Moody”s Investors Service says that the outlook on the Mongolia banking system remains negative, reflecting the expectation of continued weakness in Mongolia”s key commodity exports, namely coal and copper, which account for 88% of its exports and 20% of its GDP.

“While oversupply and weak global prices in the steel and coal sectors constitute a primary and external pressure point, our outlook also takes into account the Mongolian government”s aggressive macroeconomic measures to support the economy against the resultant growth headwinds,” says Hyun Hee Park, a Moody”s Analyst.

Park was speaking on a just-released Moody”s report, titled “Mongolia Banking System Outlook”, which expresses Moody”s expectation of how bank creditworthiness will evolve in this system over the next 12-18 months.

The report looks at the banking system in the five categories of operating environment; asset quality and capital; funding and liquidity; profitability and efficiency; and systemic support. Moody”s assesses systemic support as stable, but considers the other four categories to be deteriorating.

While Moody”s central scenario assumption is for the economy to maintain an annualized real growth pace of 11% in the coming 12-18 months, this growth will be powered by the government”s ongoing pump-priming measures, some of which are heavily credit-driven.

Specifically, aside from policy rate reductions and fiscal spending, the government also provided MNT4.3 trillion in loans to the banking system as of end-2013, representing about 40% of total credit. These loans were extended to the banking system for on-lending to targeted industries. As a result, bank assets grew rapidly by 74%, and loans by 54%, in 2013.

“A continuation of the current credit growth pattern increases risks to the banks” liquidity, capitalization and profitability,” adds Park.

Current cyclical headwinds have exacerbated the system”s vulnerability. As such, Moody”s expects asset performance to deteriorate further in 2014, as the mining sector remains under pressure, and while the current credit boom seasons.

The liquidity and capital conditions of Mongolian banks have continued to tighten — despite liquidity injections by the Bank of Mongolia (BOM) in 2013 — as loan growth has exceeded both growth in deposits and expansion in internal capital sources.

In particular, the foreign currency loan-to-deposit ratio jumped to a record high of 112% in late-2013. In a system where foreign currency deposits account for 23% of total deposits, this development highlights the risks faced by the system, especially in the context of a sharp depreciation in the MNT.

Moody”s report further states that the system”s profitability will likely shrink, as banks lower their lending rates to support the government”s accommodative policy, while maintaining relatively high deposit rates to stem their deteriorating funding profiles.

Yet, the banks are also vulnerable to potential changes in economic policy, given the instrumental role that the BOM has played in the past year to support both the banks and economy.

In Moody”s view, if the BOM withdraws from its current policy lending role, it will leave a re-financing gap equivalent to as much as 22% of banking system liabilities as of end-2013.

Moody”s expects the government to support deposits at those banks considered to be of high systemic importance to the economy. However, potential government support to bank non-deposit creditors is less predictable given the experience of bank resolutions in Mongolia.

The negative outlook on the banking system is in contrast to Mongolia”s stable sovereign outlook. The sovereign outlook places more emphasis on the country”s strong growth potential and its abundant mineral resources, despite Moody”s negative outlook for the banking system.

Source: moodys.com