Transforming banks to joint-stock companies? www.jargaldefacto.com

At the beginning of this year, Mongolia is about to change laws to decrease the ownership concentration of commercial banks. Five systemically important banks (those accounting for more than 5% of combined bank assets) will become publicly traded banks by mid-2022. The remaining seven banks will become joint-stock banks by 2023 with shares of each owner not exceeding 20%. It is time that the public gains awareness and supports the reasoning behind its dramatic reform to “eliminate” the dominance of a few owners, and understand what challenges can arise, and why it is beneficial for the economy. The need for reforms The twelve commercial banks’ high interest rates for both savings and loans have led to a scarce availability of loans for business enterprises, which ultimately is a failure to fuel the economy. The main cause is that most banks are owned by one or two individuals, leading to poor governance, lack of transparency, and shortage of funds. The continuous degradation of their governance is attributed to the fact that banks’ external and internal monitoring was dependent from the owners for a long time. Banks have become the actors that manipulate the economy, block business competition, and feed into injustice. The owners, who possess only 10% of the total assets, have kept the bank activities secret from the customers and society that make up the remaining 90% of the assets. Commercial banks obtain confidential information from individuals and business enterprises to exploit them to the advantage of their owners’ various business interests. Mongolia’s major banks now primarily serve their owners’ businesses interests, eradicating fair competition. Large banks only use the cars and food that their owners import, operate on their properties, and provide loans for their construction projects. Besides, the owners embezzle public funds and conspire with the authorities to implement large infrastructure projects such as railways. Meanwhile, small banks have gone bankrupt after stealing funds from the state treasury. Consequently, non-performing loans make up more than 10% of the portfolio, while loan loss reserves and the bank’s equities have long been deficient. After being overwhelmed by foreign debt in 2017, Mongolia has borrowed money (EFP) from the IMF and made a commitment to improve the quality of the assets of commercial banks and to increase them. After the audit commenced by the reputable international company Duff & Phelps, it was concluded that 90% of the increased equity does not meet the international banking criteria. However, this report is still kept secret from the public by the Central Bank. As a result, only the initial funding of 450 million USD and half of the additional 5 billion USD worth of grants and loans were provided by the IMF. The program was unsuccessful. Mongolia was even enlisted in FATF’s grey list for a short period. Due to all these reasons, the Central Bank of Mongolia has lowered its key interest rate by 500 units, but still, commercial banks lack the funds to issue loans. Moreover, the global pandemic has interrupted businesses since the 2020 with consecutive lockdowns, inflicting damage to the national economy and health. The challenges Although the banking reform is heading towards the right direction, its implementation is set to face challenges such as valuating the assets correctly, preventing from causing undue losses to the current owners, and gaining trust from the investors in order to be able to sell its shares. To determine the fair valuation of banks, it is first necessary to cover bad and low-quality loans with the loan loss reserves and its own equity, in order to write them off the bank’s balance sheets. In South Korea, after the 1998’s crisis, the Korea Asset Management Corporation (KAMCO) was established, and the state was buying up collateral for bad loans to get out of the crisis. For Mongolia, if corruption still prevails (Mongolia ranked 111th out of 181 countries on the corruption index as of 2020), there is a high risk that politicians will influence the corporations and supply it with overpriced, low-quality properties. To earn the trust of investors, banks must be separated from businesses or loans affiliated to their owners entirely while ensuring professional and independent management is in place. Without trust, nobody will take a risk buying the bank’s stocks. There are many ways to assess a company’s value before the Initial Public Offering (IPO). The simplest one is to assume the current profit to continue for ten years. The total profit of Mongolia’s 12 commercial banks was 290 billion tugriks (Central Bank of Mongolia data) in 2020. The market capitalization of the system was almost 3 trillion. Therefore, if 80% of that is sold, the current owners will earn 2.4 trillion tugriks. This process would not be a confiscation or theft of their wealth, but rather a fair purchase with actual prices. The capital would make its way to the stock market through funds and would be used to buy shares in businesses other than banks. If all the steps are taken appropriately by international standards, even foreign investments can be attracted, bringing management know-how with it. If things go wrong, investors will not buy banks’ shares, and therefore, the requirement set by the Law of Mongolia on Commercial Banks to have more than five owners cannot be complied with. What measures can the Central Bank of Mongolia then take in that instance? The benefits Fair competition and low interest rates can be a reality only when commercial banks cease to serve a handful of owners and their businesses. Instead, they must have numerous owners, stay free of corruption, and maintain good governance and controlling that ensures transparency. Lower interest rates will allow citizens and business enterprises to expand their businesses and increase their consumption. The availability of low interest rates for loans is the most required condition for our economy to prosper. As businesses grow, more jobs will be created, poverty and unemployment will decrease, and new technologies will be introduced. Furthermore, companies will have increased competitiveness and greater ability to export their products and services. Therefore, limiting the shares of the shareholders is a beneficial decision for all - the banks, the bank owner, the businesses, and the country’s economic development. Currently, 50 countries limit the shares of bank ownership, of which 16 have 20%, 6 have 15%, 4 have 10%, 5 have 5%, and 2 have less than 5% (“Banks and Bank Systems” Journal. 06 February 2009) as the maximum share an owner can possess. 2021.02.03 By: D.Jargalsaikhan Trans. by Riya.T and Munkh-Erdene.D

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