The Mongolian banking sector may undergo a significant consolidation over the next few years due to tighter legislation and its enforcement, Fitch Ratings says. The strong majority retained by the incumbent party in the country’s parliamentary election in June should provide a favourable backdrop for local authorities to resume banking sector reforms, one of the main objectives in the State Monetary Policy for 2020.

We believe that political stability in a frontier market is crucial to the execution of banking sector reform initiatives. It is especially the case in Mongolia, where the IMF’s Extended Fund Facility programme that drove the reduction in banking sector vulnerabilities for three years expired in May 2020. The programme ended without concluding its reviews due to a prolonged period with insufficient progress in banking recapitalisation amid the coronavirus pandemic.

The announcement by the Bank of Mongolia (BOM) in late June on the merger of two of the country’s six domestic systemically important banks, Trade and Development Bank of Mongolia LLC (TDB) and Ulaanbaatar City Bank LLC, is evidence of the local regulator’s commitment to address the structural benchmarks under the previous IMF programme. The merger was partly the result of enforcing the Banking Law amendment of early 2018, which introduced restrictions on a shareholder having control of more than one bank simultaneously.

The merger was possibly one of the options the BOM had in addressing the two banks’ recapitalisation as the central bank also enforced the liquidation of Capital Bank, a small bank that failed to recapitalise, following a forensic audit exercise requested by the IMF. However, we note that there has been a lack of official update on the follow-up work, including whether the new TDB is required to take further remedial action under the forensic audit.

We expect further banking consolidation in the near-to-medium term as the BOM is increasing the capital requirements for banks, with minimum paid-in capital rising to MNT100 billion from MNT50 billion by end-2021. Moreover, the serious discussion by the incumbent politicians prior to the election over reducing shareholder concentration to improve corporate governance suggests the country’s smaller banks may merge with each other in order to meet both requirements.

Local media reports indicate that the government may introduce additional legislation to restrict a single shareholder from owning more than a 20% stake in a commercial bank. We believe such a reform will improve corporate governance at individual banks and contribute towards enhancing the banking sector’s stability. Currently, only XacBank LLC (B/Stable) out of the 12 commercial banks in Mongolia can meet the 20% rule immediately.

In the area of corporate governance, we believe that Mongolia has been making noticeable improvements in anti-money laundering and counter-terrorism financing as regulators have increased sanctions and remedial actions for identified violations. The authorities’ goal appears to involve making further inroads in this direction, with Mongolia being on and off the global Financial Action Task Force’s grey list since 2011. (Fitch)