Boubakri et al.

2005; Clarke, Cull, and Shirley 2005; Otchere 2005; Bertay et. al 2020). But private ownership by

itself is not a panacea for reforming a state-owned banking system. Five key lessons, among others,

have emerged from privatization reforms. First, the most successful method of privatization is sale

of a state-owned bank to strategic and reputable investors (Hawkins and Mihaljek 2001; Bonin

and Wachtel 2002; Mako 2020) through an open and competitive bidding process (Clarke, Cull,

and Shirley 2005; Megginson 2005) that is accessible to all investors, including foreign investors.

Second, privatization of state-owned banks had a greater positive impact when it was total rather



                                                5
than partial (Ehrlich, Gallais-Hamonno, Liu, and Lutter 1994; Megginson, Netter, and Chahyadi

2005; Bonin, Hasan, and Wachtel 2005; Beck, Crivelli, and Summerhill 2005). Third, privatization

in certain cases (such as Hungary and the Czech Republic) required prior cleanup of state-owned

bank balance sheets and operational restructuring, making the privatization the last and not the

first step in the transformation process (Hawkins and Mihaljek 2001). Fourth, the benefits of

privatization are weakest for countries where it was rushed the most, such as in Eastern Europe

(Megginson and Netter 2001) and where it was not paired with institutional strengthening of the

regulatory and supervisory framework (Azam, Biais, and Dia 2004; Reinhart and Rogoff 2013;

Estrin and Pelletier 2018). Fifth, the success of banking sector reform is dependent on and supports

the reform of the state-owned enterprise (SOE) sector. The above-mentioned elements of

successful transformation apply even more when the banking sector is concentrated and

underdeveloped, as shown by two papers that examine the privatization of banks in Uganda and

Tanzania (Clarke, Cull, and Fuchs 2009; Cull and Spreng 2011).



A recent study covering about 500 bank privatization events in 70 countries in emerging and

advanced economies during the 1995‒2017 period shows that the majority of bank privatizations

involved governments selling their equity publicly in their domestic capital markets, which has

yielded significant state revenues (Bertay et. al 2020). Banks chosen to be privatized were

consistently those underperforming in terms of profitability and quality of assets—although

domestic banking crises did not emerge as the main reason for privatization. Following

privatization, the private banks focused on corporate lending, increasing credit growth, working

with lean buffers of liquidity buffers, avoiding a significant rise in non-performing loans (NPLs),

and lowering operational costs.



                                                 6
The preceding arguments for state-owned bank privatization, however, do not imply that there is

no role for state-owned banks to play in the economy. After the 2007‒09 global financial crisis

and during the recent COVID-19 crisis, state-owned banks have grown in importance. For example,

state-owned banks have expanded both their assets and branch networks in the regions covered by

the European Bank for Reconstruction and Development (EBRD) over the past decade and have

become serious competitors to private banks, EBRD (2020) documents. Given the recent rise of

state-owned banks, policy makers in developing countries are reassessing the optimal role of state

interventions and ownership in the financial system (Melecky 2021).



There are sound justifications for state-ownership of banks in a market-based economic system.

Because of market failures or profitability considerations, private financial institutions underserve

certain market segments and thus provide the main rationale for state intervention (Atkinson and

Stiglitz 1980; Stiglitz 1993; World Bank 2013; Fernández-Arias et al. 2020). For example, some

state-owned banks focus on financing large infrastructure projects, in which the need for large

amounts of long-term funding and the existence of external social benefits provide the rationale

for state intervention (Levy-Yeyati, Micco, and Panizza 2007; Fernández-Arias, Hausmann,

Panizza 2020). There are also state-owned banks that have a wide network in rural areas where

private banks are not present, and act as a financial agent for the disbursement of government funds

such as social subsidies. State-owned banks are also tasked with countercyclical lending during

periods of crisis (Micco and Panizza 2006; Bertay, Demirgüç-Kunt and Huizinga 2015; Bertay et

al. 2020; Bosshardt and Cerutti 2020; EBRD 2020; Panizza 2021). However, where market failures

do exist, direct state ownership is not always the optimal solution. Government regulation and



                                                 7
contracting could be better alternatives than direct state ownership in banks to address the market

failures (Shleifer 1998).



In practice, state-owned banks typically fail to have clearly defined developmental mandates for

addressing market failures. Many have mandates that are vague and hard to measure, and thus

difficult to establish key performance indicators by which to gauge accountability (Ferrari, Mare,

and Skamnelos 2017; Fernandez-Arias et al. 2020). In many circumstances, in the absence of

clearly defined mandates, state-owned banks compete with private banks for the same clients and

businesses.



Importantly, the downside of state-owned banks is particularly problematic: state-owned banks

typically face aggravated agency problems because it is hard to align the incentives of public

managers with multiple tasks/mandates that are often very difficult to measure (Perotti and Vorage

2010; Cull, Martinez Peria, and Verrier 2018). As a result, many state-owned banks suffer from

low operational efficiency and poor risk management. The unclear developmental mandates lead

to capital misallocation and inefficient financial intermediation (Banerjee 1997; Hart, Shleifer, and

Vishny 1997; La Porta, Lopez‐de‐Silanes, and Shleifer 2002; Barth, Caprio, and Levine 2004; De

Nicolò and Loukoianova 2007; World Bank 2013; Melecky 2021).



How to optimize state ownership and interventions in the financial sector during economic

transitions remains an important policy question as many developing economies struggle with low

financial development and heavy state interventions in the financial sector (Beck, Demirgüç-Kunt,

and Levine 2010; Beck and Cull 2013; World Bank 2013). State-owned commercial banks



                                                 8
represent, on average, about 18 percent of banking sector assets across all countries, but the share

of state ownership varies substantially (Cull, Martinez Peria, and Verrier 2018). In many

developing countries such as Argentina, Bangladesh, Belarus, Brazil, China, Ethiopia, India,

Myanmar, Russia, Ukraine, Uzbekistan, and Venezuela, state ownership remains high in the

banking sector (Cull, Martinez Peria, and Verrier 2018; EBRD 2020). For example, in the

developing countries of South Asia, state-owned banks still dominate the financial system. While

some of these state-owned banks serve certain developmental mandates such as countercyclical

lending, they were also plagued by operational inefficiency and poor risk management, leading to

resource misallocation in the wider economy (World Bank 2010, 2020). Against this backdrop,

policy makers are eagerly looking for renewed evidence about how to optimally proceed with

financial sector transitions and reforms of state-owned banks.



Existing studies on Uzbekistan’s financial sector focus on describing past and ongoing reforms

using aggregate data. For example, Akimov and Dollery (2008) and Ahunov (2015) document

Uzbekistan’s financial development reform and examine the developments and policy

achievements using aggregate economic and banking sector indicators. Detailed studies on

banking sector development after the 2017 economic liberalization are missing and so are studies

that compare Uzbekistan’s experience to that of earlier reformers. This paper aims to fill this gap.



3. Data and Methodology

We use bank-level supervisory data collected by the Central Bank of Uzbekistan to construct and

analyze trends and risks in the Uzbekistan banking sector during the period 2017-2021, compare

them to the experience of former transition countries in the relevant past periods, and relate the



                                                 9
resulting observations to the quantitative and qualitative findings from relevant literature. We use

data from World Bank Global Financial Development Database to retrieve comparable indicators

of financial depth, efficiency, and stability, and the World Bank Enterprise Survey, IMF’s

Financial Access Survey and World Bank Findex data to retrieve comparable indicators of

financial access and inclusion. The data sources together with relevant periods that are being

analyzed are described in the sources and notes of the presented figures. While the bank-level

supervisory data from CBU are confidential, the authors secured the permission to publish the

aggregated data by topic and ownership (state, private) indicator. The banking system indicators

for Uzbekistan are summarized in Table 1 for the system in aggregate, and separately for SOCBs

and private banks.



The paper uses the method of comparative analysis to compare trends and risks in Uzbekistan’s

banking sector since the beginning of its transition in 2017 to the corresponding data from the

periods of banking transitions in Poland, Russia, and Vietnam. The three earlier transition

countries are chosen because they present comparable structural features and constitute interesting

counterfactuals for Uzbekistan. The EBRD’s 1998 Transition Report ranked Poland as the top

reformer—second only after Hungary, which began its transition earlier in a phased process that

impedes comparability. Although ranked toward the bottom by the report, Russia is included

because of its influence on the economic and financial systems of other former Soviet republics.

Vietnam is included as an example of a “socialist-market” economy in Asia. As in Uzbekistan, the

share of agriculture in the three comparator economies has been large and the three comparators

have a relatively greater reliance on state-owned enterprises, even to date. In instances in which

comparisons to the experience of these three former transition countries are not possible for some


                                                10
banking microdata indicators, we compare the state-owned banks with the private banks in

Uzbekistan to form an informative counterfactual.



4. Comparative Analysis

4.1. The Development of Uzbekistan’s Financial Sector Relative to Former Transition Peers

In 2021, commercial banks account for more than 95 percent of total financial sector assets in

Uzbekistan. Thirteen state-owned commercial banks (SOCBs), out of a total of 32 commercial

banks, held 85 percent of banking sector assets and 88 percent of total credit as of the end of 2020

(figure 1, panel A). The three (six) largest SOCBs account for almost 50 (70) percent of total sector

assets. The government is the sole shareholder or holds nearly all shares (more than 90 percent) of

these SOCBs via various state agencies and public companies: the Uzbek Fund for Reconstruction

and Development (UFRD), the Ministry of Finance (MoF), the State Assets Management Agency

(SAMA), other public agencies, and state-owned enterprises. The UFRD is the largest SOCB

shareholder because its funds have often been used to replenish the equity of SOCBs. However,

as of 2020, the formal responsibility to exercise shareholder rights over SOCBs on behalf of the

government and all its agencies was transferred to the MoF. In its banking sector strategy,

Uzbekistan plans to privatize all but 3-4 SOCBs that should stay in public ownership for the

foreseeable future and be mandated with double bottom line of both commercial and social

objectives.



SOCBs traditionally focused on intermediating funds from the government to provide credit to

priority sectors and state-owned enterprises at below-market rates. They funded their lending

activities mostly by using the lines of long-term credit from the government, UFRD, and foreign

banks, rather than local deposits. Until recently, almost half the SOCB loan portfolio comprised

                                                 11
loans to state-owned enterprises (SOEs), many of which distort competitive private sector

development and are the subject of recent government reform. 1 Preferential (below money market

rate) lending—about 80 percent of the total loan book in 2018—was provided to support priority

segments such as national projects, low-income housing, and entrepreneurship, agriculture, and

other targeted sectors. Such funding and loan structure suggest that SOCBs largely continue to

channel public sector funding to public sector entities and policy directed loans. As such, SOCBs

conduct only a limited assessment of borrowers’ repayment capacity when originating preferential

loans, mostly checking compliance with program eligibility criteria. This practice reflects the

political mandate to grant those loans, as well as soft budget constraints stemming from the

availability of UFRD funding and equity injections.



Private banks are small and have mainly served the private sector, mostly on commercial terms.

The nineteen private banks in operation (two of which were licensed in 2020 and one in 2019) are

very small, holding average equity of $48 million. 2 SOCBs hold about ten times the total assets of

private banks: the median size of private banks is $110 million, compared with $1,520 million for

SOCBs. Their small size prevents private banks from realizing economies of scale comparable to

SOCBs and reaching an efficient scale of operation—as evidenced by the significantly higher ratio

of operational costs to assets reported by private banks (5 percent) compared with SOCBs (3

percent). The loan portfolio of private banks amounts to less than 60 percent of their total assets,

on average, while liquid assets and interbank exposures amount to about 30 percent. Unlike



1
  See details in Iootty and Ospanova (2021). In July 2020, the government issued a presidential decree setting
comprehensive milestones to promote competition in the country. The decree touches on the key constraints affecting
the development of competition in Uzbekistan, including significant and distortive state aid and the significant
presence of SOEs in competitive markets and the lack of a level playing field.
2
  The smallest private banks hold equity totaling only $14 million, while equity ranges from $60 million to $130
million for the largest private banks.

                                                        12
SOCBs, private banks fund their operations mostly through retail deposits, which account for more

than 60 percent of their liabilities. The remaining funding originates from foreign banks and

international development financial institutions (about 15 percent), in addition to SOE and state

deposits (about 9 percent).



There are virtually no financial sector alternatives to banks because nonbank financial

organizations and capital markets remain underdeveloped. Microcredit organizations (MCOs),

leasing companies, and pawnshops provide nonbank alternative sources of credit. There are 61

MCOs and 63 pawnshops operating in the market, accounting for just 0.2 percent of banking sector

assets. MCOs provide microfinance (microloan, microcredit, and microleasing) services and

factoring, while pawnshops provide short-term microloans backed by movable collateral (mostly

gold). There are more than 100 leasing companies. Their leasing portfolio accounts for 1.7 percent

of banking sector loans. The top five leasing companies have more than 70 percent of the market

share. Capital markets are virtually nonexistent. The insurance sector is small, and the presence of

state-owned insurance institutions is significant. 3



Uzbekistan is at a nascent stage of its transition to market compared with earlier reformers.

Although the private sector is not yet developed and vibrant, its transactions, investments, and

innovations require adequate finance to boost productivity and equal access to economic

opportunities—especially for existing and emerging micro-, small- and medium-sized enterprises

(MSME) that need to expand for shared prosperity to take place (Gould and Melecky 2017). Even


3
  Of the 28 insurance companies, the 3 largest state-owned companies account for 36 percent of total premiums. Major
insurance products include compulsory motor insurance, compulsory employer's liability insurance, contractor’s all-
risk insurance, property insurance (against pledges and all types of catastrophes), agricultural insurance, and export
credit insurance.

                                                         13
though the country lags its peers in financial deepening, the ongoing credit expansion appears too

rapid, creating risks to financial stability (figure 2). As many other countries before, Uzbekistan

thus faces a balancing act in its banking sector transition.



By a broad measure of financial deepening, Uzbekistan falls behind not only the aspirational

averages for East Asia and Pacific (EAP) and Europe and Central Asia (ECA) countries, but also

the averages for Commonwealth of Independent States (CIS) countries and lower-middle-income

country (MIC) peers (figure 2, panel A). In parallel, Uzbekistan shows high bank concentration as

well as a high share of loans to SOEs and government compared with the experience of former

transition countries (figure 2, panel B). Such concentration weakens competition in financial

intermediation because of excessive market powers that the biggest banks hold. The large share of

lending to state enterprises by state banks funded from state (non-market) resources can further

impair the allocative efficiency of the banking system.



Benchmarking the credit growth of Uzbekistan to the historical experience of transition countries

shows that Uzbekistan may be growing credit too quickly. Economic transitions typically entail

rapid changes in countries’ macrofinancial systems that, if not managed properly, could trigger

systemic vulnerabilities and instability. Fast credit growth is yet another factor that helps predict

future banking crises, including in transition countries. 4 In the early stages of their transition,

Poland, Russia, and Vietnam grew their credit much less than Uzbekistan and still experienced

banking crises and systemic instability (figure 2, panel D). Hence, Uzbekistan faces a tough


4
  Caggiano et al. (2016), for example, find that excessive credit growth can trigger bank problems through a
generalized deterioration in banks' asset quality (as a result of over-indebtedness of borrowers and loosening credit
standards) and/or a reduction in liquidity (due to aggressive maturity transformation and reliance on wholesale sources
of funding).

                                                          14
balancing act: to let its financial depth converge to that of peers while not converging too fast to

crash (Gould and Melecky 2017; Cihak, Mare, Melecky 2021).



4.2. Banking Sector Links to the Real Economy

Because SOCBs have largely operated as public sector credit agencies—serving SOEs and priority

sectors—much of the population and private firms lack access to suitable financial services. As

in other former socialist countries, SOCBs have mainly acted as channels for the state to implement

its credit plan and grant mostly subsidized lending to specific sectors and SOEs—rather than acting

as true banks that allocate resources to the most productive uses based on market signals and

considering risk and return. Until very recently, the boards of SOCBs were dominated by senior

public officials who lacked the required knowledge and experience in banking as well as the time

and operational independence to duly carry out their roles. Consequently, SOCBs lacked any

proper corporate governance and risk management capabilities and relied on frequent

recapitalizations by the state when liquidity or capital shortfalls emerged.



The banking sector has had little incentives to mobilize household savings. The history of cash

shortages, 5 non-core functions imposed on banks, 6 restrictions on currency conversion, and

disruptions in payment systems has eroded the public’s trust in the banking system and reduced




5
  Mandatory encashment rules forced firms to surrender cash collections every few days. Surrender amounts were not
based on actual cash collections by firms but a norm established by the authorities based on on-site audits of business
activity.
6
  Banks in Uzbekistan have performed non-core functions—such as tax administration, cash monitoring, and reporting
on their clients—which has impaired bank-client relationships, lowered trust, and inhibited financial intermediation.
While some of those functions are no longer required, others remain. In particular, according to the Joint Instruction
N 2432 (CBU, MoF, Tax Authority) dated March 15, 2012, banks must decide on the amount and sequence of
payments to be made from their client companies' main bank accounts with regard to government-related payments
(tax, customs, and so on) and salary payments, in case there are insufficient funds to meet all bills.

                                                          15
demand for deposits. Broad money 7 accounted only for about one-fifth of GDP—well below the

range of 30 percent to 40 percent in Poland and Vietnam on average during 1997‒2000 and two-

thirds of GDP in countries at similar income levels by the end of 2018.8 By the end of 2020, the

ratio of bank deposits to GDP stood at 19 percent in Uzbekistan. However, around 40 percent of

deposits belonged to the government and SOEs. Because data are lacking, we cannot compare this

structure to other early reformers where this issue may or may not have been similar. Bearing in

mind this structural issue, during 1997‒2000, bank deposits to GDP averaged about 30 percent in

Poland, 13 percent in Russia, and 6 percent in Vietnam.



Access to financing for micro, small and medium enterprises (MSMEs) remains a significant

challenge in Uzbekistan compared to peer countries. According to the World Bank Enterprise

Survey, only about 22 percent of Uzbek firms had access to a loan in 2019, compared to the average

of 28 percent for lower-middle-income countries and 38 percent for countries in developing

Europe and Central Asia. 9 Comparing Uzbekistan today to Poland and Russia in 1999 and focusing

on “the degree to which financing is problematic for operation and growth of business,” the EBRD-

World Bank Business Environment and Enterprise Performance Survey (BEEPS) indicates that

about 20 percent to 30 percent of respondents in Poland and 40 percent of respondents in Russia

perceived financing to be a “major or moderate obstacle” in 1999, compared with about 30 percent

of respondents in Uzbekistan in 2019. The comparison indicates that Uzbekistan does not stand

out historically. However, from today’s viewpoint, Uzbek MSMEs lack access to an appropriate



7
  Broad money is a category for measuring the amount of money circulating in an economy. It is defined as the most
inclusive method of calculating a given country's money supply, and includes narrow money along with other assets
that can be easily converted into cash to buy goods and services.
8
  Data source: GlobalEconomy.com.
9
  Ownership of a bank account among MSMEs is about 84 percent, compared with the average of 95 percent for the
ECA region.

                                                       16
range and quality of financial products that their counterparts in other countries at a similar income

level enjoy—including digital account services, investment loans, agricultural loans, and factoring.

One reason is that credit providers do not employ proper cash-flow analyses, credit risk

management methods, or credit scoring systems in their lending decisions. They rely mostly on

high collateral requirements and relationship lending.



In the absence of banking sector reform, including of corporate governance, risk management, and

business models, the system could continue misallocating credit and, at some point, experience

financial distress—which could compromise economic stability and hamper economy-wide

reform efforts. Banks’ business models need to transform to discourage the reliance on public

sector funding and its repercussions for hampering efficient credit allocation and much-needed

deposit mobilization. Privatization and restructuring of state-owned commercial banks can ensure

more efficient allocation of capital to productive investments and wind down the practice of

distortive directed lending that enables the survival of unviable (and politically connected) firms

(Bussolo et al. 2019).



In this regard, insolvency and creditor rights (ICR) systems are widely recognized as important

elements of financial system efficiency and stability—including during economic transitions

(Balcerowicz, Gray, and Hoshi 1998). They enable creditors to better manage financial risk and

other difficulties dealing with problem borrowers. The need for reform of the ICR systems stems

from the many issues that weaknesses in effective ICR system create if not addressed adequately.

These issues include: (1) posing major bottlenecks in efforts to reduce banks’ exposure to problem

assets and encouraging banks to keep nonviable borrowers afloat with extend-and-pretend



                                                 17
practices; (2) weakening repayment discipline; and (3) maintaining high levels of unresolved NPLs,

making banks (and non-bank credit providers) reluctant to lend to new customers and keeping the

banking sector from fulfilling its potential to support the economic recovery with credit (BIS 2017;

World Bank 2020). When aggregate NPLs are rising, MSMEs are typically the most disadvantaged

segment in emerging market and developing economies, experiencing credit rationing and rising

lending rates (Feyen and Zuccardi 2020).



4.3. Credit Booms and Deepening after Economic Liberalizations

The 2017 economic liberalization triggered a credit boom at rates that may not be sustainable. The

economic liberalization—notably involving the foreign exchange and trade regime

liberalizations—pushed the banking sector into a frenzied credit growth driven by both demand

factors (such as increasing retail and private sector demand) and supply factors (more state

funding). After growing by 110 percent in 2017—partly due to local currency depreciation—credit

grew at about 50 percent per year in nominal terms in 2018 and 2019, slowing down to only 30

percent in 2020 because of the COVID-19 crisis (figure 3, panel A).



Both SOCBs and private banks have experienced a credit boom (figure 3, panel B). Thirteen banks,

including three large ones, doubled their balance sheets, and four small and medium banks tripled

their balance sheets over 2018–20. Lending to the industrial sector and loans to individuals

contributed the most to the 79 percent nominal credit growth over 2018‒20—making up 23

percentage points and 19 percentage points of the 79 percent growth, respectively. Lending to

agricultural, transport, communications sectors were not far behind, each with a 12-percentage

point contribution rate. Overall, credit to the private sector in Uzbekistan grew from 12 percent to

30 percent of GDP from 2016 to 2019, an annual growth of around 6 percentage points of GDP.

                                                18
This is more than three times the average annual growth experienced by other transition economies

such as Poland, Russia, or Vietnam during the initial years of transition. Credit to the private sector

(as a share of GDP) barely grew in Poland from 1990 to 1995, grew by 1.1 percentage points per

year from 1996 to 2001 in Russia, and grew by 1.1 percentage points per year from 1992 to 1997

in Vietnam.



The room for aggressive lending in Uzbekistan opened further with the “cleanup” (a reduction) of

policy lending from SOCBs’ balance sheets by the end of 2019. This was also a crucial reform to

prepare banks for privatization. Traditionally, SOCBs have relied on frequent recapitalization by

the UFRD when their capital buffers were depleted due to excessive lending. The removal of

UFRD-funded SOE loans from the banking sector and the conversion of some UFRD loans to

banks into equity at the end of 2019 boosted the capital buffers of SOCBs by about 8 percentage

points. Unintentionally, the increased capital buffers supported further aggressive credit growth

throughout 2020. Several banks (mostly SOCBs) exhibited rapid growth of their loan portfolios in

2020—at a rate of 50 percent to 80 percent.



Estimates for 2021 by the Central Bank of Uzbekistan (CBU) reveal signs of credit market

overheating. The CBU estimated that the credit-to-GDP gap 10 ranged from 2 percentage points to

5 percentage points over the past several years. 11 When a credit-to-GDP gap exceeds 2 percent,

international standards typically call for the imposing of a countercyclical (add-on) capital buffer

on the banking system. The broader macroprudential goal is to both contain the excess of aggregate



10
   The credit-to-GDP gap is the deviation of the credit-to-GDP ratio from its long-term trend, as per the methodology
proposed by the Bank of International Settlements.
11
   “Monetary Policy Review: IV quarter 2020,” Central Bank of Uzbekistan, 2021.

                                                         19
credit growth that builds systemwide risks and create an additional cushion for banks to be able to

absorb much of the losses that can arise because of excessive credit growth (BCBS 2011). The

CBU has also concluded that while the credit indebtedness of the population is relatively low, its

growth rate is not in line with the income growth of the population, reflecting overoptimistic

attitudes toward creditworthiness.



The strong credit boom, although precarious, helped boost the private sector’s access to financial

services. While the number of depositors gradually increased from 609 per 1,000 adults to 809 per

1,000 adults from 2015 to 2019, the number of borrowers from commercial banks almost tripled,

from 57 per 1,000 adults to 152 per 1,000 adults (figure 4, panel A). By way of comparison,

looking at Poland, the earliest data available from the IMF’s Financial Access Survey indicate 824

depositors and 449 borrowers per 1,000 adults in 2008—suggesting that the number of depositors

in Uzbekistan could be comparable to or even ahead of that of Poland in parallel times of transition,

while the access of borrowers to financial services could fall behind Poland’s transition experience.



World Bank Enterprise Survey data for 2019 indicate that only 5.8 percent of Uzbek firms see

access to finance as a major constraint, well below levels for regional and income peers (17 percent

and 26 percent, respectively). However, only 22 percent of surveyed firms report having a bank

loan or credit line (24 percent in 2013), well below the 28 percent average for lower-middle-

income countries and 38 percent for developing Europe and Central Asia. Over the past few years,

the share of loans provided to small businesses and sole entrepreneurs has ranged between 30

percent and 40 percent of total lending, while the share of lending to individuals has been

increasing more steadily. Despite these positive developments, banks continue providing a limited



                                                 20
range of credit products to MSMEs—most of them with high collateral requirements. Mid-sized

firms have the greatest unmatched needs for finance and are more likely to be more credit-

constrained compared with smaller and large firms (figure 4, panel B).



4.4. Institutional Reforms in Uzbekistan’s Banking Sector and the Global Experience

There is no strong rationale for having a large state commercial banking sector in Uzbekistan and

other developing economies. Around the world, ownership of multiple commercial banks by the

state is rare. The consideration of providing a “safe haven” against financial instabilities in the

future, helping firms and households weather the impact of economic downturns, the presence of

market failures, and the need for performing some developmental functions may provide a

rationale for having one or very few state-owned commercial banks. However, the benefits of a

strong SOCB presence should be weighed against the potential for distortionary effects in the

longer term (EBRD 2020). These distortionary effects include misallocation of credit,

impediments to the effective reallocation of capital and labor across firms and industries, and

ultimately reduced productivity growth in the medium to longer term. Therefore, restructuring and

privatization of most SOCBs is needed, and the few SOCBs that may remain in public hands must

undergo governance reform, capacity building, and development of business process and lending

technology commensurate with the envisaged dual commercial and social mandate (Fernández-

Arias et al. 2020; Gutierrez and Kliatskova 2021; Melecky 2021). For instance, Fernández-Arias

et al. (2020) suggest leveraging the intelligence-gathering role of development banks along the

lines of the role that modern theories of financial intermediation assign to banks as institutions

with a comparative advantage in producing and processing information. However, while private

banks focus on information on private returns, public banks with social objectives could produce

and organize information about social returns.

                                                 21
The experience of many countries shows that financial liberalization, when not paired with proper

regulation and supervision, has led to banking crises. These studies show that the probability of

banking crises conditional on financial liberalization is higher than the unconditional probability

of banking crises (Hawkins and Mihaljek 2001, Angkinand, Sawangngoenyuang, and Wihlborg

2010; Reinhart and Rogoff 2013). The experience from individual transition economies highlights

the importance of strengthening financial sector institutions for successful economic transitions.

For example, Poland, one of the transition leaders in developing Europe and Central Asia, early

on implemented numerous reforms to strengthen the financial sector’s institutional capacity and

infrastructure—including developing prudential and supervisory regulation, passing a new

securities law, and revising national accounting standards—and then proceeded with gradually

privatizing the state-owned banks (Mako 2020). By contrast, Russia pursued privatization while

leaving many gaps in financial market infrastructure unfilled. Its banking activity surged ahead of

regulatory and supervisory capacity and Russia underperformed its peers in subsequent growth.



Unlike the former transition economies such as Poland, Russia, and Vietnam that started building

their market and financial sector infrastructure early in their transitions, Uzbekistan is

comparatively ahead on its path toward a functioning market system and operational financial

sector infrastructure. However, amid the fast credit growth and high share of state-ownership in

the banking sector, institutional capacity must be boosted to improve the private sector’s access to

finance while mitigating the risk of a future banking crisis. Therefore, improving the CBU’s

capacity to perform its proper “gatekeeper” function; improving its licensing, supervisory, and

resolution frameworks; upgrading insolvency frameworks; and reforming state-owned banks will



                                                22
be key to ensuring that only financially strong and reputable shareholders enter the banking system

for the long term and fostering the safety and soundness of the financial system.



In 2019, Uzbekistan made strong progress in implementing structural reforms in the banking sector.

In October 2019, the country enacted new laws with respect to the central bank, banks, and banking

that provide a robust legal basis for developing a modern bank regulatory and supervisory

framework. 12 In December 2019, large preferential loans to SOEs funded through UFRD resources

were transferred out of the SOCBs’ balance sheets back to the UFRD. This reform has considerably

improved the capital positions of SOCBs, decreased exposure to foreign currency risk, and paved

the way for further banking sector reforms and eventual privatization of most SOCBs. Further, the

government took measures to wind down the practice of preferential lending with the introduction

of interest rate subsidy mechanisms only where needed. All directed lending programs have been

concentrated in three SOCBs that will remain in the public domain for the foreseeable future.



In 2020, the country adopted the 2020–25 banking sector strategy. The strategy’s implementation

roadmap includes; (1) actions to advance SOCBs’ privatization and restructuring—most SOCBs

are to follow a two-stage privatization process with support from an international financial

institution(s) (IFI); (2) strengthening micro- and macro-prudential oversight of the financial sector;

(3) the development of an ecosystem of nonbank financial providers—facilitated through the

adoption of a new law on non-bank financial institutions; and (4) the adoption of a comprehensive

strategy for financial inclusion.




12
  Miquel Dijkman and Eva Gutierrez, “Establishing a Fit-for-Purpose Banking Law in Uzbekistan,” World Bank
blogs, December 2019.

                                                   23
The ownership function for SOCBs and the oversight of SOCB restructuring and privatization

were centralized in the MoF within a dedicated SOCB department. This department has five main

objectives: (1) to minimize the scope for political interference and bring greater professionalism

to the state’s ownership role; (2) to promote consistency in applying corporate governance

standards and in exercising the state’s ownership role across SOCBs; (3) to achieve greater

transparency and accountability in SOCB operations through better performance monitoring; (4)

to decrease the state share in the banking sector through the privatization of selected SOCBs to

strategic investors based on transparent and competitive international tenders; and (5) to conduct

privatization with a systemic approach in mind to competitively serve various parts of the economy

while ensuring the diversity of the banking system for purposes of economic stability.

Strengthening the capacity of the MoF SOCB department is therefore crucial for effective

implementation and coordination of the banking sector reform.



Several IFIs have been invited to work with some of the largest SOCBs to help prepare their

privatization. The adopted strategy envisions privatization of at least six SOCBs by 2025,

including full privatization of three SOCBs to strategic investors. This reform will increase the

share of private banks in total banking system assets from 15 percent to 60 percent and their share

of deposits in total bank liabilities from 40 percent to 60 percent. The IFIs have either started

working or are in the process of negotiating cooperation with the largest SOCBs to ensure their

due transformation and prepare them for privatization. The Hungarian OTP bank signed a

memorandum with the Uzbekistan government in September 2021 to purchase a 75 percent stake

in the Ipoteka bank 13—a large SOCB that has been under transformation with support from the



13
     See news coverage in Reuters, MIFT, Financial Times. 14 See news coverage in Gazeta.uz, RBC, Kun.uz.

                                                        24
International Financial Corporation (IFC). This transaction will be followed by OTP’s purchase of

the remaining stake of the Ipoteka bank within the next three years. In addition, two Russian banks

intend to buy the entire stake in two small SOCBs. 14



The central bank continues improving its regulatory and supervisory framework. Following the

adoption of the laws on the central bank, banks, and banking, the CBU has self-assessed its

regulatory and supervisory framework against the global standards (the Basel Core Principles)

(BCBS 2012). The comprehensive assessment identified main weaknesses in the CBU’s regulatory

framework and supervisory approaches. Since mid-2019, the CBU has been addressing key

prudential challenges (asset classification, capital), and implementing measures to bring all banks

in compliance with the established rules. A draft risk-based supervisory manual has been

developed, and gradual transition to risk-based supervision has been piloted with four banks. The

CBU is in the process of preparing a system of early supervisory interventions to address problems

at banks in a timely manner. Numerous regulations have been developed in accordance with

international standards, including on bank licensing, corporate governance, risk management,

large exposures, prudential reporting, and liquidity risk.



In line with the experience of former transition economies, financial sector reforms in Uzbekistan

have been complemented by simultaneous reforms to support private sector development and

strengthen the demand side of finance. In successful transition economies, policies that promote

market-based competition, improve the business environment, and attract foreign investments

have been adopted alongside banking sector reforms. In Poland, the rapid opening of markets,



14
     See news coverage in Gazeta.uz, RBC, Kun.uz.

                                                    25
liberalization of prices, and dismantling of monopolies gave a big boost to growth and helped the

country start its economic recovery earlier than its regional peers. SOEs in Poland performed better

than elsewhere because of uncompromising hard budgets imposed on SOEs with credible signals

from the Ministry of Finance that the SOEs had to make it on their own or fail (Piatkowski 2018).

At the same time, competition from imports was allowed—which compressed profit margins and

imposed efficiency pressures on SOEs, bank lending tightened, and SOE management became

motivated to exhibit good managerial abilities in anticipation of SOE privatization—which was

delayed but inevitable (Pinto 2014). 15 These policies supported the development of a private sector

that the reformed and improved banking system can help to thrive and become more competitive.

What ultimately determined the success or failure of transition for most Eastern European

economies was not the restructuring of SOEs, whose share in the economy was fast declining

anyway, but the pace at which the private sector grew. In Poland, the share of the private sector

increased from initial levels of about one-quarter of GDP in 1989 to two-thirds of GDP by 1995.



In Uzbekistan, the private sector still suffers from low degree of competition, subdued firm

productivity, and insufficient connectivity with international markets. 16 Starting in 2017, the

government began pursuing a series of reforms to promote competition, 17 enhance connectivity

with international markets, 18 improve the business environment, and restructure SOEs. 19 Aiming

to complement ongoing banking sector reforms, the reforms to boost private sector development



15
   See also Mako (2020) for detailed descriptions on key reforms supporting private sector development during the
economic transitions in Poland, Russia, and Vietnam.
16
   See Iootty and Ospanova (2021) for further details.
17
   An Anti-Monopoly Committee was introduced in January 2019 to enhance competition through legal and regulatory
and institutional changes (Presidential Decree 4126, dated 24 January 2019).
18
   This includes the reduction of import tariffs and the improvement of trade facilitation to accelerate the accession
process to the World Trade Organization (WTO) (Iootty and Ospanova 2021).
19
   Notably, Presidential Decree 6096 aims to accelerate the reform and privatization of SOEs.

                                                         26
need to speed up to provide timely support. International experience suggests that, early on in its

transition, Uzbekistan needs to introduce the concept of competitive neutrality and start

implementing and enforcing its principles in the real and banking sector for a competitive private

sector to emerge and ensure growth and wealth distribution are equitable (Menkhoff 1997; Wei

and Wang 1997; Lin, Cai and Li 1998; Capobianco and Christiansen 2011; Watanabe 2020).

Importantly, this includes breaking the noncommercial links between SOEs and SOCBs and

tightening SOEs soft budget constraints (Wei and Wang 1997).



4.5. Reorientation of State-Owned Commercial Banks to the Private Sector

SOCBs have started their transition from a conduit for on-lending of state funds to SOEs on

preferential terms toward financing the private sector and individuals. The share of loans provided

to SOEs and budget organizations in total new loans have markedly decreased (figure 5, panel A).

The transfer of UFRD-funded loans off the SOCBs’ balance sheets at the end of 2019 triggered

the dynamic that has remarkably decreased the share of SOE loans in the total stock of SOCB loans

(figure 5, panel B). On SOCB loan books, the loans to SOEs have been replaced with loans to

individuals and private companies. However, state-funded and state-directed lending to priority

sectors has remained in place and is not captured in the SOE lending in figure 5.



The government has begun winding down preferential lending by SOCBs. If sustained, the

winddown could help significantly reduce market distortions. Starting January 1, 2020, the

government restricted all state-directed lending below the central bank’s reference rate. 20 The

measure also called for full liberalization of interest rates starting January 1, 2021, with the


20
  See Presidential Decree #5877, “Government loans for mortgage lending and the production of raw cotton and
grains temporarily exempted.”

                                                      27
introduction of interest rate subsidy mechanisms only where needed. Furthermore, only three

SOCBs will be able to lend under public credit programs using funding from the state budget and

UFRD. 21 As a result of these and earlier measures, the outstanding preferential loans as a share of

total SOCB loans decreased from 77 percent at the end of 2018 to 50 percent at the end of 2020

(figure 6, panel A) and commercial lending increased (figure 6, panel B). Effective implementation

of this policy in the future will help reduce market distortions created by the preferential lending

and contribute to improved monetary policy transmission.22



Anecdotal evidence, however, suggests that considerable directed lending by SOCBs to the

economy continues, including as part of the response to the COVID-19 crisis. Even during the

COVID-19 crisis, several SOCBs lent aggressively in 2020, with their credit growing by 50

percent to 80 percent, compared with 25 percent in other banks. Although part of this credit growth

happened under state programs funded by UFRD, another part was most likely directed by the

state or state officials. A similar situation has been occurring at other SOCBs, albeit to a lesser

extent. The fact that the “directed” loans are in most cases provided at “commercial” rates—that

is, at or slightly above the CBU base rate—and do not officially fall under state lending programs

makes them practically untraceable. These “hidden” directed loans contaminate the balance sheet

of SOCBs and risk derailing efforts at SOCB restructuring and privatization. Because they are not

properly underwritten, these loans may necessitate another round of SOCB balance sheet cleanups

at high fiscal costs.


21
  According to Presidential Decree #ПП-4498.
22
  Two recent papers on Vietnam (Nguyen, Ngo, and Nguyen 2021) and China (Bashir, Yugang, and Hussain 2020)
concluded that higher market concentration and higher state ownership in commercial banks weaken the effectiveness
of monetary policy transmission. For Uzbekistan, the IMF notes (IMF Article IV 2021) that as long as Uzbek banks
do not operate fully on market principles, the transmission of the policy rate to SOCB lending and deposits will remain
limited, while the easy access to state funding and policy lending will undermine the effectiveness of the country’s
monetary policy.

                                                          28
In 2020, the government started implementing its 2020–25 banking sector reform strategy focusing

on improving the corporate governance of the SOCBs. The strategy is accompanied by an

implementation roadmap to prepare at least 6 out of the 13 state-owned banks, representing

45 percent of assets in the banking sector, for privatization between 2021 and 2025. As part of

improving the corporate governance of SOCBs, more than 20 new and independent board

members have been appointed in SOCBs. Although private banks have on average smaller boards

than SOCBs, their boards traditionally have included more independent, female, and foreign board

members than the boards of SOCBs—but this gap is decreasing (figure 7). Independent, diverse,

and empowered supervisory boards are the foundation of good corporate governance (Claessens

2006; De Nicolò, Laeven, and Ueda 2008; Cihak and Sahay 2018). Beyond regulations, laws on

the books, or voluntary codes, enforcement of these measures is critical to creating an effective

business environment and good corporate governance in transition economies, Berglof and

Claessens (2006) highlight. However, political economy constraints in transition economies,

resulting from the intermingling of business and politics, often prevent improvements in the

enforcement environment and the adoption and implementation of public laws.



In Uzbekistan, much remains to be done regarding the corporate governance of SOCBs. Boards

need to set up functional secretariats and specialized board committees, as well as enhance

coordination and information sharing, among other needed improvements. Importantly, Chief

Executive Officers (CEOs)—still politically appointed—must start reporting to boards and

become accountable to them rather than individual government bodies or state officials. Moreover,

lessons from the 2007–09 global financial crisis highlight the key role of a Chief Risk Officer



                                               29
(CRO)—who should report directly to the board of directors—in safeguarding good bank

performance during a crisis (Aebi, Sabato, and Schmid 2012). The CRO function typically was

missing in earlier banking transitions and is largely lacking in later transitions—including that of

Uzbekistan. Bank directors need to be held to high professional standards rather than the amateur

standard that governs directors generally, Macey and O’Hara (2016) emphasize. They propose that

all bank directors should be “banking literate,” possessing the specialized knowledge needed to

monitor and control risk taking in financial institutions, which are fundamentally different than

that of other entities because of the increasing complexity and opacity of bank activities. They also

argue for “banking expert” requirements for risk committee members similar to the requirements

on audit committees.



In Uzbekistan, weak governance in and with respect to SOCBs makes the state-run banks

continuously underperform private banks in terms of profitability. The average pre-tax return on

assets for SOCBs over 2015–20 was 1.6 percent, compared with 4.2 percent for private banks

(figure 8, panel A). Similarly, the average net return on equity was 10 percent for SOCBs,

compared with 25 percent for private banks. The lower profitability of SOCBs is mainly caused

by smaller net interest margins (due to a higher share of preferential loans) and lower non-interest

income (figure 8, panel B). On the upside, SOCBs benefit from lower operational costs thanks to

the larger scale of their operations. At 50 percent on average during 2015–20, the cost-to-income

ratio of SOCBs is much lower than the 70 percent average in peer countries (around 64 percent in

developing Europe and Central Asia and 70 percent in lower-middle income countries—based on

CBU and World Bank Finstats data). The low operational costs of SOCBs reflect their business

model oriented toward corporations—large captive loans that are easier to originate and process.



                                                 30
But for the broader activity of commercial banking, SOCBs lack proper marketing, product

diversity and innovation, technology in banking operations, and risk management. Moreover, low

salaries that SOCBs offer match and attract staff who lack professional skills and specialization.



Low human capital in banking is a more general and urgent problem of Uzbekistan’s banking

system. Local banks try to address this gap by outsourcing training and building of corporate

training centers. The state-owned banking academy is also introducing practical banking courses.

Still, access to high-quality professional training is low—and more so outside bank headquarters—

while the urgency of retooling and obtaining the latest skills is not felt enough by most in the local

banking industry. Several studies highlight the importance of develop the human capital along

with market conditions for a competitive banking environment to emerge (Borish, Long, and Noel

1995; Claessens 1998a; Claessens 1998b; Brandt and Li 2003; Bonin, Hasan, and Wachtel, 2014).

Claessens (1998) highlights that strong institutions could help substitute for the shortage of

banking skills in the initial stages of transition. Foreign investment and participation in banking is

one way to speed up knowledge transfer and the needed upgrade of banking skills in the banking

sector of transition economies (Bonin, Hasan, and Wachtel, 2014). But relaying on future FDI is

not a silver bullet. Many international banking groups rely on local staff capacity in their branching

strategy and local human capital is thus part of the franchise value when international banking

groups strategize about acquisitions in transition countries or greenfield investments.



The underdeveloped and uncompetitive nature of Uzbekistan’s banking market is reflected in

private banks’ generous interest margins. Interest rate spreads on credit portfolios have been

relatively high and increasing in private banks over 2018-2021, reaching almost 7 percent,



                                                 31
compared to 4.3 percent and 4.7 percent of median net interest margin for developing Europe and

Central Asia and lower middle-income countries, respectively, based on CBU data. SOCBs’ net

interest margins are significantly lower but also increasing—reflecting a gradual shift from

preferential to commercial lending. 23 The relatively high interest margins reflect both increased

demand for credit (especially retail credit) in recent years and the relatively noncompetitive

banking system. By bringing more competition, transparency, and financial literacy, the

privatization and reform of the banking sector could lower the interest rate spreads and the

currently high profitability of banks in the medium term (Barth et al. 2009; Anzoategui, Martínez

Pería, and Melecky 2012; Love and Martinez Peria 2015; Chauvet and Jacolin 2017; Fungáčová,

Shamshur, and Weill 2017). This competitive pressure may eventually reveal the need for banking

sector consolidation—with possible trade-offs regarding the ultimate structure of the banking

sector and its relationship to growth (Cetorelli and Cambera 2001; Claessens, and Laeven 2005).



The shortcomings in bank governance, “hidden” policy lending, and the low competitiveness of

banks translate into banking sector inefficiency that drives credit and credit and capital

misallocation (Barth et al. 2009; Bussolo et al. 2019). As a result, some sectors may receive much

less credit than is desirable for their productive growth (figure 9). For instance, the industry and

transport sectors—full of inefficient SOEs—could be overcredited by banks, especially by SOCBs.

By contrast, some other sectors such as trade and services receive disproportionally less credit

from SOCBs compared with private banks. The varying credit intensity of individual sectors plays

a role though, and a deeper assessment is needed to identify potential credit gaps and overheating.


23
  The higher net interest rate margins of private banks can be partly explained by their higher risk-taking, and partly
by the near-absence of preferential lending in the private banks’ portfolio. Preferential lending is still significant, albeit
decreasing, for SOCBs. The ratio of risk-weighted assets to total assets averaged 88 percent for private banks and 79
percent for SOCBs during 2018‒20.

                                                             32
For instance, comparing the credit intensity (financial dependence) of industries in another

financial market with fewer frictions could be more revealing (Rajan and Zingales 1998; Fisman,

and Love 2007; Acharya and Xu 2017; Sharma and Winkler 2018; Lo Turco, Maggioni, and

Zazzaro 2019)—including accounting for possible threshold effects (Manganelli and Popov 2013).

Nevertheless, at this junction a comparison with private sector allocations could be also revealing.

By the end of 2020, only 5 percent of SOCBs’ outstanding loans went to the trade and public food

sector, compared with 22 percent of private banks’ outstanding loans. By contrast, nearly 50

percent of SOCBs’ loans went to the industry and transportation sectors—full of inefficient

SOEs—compared with 35 percent of the private banks’ loans—suggesting possible overcrediting

of these sectors.



4.6. Structural Challenges of Banking in Transition and Risks to Macrofinancial Stability

Aside from its high rates, the rapid credit growth is even more worrying because of poor credit

underwriting standards, low risk management capabilities, and weak corporate governance at

banks—especially in SOCBs. The limited financial strength of shareholders in the young private

banks also adds to the worries. Should system-wide risks materialize, the government will be

called to financially support both SOCBs and private banks—at a significant cost to taxpayers—

to avoid a boom-to-bust reversal (Rosas 2006; Hett and Schmidt 2017; Gerhart and Vennet 2017;

Grossman and Woll 2014). 24 Banking crises—including the way they are resolved—increase

income inequality (Bodea, Houle, and Kim 2021).



24
   Hett and Schmidt (2017) find that with bailouts market discipline is weaker for government-sponsored enterprises
(GSEs) and systemically important banks (SIBs) than for investment banks. Gerhart and Vennet (2017) highlight that
bailed out banks hardly improve their performance indicators in the years following government aid, and that bailouts
are not sufficient to restore bank health. Also, based on four case studies of the Irish, Danish, British, and French bank
bailout during the global financial crisis, Grossman and Woll (2014) conclude that countries with close one-on-one
relationships between policy makers and bank management tended to develop unbalanced bailout packages, while

                                                           33
Uzbekistan’s banks need to therefore strengthen credit origination and underwriting processes by

paying increased attention to borrowers’ repayment capacity, which would naturally moderate

their credit growth. Moderating credit growth is particularly important at banks earmarked for

privatization that need to attract suitable strategic investors. Earlier experience of Eastern

European transition countries is illustrative in this regard. Because of continued soft lending

practices, the initial recapitalizations of Czech banks in early 1990s were followed by bailouts and

did not result in positive outcomes (Bonin and Wachtel 1999). By contrast, in Poland, the bank-

led enterprise restructuring program—implemented based on the revolutionary Act on Bank and

Corporate Restructuring—enhanced the financial discipline of Polish banks and their risk

assessment capacity. In turn, this enhanced discipline helped decrease and sustain the low volumes

of nonperforming loans going forward (Borish, Ding, and Norl 1997). Hence, improving lending

practices and risk assessment capacity is critical for mitigating moral hazard problems of continued

state bailouts (Hett and Schmidt 2017; Gerhart and Vennet 2017; Grossman and Woll 2014).



The liquidity buffers of SOCBs are also being depleted by aggressive lending. Although the

liability structure of SOCBs appears more long term and stable than that of private banks, SOCBs’

liquidity buffers have reached critically low levels due to rapid credit growth. The ratio of high-

quality liquid assets to total assets decreased from 15.4 percent at the end of 2018 to 9 percent by

the end of November 2020—with several banks falling below the minimum regulatory threshold

of 10 percent (figure 10). 25 The liquidity position of several SOCBs worsened in 2020, also due to



countries where banks negotiated collectively developed solutions with a greater burden-sharing from private
institutions.
25
   By the end of December 2020, the ratio increased to 12 percent as a result of eurobond issuance and other funding
attracted by SOCBs.

                                                        34
reduced credit repayments because of credit deferrals provided by banks as part of COVID-19

mitigation measures. Drawdowns of current and deposit accounts, as well as the need to meet some

off-balance sheet commitments, brought further liquidity strains. To mitigate these liquidity

pressures, the central bank introduced liquidity support tools for banks (short-term liquidity

support loans and irrevocable credit lines). The CBU also takes proactive measures to bring the

banks into compliance with the established liquidity ratios and has strengthened the liquidity

coverage ratio methodology as of February 2021 in line with the Basel III standards (BCBS 2013).

Honohan (1997) urges that a rigorous application of the agreed global microeconomic regulation

to transition economies should not be deferred—including in the face of political interference,

which is the weak spot of any regulatory system.



To finance their operations, SOCBs rely mostly on credit lines from state and foreign banks, while

private banks rely mostly on private deposits. As of the end of 2020, SOCBs mobilized 55 percent

of their funding through credit lines—down slightly from the 63 percent in 2018 (figure 11, panel

A). While more than 50 percent of those credit lines were funded by the government (MoF, UFRD)

in 2018, this share declined to 30 percent in 2020. Existing credit lines are mostly provided by

foreign banks and IFIs. Some SOCBs were also able to raise funding by issuing eurobonds. SOCBs

funded less than 15 percent of their operations with private deposits of individuals and private

firms. By contrast, private banks received more than half their funding (56 percent) from private

depositors and relied on credit lines for less than 25 percent of their funding. Although deposits

are not the main funding source for SOCBs, they still attract 72 percent of total deposits in the

economy—just because of their size.




                                               35
Their long-term funding enables SOCBs to lend long term, mostly to SOEs, while private banks

have been constrained in long-term lending and consequently in supporting private investments.

SOCBs’ access to long-term credit lines helped them issue long-term loans to meet the financing

needs of SOEs in sectors that require long-term financing such as transportation, communications,

and industry. By the end of 2020, 47 percent of loans from SOCBs had a maturity of five years or

more, compared with just 8 percent for private banks. Private banks relying on deposit financing

cannot afford to take material liquidity risks from maturity transformation. As a result, private

companies—especially medium-sized—could be deprived of adequate access to investment

financing (World Bank Enterprise Survey 2019).



Even after state-owned banks are recapitalized by the government, operational restructurings must

be achieved and privatization must not be delayed—otherwise further state capital injections might

be required. One way to balance these risks is to provide recapitalizations in stages and contingent

on meeting certain restructuring objectives (Andrews 2005). In Uzbekistan, SOCBs have enjoyed

high capital buffers thanks to the 2019 cleanup of policy lending, but their buffers are being

depleted extremely fast by aggressive lending (figure 12). The SOCBs used 7 percentage points of

their capital in 2020 to extend additional loans—presumably also to counter the repercussions of

the COVID-19 economic crisis, as was the case in other countries with large state-owned

commercial banks, such as China, Germany, India, Russia, and Turkey (Gutierrez and Kliatskova

2021). While this could be the right role to play for those SOCBs that the banking sector strategy

envisages to stay in public hands, SOCBs slated for privatization need to manage their portfolios

carefully like proper commercial banks to attract respectable investors and show good performance

after privatization (Boubakri et al. 2005; Omran 2007; Englmaier and Stowasser 2017; Bertay et



                                                36
al. 2020). Instead, credit grew in six banks by more than 50 percent in the midst of the crisis, and

another seven banks grew their credit by more than 30 percent (figure 12, panel B). These credit

growth rates cannot be achieved with proper underwriting—not even in more advanced banking

systems. The combination of weak governance and internal controls, and hidden policy lending,

provides for double trouble when banks recklessly push out money and misallocate capital in

parallel (Barth et al. 2009; Bussolo et al. 2019; Melecky 2021).



NPLs in the Uzbek banking sector have traditionally been low (1 percent to 2 percent) because:

(1) loans to several large SOEs used to be restructured and granted regulatory forbearance in their

classification; (2) many of the loans granted under public programs have long grace periods and

their true quality is yet unknown; and (3) rapid growth of the loan portfolio obscures the signals

of actual credit quality. As a response to the COVID-19 outbreak, temporary deferrals have been

provided for loan repayments by firms and individuals (until October 1, 2020). The reported NPL

ratios peaked at 6.2 percent in mid-2021, compared to 2.1 percent by the end of 2020. The modest

increase in NPLs—which banks report after COVID loan deferrals have ended—may still not

reflect the full effect of the pandemic and prior rapid credit growth 26 and thus overestimate capital

buffers, risking continued aggressive lending without adequate loss-absorption capacity. Another

problem with temporary deferrals is that they may lead to lower repayment discipline by borrowers,

set expectations for banks that such deferrals might be “acceptable” for the supervisor in the future,

and predispose future SOCB investors to expect such forbearance after privatization—such as in

Mexico from the early 1990s (Gruben and McComb 1997). Correct incentives need to be built into

the forbearance programs to achieve beneficial outcomes in the long term (Edwards 2021; Shi


26
   Several SOCBs underwent asset quality reviews (AQRs) in 2020 and 2021 as part of the banking system
transformation efforts. These exercises may reveal additional capital shortages that will have to be addressed.

                                                      37
2021; Cherry et al. 2021). Proper risk provisioning at an early stage, as well as acting in a forward-

looking manner regarding the allocation of profits, remain paramount for maintaining bank

resilience during the COVID-19 crisis, Fidesser et al. (2021) argue.



In Uzbekistan, the highly concentrated and dollarized loan portfolios of the three largest SOCBs

top up the exposure of the banks and the system to financial stability risk. By the end of 2020, the

three largest SOCBs held large loans 27 that amounted to 46 percent of their total loan portfolio,

with the five largest borrowers covering 26 percent of their loan portfolios on average. The

portfolio concentration has declined from 64 percent in 2018 thanks to SOCB balance sheet

cleanup from UFRD-funded SOE loans at the end of 2019. But it remains significantly higher than

the 16 percent counterfactual for private banks (figure 13, panel A). The concentration risks could

be alleviated by enabling a framework for syndicated lending, including with the participation of

foreign banks (Gadanecz 2004; Godlewski and Weill 2008; Lin et al. 2012; Figini and Uberti 2013).

High concentration coupled with the dollarized credit portfolios of large SOCBs (figure 13, panel

B) expose the banks to greater solvency risks. Namely, a large currency devaluation could trigger

the failures of large borrowers to repay their loans because borrowers in foreign currency may not

always have foreign currency income to match the loan servicing obligations (Yeyati 2006;

Neanidis and Savva 2009; Basso, Calvo-Gonzalez, and Jurgilas 2011; Buncic and Melecky 2013).




27
  The regulation defines a large loan as a loan that exceeds 10 percent of a bank’s Tier 1 capital.28 The share of Global
Findex respondents who “saved at a financial institution” reveals that in 2017 Uzbekistan ranked the lowest in Central
Asia with its 2 percent share—compared with shares of 3 percent in Kyrgyz Republic, 5 percent in Turkmenistan, 11
percent in Tajikistan, and 13 percent in Kazakhstan.

                                                           38
5. Conclusion


In 2017, Uzbekistan joined the latest cohort of transition economies. In the effort to transition its

financial system to market principles, Uzbekistan started vital reforms in the banking sector and

particularly began to restructure and privatize state-owned commercial banks. Historical evidence

suggests that such financial liberalization should be matched with institutional strengthening to

avoid costly financial crises. The CBU has been improving its regulatory and supervisory

framework to that effect. Based on international experience, it is also important that the

government complement banking reforms with reforms of SOEs and the business environment

and by strengthening competition to create benefits for the economy.



Crucial reforms to help the banking system finance a successful transition to a market economy,

while avoiding capital misallocation and destabilizing credit booms, include improving banking

culture, strengthening credit risk management, mobilizing greater amounts and numbers of bank

deposits, and developing additional and more modern financial products and solutions.



Improving banking culture. Banking culture is where corporate governance, directed policy

lending, and human capital in banking meet. SOCBs—at least those at the top of the list for

privatization—must be freed from political interference in their lending. All remaining official and

“hidden” directed lending should be required by the CBU and MoF to be properly registered under

the “directed lending portfolio” and reported in the SOCBs’ financials so that the supervisor (CBU),

the owner (MoF), investors, and the public can monitor the dynamics of their volume and quality.

The MoF needs to clearly define developmental mandates for SOCBs that will remain in public

ownership, establish transparency and accountability mechanisms for the provision of “public


                                                 39
services” by SOCBs and the associated fiscal costs, and improve their digital capabilities (Melecky

2021). The relationship to and the influence of boards regarding SOCB management needs to be

strengthened for the SOCBs to commercialize or, for those that shall stay in public hands for the

foreseeable future, better perform their dual commercial and social objectives (Fernández-Arias et

al. 2020). The human capital shortfalls in banking will need to be replenished with adequate access

to modern training and education opportunities. Improving the public banking academy and further

modernizing and tailoring its programs to the needs of various existing and aspiring banking

professionals is one promising avenue.



Strengthening oversight of credit risk. Credit risk oversight by the CBU needs further

improvements. The CBU should conduct thematic reviews related to credit quality (such as of

bank underwriting practices). Over time, the CBU should build the capacity for conducting

targeted horizonal reviews across banks of credit quality and asset quality. This initial review and

gradual capacity building are needed to better understand the extent and dynamics of non-

performing loans and the implications for bank capital buffers. CBU should improve the

classification methodology for NPLs (or broadly, assets) to include a forward-looking dimension

and enforce its application by banks—reflecting the methodology but not yet the complexity of

the recent global reforms—such as the impairment requirements of International Financial

Reporting Standard (IFRS) 9 Financial Instruments. It should also better oversee the quality of

credit reporting to the registry and systems for sharing credit information (Jappelli, and Pagano

2002; Barth et al. 2009; Bennardo, Pagano, and Piccolo 2015; Cihak, Mare, and Melecky 2021;

Bahadir and Valev 2021)—while closely monitoring possible trade-offs (Gehrig and Stenbacka

2007). The CBU should put pressure on all banks to strengthen corporate governance, internal



                                                40
controls, risk management, and underwriting standards. Furthermore, it should continue

strengthening its gatekeeper’s capacity for banking market entry, supervision of banking

operations, bank exit, and crisis preparedness.



Mobilizing greater amounts and numbers of bank deposits. Greater deposit mobilization is a big

challenge for Uzbekistan. Uzbek banks are not as successful at deposit mobilization as they should

be, including because of historical distrust of the public toward their services. 28 In tandem, the

banking system is enjoying access to credit lines from the government—especially SOCBs—and,

more recently, has managed to attract foreign debt financing in local currency (soms). The

incentives for mobilizing domestic deposits are thus weak. In the medium to long term, Uzbekistan

will need to rely on supplemental financing of its development through foreign savings. However,

the mobilization of domestic deposits can make the funding structure of banks more resilient (Han

and Melecky 2017) as well as help households and firms build financial wealth and self-insure

against risks (World Bank 2014). In turn, more resilient households and firms lower the credit risk

for banks.



Developing additional and more modern financial products and solutions. Development of

additional financial products and solutions is warranted to address the needs of banks and their

clients. There are several products that the market, with the help of authorities, could develop in

the short term to help strengthen the efficiency and resilience of credit intermediation. For example,

to help alleviate credit concentration risks and help the CBU implement tougher standards, a


28
  The share of Global Findex respondents who “saved at a financial institution” reveals that in 2017 Uzbekistan
ranked the lowest in Central Asia with its 2 percent share—compared with shares of 3 percent in Kyrgyz Republic, 5
percent in Turkmenistan, 11 percent in Tajikistan, and 13 percent in Kazakhstan.


                                                       41
framework for loan syndication, including with foreign bank participation, could be further

developed (Gadanecz 2004; Godlewski and Weill 2008; Lin et al. 2012; Figini and Uberti 2013).

While recently the banks have been able to attract foreign financing in soms, foreign currency

financing will continue. Developing the hedging market (over-the-counter or organized through

the stock exchange) could help mitigate banks’ and borrowers’ exposures to foreign currency risk

(Alfaro, Calani, and Varela 2021). The agriculture sector is a major part of Uzbekistan’s economy

and a sector that can become competitive in the long term. Sustained competitiveness will require

agri-financial products that the market could develop with the help of public policy—such as

tailored financing reflecting seasonal specifics, and crop insurance to cope with climatological

risks as well as mitigate the credit risk of agricultural financing (Clarke and Derkon 2009). Political

economy factors, ad hoc resolution of operational challenges, and fraught commercialization of

financial services are barriers that need to be overcome to truly spur such development of argi-

finance products (Bernards 2022). To advance shared prosperity in Uzbekistan through

connectivity to markets, the banking system should continue to promote fast digital payments and

solutions to help with e-commerce and broader market integration (Mishra, Walsh, and Srivastava

2021).




                                                  42
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                                                 56
 Table 1: Uzbekistan banking sector indicators: Aggregate, SOCBs, and Private banks
                                                               2018    2019    2020    2021
Credit portfolio
Credit portfolio growth                                        51%     58%     31%     18%
   of which: state-owned banks                                 51%     62%     31%     15%
   of which: private banks                                     55%     34%     30%     35%
Share of preferential loans to total loans                     71%     58%     46%     39%
   of which: state-owned banks                                 78%     64%     51%     44%
   of which: private banks                                     18%     19%     11%      5%
Share of credit portfolio to total assets                      78%     78%     76%     73%
Capital adequacy
Total Regulatory capital to risk-weighted assets               16%     24%     18%     17%
    of which: state-owned banks                                15%     25%     18%     18%
    of which: private banks                                    17%     18%     19%     17%
CET 1 capital to risk-weighted assets                          14%     20%     15%     15%
Leverage ratio (Capital to assets)                              9%     14%     11%     12%
Asset quality
Non-performing loans to total gross loans                      1.3%    1.5%    2.1%    5.2%
    of which: state-owned banks                                1.4%    1.5%    2.1%    5.4%
    of which: private banks                                    0.7%    1.5%    2.0%    4.1%
Non-performing loans net of provisions to regulatory capital    5%      3%      4%     13%
Profitability
Net interest income to average interest-bearing assets (NIM)    3.9%    4.3%    5.0%    5.0%
    of which: state-owned banks                                 3.3%    3.7%    4.5%    4.3%
    of which: private banks                                     7.3%    8.3%    8.5%    8.9%
Operating costs to net income (CIR)                             49%     41%     36%     38%
    of which: state-owned banks                                 49%     40%     34%     36%
    of which: private banks                                     48%     45%     44%     45%
Return on assets                                                2.0%    2.2%    2.2%    1.3%
    of which: state-owned banks                                 1.6%    1.8%    1.8%    0.7%
    of which: private banks                                     4.2%    4.7%    4.3%    4.3%
Return on equity                                               16.2%   16.7%   10.3%    6.1%
    of which: state-owned banks                                13.1%   13.7%    8.4%    3.0%
    of which: private banks                                    29.5%   30.8%   20.7%   20.2%
Liquidity
Liquid assets to total assets                                  14%     14%      15%    19%
    of which: state-owned banks                                10%     11%      13%    15%
    of which: private banks                                    33%     27%      30%    33%
Liquid assets to short-term liabilities                        41%     40%      67%    47%
    of which: state-owned banks                                35%     37%      54%    43%
    of which: private banks                                    57%     50%     142%    57%
FX exposure
Net FX open position to Total Regulatory capital                8%      7%      4%      6%
Ratio of FX loans to total loans                               56%     48%     50%     50%
    of which: state-owned banks                                59%     49%     51%     52%
    of which: private banks                                    33%     38%     39%     37%
Ratio of FX liabilities to total liabilities                   63%     58%     60%     57%
    of which: state-owned banks                                66%     60%     61%     59%
    of which: private banks                                    48%     49%     51%     45%

                                                     57
Source: CBU, (End of period in percent)



Figures



     Figure 1. State-owned commercial banks have traditionally dominated Uzbekistan’s banking
                                              sector
    A. The number of banks (left axis) and share of SOCB assets   B. Banking system asset-to-GDP and credit-to-GDP ratio
                    (right axis) in Uzbekistan                                        dynamics (%)
    20                                              19   90%       70%                                       63%
              17       17                  17
                                 16                                                55%
                                                 13                60%                      53%      53%
    15                        13        13               85%                                                    48%
                                                                   50%
                   11                                                                          41%     41%
           10                                                                         37%
    10                                                   80%       40%    35%
                                                                   30%
                                                                             22%
      5                                                  75%
                                                                   20%
                                                                   10%
      0                                                  70%
           2016     2017     2018      2019     2020                0%
                                                                           2016     2017    2018     2019     2020
                     SOCBs
                     Private banks                                            Banking system assets to GDP
                     Share of SOCBs in total assets                           Banking system credit to GDP

   Source: CBU Bulletin.
   Note: CBU = Central Bank of Uzbekistan; SOCB = state-owned commercial bank.




                                                            58
 Figure 2. Uzbekistan lags its peers in financial deepening (panels A, B, C), but the country may
              be growing credit too fast, risking a possible banking crisis (panel D)
 A. Share of domestic credit to the private sector (% of GDP)                   B. Asset concentration of the top three banks (%)

160                                                                       120
120                                                                       100
 80                                                                        80
 40                                                                        60
  0                                                                        40
      Uzbekistan      Lower            CIS       Europe & East Asia &
                     middle          countries Aentral Asia Pacific        20
                     income                     (excluding (excluding       0
                                                    high   high income            0      1        2        3       4         5      6        7
                                                  income)
                                                                                                      year from transition


                                                                                      Poland (1991-1998)               Russia (1992-1999)

                                                                                      Uzbekistan (2016-2019)           Vietnam (1992-1999)


   C. Share of credit to government and SOEs (% of GDP)                     D. Average annual growth in domestic credit to private
                                                                                     sector relative to GDP growth (%)

 25                                                                       7.00%

 20                                                                       6.00%

 15                                                                       5.00%                                        Banking
                                                                                                                       crisis in
 10
                                                                          4.00%                                         1998

                                                                          3.00%
  5                                                                                                   Banking
                                                                                      Banking         crisis in
                                                                          2.00%       crisis in
  0                                                                                                    1997
        0        1      2        3        4       5      6     7                       1992
                                                                          1.00%
            Poland (1991-1998)                Russia (2001)               0.00%
            Uzbekistan (2016-2019)            Vietnam (1992-1999)                       Poland         Vietnam Russia (1996- Uzbekistan
                                                                                      (1990-92)       (1992-97)     98)      (2016-19)

Sources: IMF, World Bank 2019. Laeven and Valencia (2014).
Note: For panel A, data are for 2019: In ascending order, developing Europe and Central Asia (ECA); developing East Asia
and Pacific (EAP); CIS countries; lower-middle-income countries; Uzbekistan. The transition years for Russia is selected
based on data availability. CIS = Commonwealth of Independent States; SOEs = state-owned enterprises.




                                                                     59
 Figure 3. Bank loans have grown sharply in recent years, with SOCBs accounting for most of the
                                             loans
         A. Growth rate of banking sector credit (%)                      B. Outstanding loans from SOCBs and private banks

  140%
  120%                                                                     300

  100%                                                                     250




                                                          Trillion soms
   80%                                                                     200
   60%                                                                     150
   40%                                                                     100
   20%
                                                                            50
    0%
            2015 2016 2017         2018 2019       2020                      0
             Banking sector            SOCBs                                      2015    2016   2017    2018      2019   2020
              Private banks                                                              SOCBs     Private banks

 Sources: CBU, World Bank staff calculations.
Note: CBU = Central Bank of Uzbekistan; SOCBs = state-owned commercial banks.




                                                          60
Figure 4. Access to finance has advanced on the back of fast credit growth, but challenges remain
               A.         Number of bank depositors and borrowers                                                             B. MSME access to finance (%)

                                                                                                                                                                    All
                                                                                                                                             UZB        ECA
                                                                                                                                                                 countries
 900                                                                                             180              Percent of firms
 800                                                                                             160              with a checking or            84        95             89
 700                                                                                             140              savings account
 600                                                                                             120              Percent of firms
                                                                                                                  with a bank                   22        37             33
 500                                                                                             100
                                                                                                                  loan/line of credit
 400                                                                                             80               Proportion of loans
 300                                                                                             60
                                                                                                                                                96        71             77
                                                                                                                  requiring collateral
 200                                                                                             40               Value of collateral
 100                                                                                             20               needed for a loan
                                                                                                                                               166       175         199
                                                                                                                  (% of the loan
   0                                                                                             0
               2015              2016          2017              2018              2019                           amount)
                                                                                                                  Percent of firms
    Number of depositors with commercial banks per 1,000 adults                                                   identifying access to
                                                                                                                                                    6     16             26
    Number of borrowers from commercial banks per 1,000 adults                                                    finance as a major
                                                                                                                  constraint
Sources: IMF Financial Access Survey (FAS), World Bank                                                        Source: World Bank Enterprise Survey, 2019 data.
Enterprise Survey.                                                                                            Note: ECA = developing Europe and Central Asia; MSME =
                                                                                                              micro, small, and medium enterprise; UZB = Uzbekistan
                                                                                                                 .




   Figure 5. SOCBs have reduced exposure to SOEs and increasingly lend to the private sector
           A. Structure of extended loans by borrower type                                                            B. Share of outstanding loans to SOEs and non-SOE
                           (% of total loans)                                                                                      sectors (% of total loans)
                                   .
                                                                                                                    100%
    14%             9%           15%     16%             20%       19%             23%     21%                       90%
                                                                                                                     80%
                                                                                                                               51%
                                                                                                                     70%
    56%                                                                                                              60%                     73%
                83%              62%                     57%
                                         80%                       78%             64%                               50%                                97%        98%
                                                                                           76%
                                                                                                                     40%
                                                                                                                     30%
    31%                          23%                     24%                                                                   49%
                                                                                   13%                               20%
                    8%                   4%                        3%                        3%                                              27%
                                                                                                                     10%
                                                                                                                                                         3%
       SOCBs

                 Private banks

                                 SOCBs

                                         Private banks

                                                         SOCBs

                                                                   Private banks

                                                                                   SOCBs

                                                                                             Private banks




                                                                                                                      0%                                           2%
                                                                                                                               2018          2020       2018      2020
                                                                                                                                      SOBs               Private banks

                                                                                                                        Lending to non-SOE sector including individuals and
           2017                      2018                    2019                      2020
                                                                                                                        private businesses
                SOEs                Private companies                          Individuals                              Lending to SOEs

Sources: CBU, World Bank staff calculations.
Note: CBU = Central Bank of Uzbekistan; SOCBs = state-owned commercial banks; SOE = state-owned enterprise.


                                                                                                             61
                      Figure 6. SOCBs have reduced preferential lending in recent years
   A. Share of preferential loans in total new extended loans (%)    B. Share of preferential loans in total SOCB loans (%)
                              (percent)

 70%
                                                                          4%        5%          6%          6%        6%
 60%                                                                     19%        21%
                                                                                               31%
                                                                         10%                               41%        43%
 50%                                                                                11%
                                                                                               13%
 40%                                                                                                       13%
                                                                                                                      13%
 30%                                                                     67%        64%
                                                                                               51%
                                                                                                           40%        37%
 20%

 10%
                                                                       12/31/2018 6/30/2019 12/31/2019 6/30/2020 12/31/2020
  0%                                                                              Commercial loans to individuals
       Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov                            Commercial loans to corporates
                                                                                  Preferential loans to individuals
                   2019                        2020
                                                                                  Preferential loans to corporates
Sources: CBU, World Bank staff calculations.
Note: CBU = Central Bank of Uzbekistan; SOCBs = state-owned commercial banks.




                                                                62
    Figure 7. SOCBs have fewer independent, foreign, and female board members than private
                banks, but have progressed to include more such board members

 9.0
 8.0
 7.0
 6.0
 5.0
 4.0
 3.0
 2.0
 1.0
 0.0
           Average       Average       Average     Average              Average        Average       Average     Average
          number of     number of     number of   number of            number of      number of     number of   number of
            board      independent female board foreign board            board       independent female board foreign board
          members         board       members     members              members          board       members     members
                         members                                                       members
                          (strict                                                       (strict
                      definition - no                                               definition - no
                      govt officials)                                               govt officials)
                                  SOBs                                                      Private Banks

                                                        2020        2019 value
Sources: CBU data, World Bank staff calculations.
Note: CBU = Central Bank of Uzbekistan; SOCBs = state-owned commercial banks.
a. For the average number of independent board members, a strict definition is used, excluding all government officials.




                        Figure 8. SOCBs are much less profitable than private banks
       A. Pre-tax return on average assets (RoAA) (%)                 B. Net interest margin (as a % of average total assets)



                                                                        )
 6.0%                                                           7.0%
 5.0%                                                           6.0%
 4.0%                                                           5.0%
 3.0%                                                           4.0%
 2.0%                                                           3.0%
 1.0%                                                           2.0%
 0.0%                                                           1.0%
           2015    2016    2017    2018    2019     2020
                                                                0.0%
                  SOCBs                                                     2015     2016     2017     2018     2019      2020
                  Medium-sized Private banks
                  Small Private banks                                                SOCBs            Private banks
Sources: CBU, World Bank staff calculations.
Note: CBU = Central Bank of Uzbekistan; SOCBs = state-owned commercial banks.




                                                               63
 Figure 9. The trade and service sector receives less attention from bank lending than its share in
                          the economic output of the country warrants

                        40%
                        35%
                        30%
                        25%
                        20%
                        15%
                        10%
                        5%
                        0%
                              Share of Share of Share of Share of Share of Share of Share of Share of Share of Share of
                               GDP Credit GDP Credit GDP Credit GDP Credit GDP Credit
                                Agriculture,        Industry       Construction        Trade and         Transport and
                                forestry, and                                           Services            storage,
                                  fisheries                                                             information and
                                                                                                        communication
Sources: CBU, World Bank staff calculations.
Note: CBU = Central Bank of Uzbekistan.




                              Figure 10. Liquidity buffers of SOCBs are low and decreasing
A. Total loan and liquidity position                                         B. Share of liquid assets to total assets (%)


               300000                                                   30% 40%
                                                                                          34%
                                                                            35%
               250000                                                   25%
Billion soms




                                                                            30%                      28%       27%
               200000                                                   20%                                                         24%
                                                                            25%                                              20%
               150000                                                   15% 20%
               100000                                                   10% 15%                              11%                   12%
                                                                                        9%        10%                     9%
               50000                                                    5%     10%
                                                                                5%
                   0                                                    0%
                                                                                0%
                        Apr
                         Jul


                        Apr
                         Jul


                        Apr
                         Jul


                        Apr
                         Jul
                        Jan


                        Oct
                        Jan


                        Oct
                        Jan


                        Oct
                        Jan


                        Oct




                                                                      31-12-18 30-06-19 31-12-19 30-06-20 31-12-20
                  2017        2018      2019       2020
          Total loan portfolio      Liquid assets to total assets                SOBs     Private banks
Sources: CBU, World Bank staff calculations.
Note: CBU = Central Bank of Uzbekistan; SOCBs = state-owned commercial banks.




                                                                      64
  Figure 11. SOCBs rely heavily on funding by credit lines, which help them extend long-term loans
A. Funding structure of SOCBs and private banks (% of total non-           B. Maturity of corporate loans, 2020 (%)
                         equity funding)
 100%                                                              100%                                     2%
              7%           14%         8%          11%                                                      6%
                                                                   90%             15%
  80%                                  15%         19%
                                       9%                          80%
                                        7%         7%
  60%        63%           55%                      7%             70%             32%
                                                                                                            57%
  40%                                                              60%
             9%            5%          60%          56%
  20%                      13%                                     50%
             9%
             13%           14%                                     40%
    0%                                                                             41%
                                                                   30%
             2018          2020        2018        2020
                                                                   20%                                      35%
                    SOBs                 Private banks
                                                                   10%
                                                                                   13%
                Other funding sources                               0%
                Credit lines                                                       SOBs                Private banks
                Other deposits
                Public deposits (SOE and govt.)                      < 1 year   1-5 years 5-10 years   10 years and above

Sources: CBU, World Bank staff calculations.
Note: CBU = Central Bank of Uzbekistan; SOCBs = state-owned commercial banks.




                                                           65
      Figure 12. SOCBs appear well capitalized, but rapid lending is fast depleting capital buffers
                   A. Capital adequacy ratio (%)                       B. Number of banks with high annual rates of credit growth
  30%
                              25%                                                                                  20
  25%
  20%              17%
                                    18%         18% 19%                                                 15
             15%                                                                                                               13
  15%
                                                                           7             7 8        6                      6        7 6
  10%                                                                                                          4
                                                                               2
   5%
   0%
                                                                          2015         2016      2017          2018       2019      2020
               2018             2019               2020
                       SOBs     Private banks                                                  30%-50%                  > 50%
 Sources: CBU, World Bank staff calculations.
Note: CBU = Central Bank of Uzbekistan; SOCBs = state-owned commercial banks.




             Figure 13. Large SOCBs have highly concentrated and dollarized loan portfolios
    A. Share of all large exposures in the credit portfolio (%)        B. Share of foreign currency and local currency loans (%)



                                                                       100%
   70%      64%                                                         90%        23%
   60%                                                                  80%              35% 32%
                                                                                                        49%
                                                46%                     70%                                               62% 61%
   50%                        42%                                       60%                                   74% 71% 67%
   40%                                                                  50%
                                                                        40%        77%
   30%                                                                  30%              65% 68%
                     18%                              16%                                               51%
   20%                                                                  20%                                               38% 39%
                                    13%
                                                    9%                  10%                                   26% 29% 33%
   10%           5%               4%                                     0%
    0%                                                                             2018 2019 2020 2018 2019 2020 2018 2019 2020
                2018             2019              2020                             Top 3 largest       Other SOCBs        Private banks
          Top 3 largest SOCBs       Other SOCBs                                       SOCBs
          Private banks                                                  Share of FX loans                      Share of LC loans
 Source: CBU, World Bank staff calculations.
 Note: CBU = Central Bank of Uzbekistan; SOCBs = state-owned commercial banks.




                                                                  66