2. Banking in the Kyrgyz Republic
This chapter describes the challenges facing the Kyrgyz banking system. It then briefly explains why financial access and use of formal financial instruments are important for economic development. It suggests ways to increase financial access in the Kyrgyz Republic. Several instruments are proposed to improve financial literacy; to provide affordable, targeted financial products by lowering credit risk, alleviating collateral constraints and pooling demand; to increase trust in financial institutions; and to improve access to physical banking infrastructure. Some of these instruments already exist in the country and could be scaled up. Others have worked in countries from the region and beyond, and could be adopted.
As one key area of focus, this report aims to understand the demand for and use of green financial instruments. If there is little use of financial products and services in general, then use of green financial products and services (a subset of financial instruments) will also be limited. Widening access to and use of green financial products and services therefore needs to go hand in hand with development of the financial market in Kyrgyzstan. A functioning financial market where households and businesses actively use financial products and services is in many ways a precondition for introducing elements of green finance.
When compared with other countries in the region, the Kyrgyz Republic’s financial development1 is at par with Tajikistan but lags behind Uzbekistan and Kazakhstan (Yamano et al., 2019[1]). Credit to the private sector as a share of gross domestic product (GDP) has almost doubled since 2011, from about 12% to almost 24% in 2018. However, Kyrgyzstan still ranks low in credit and deposit penetration compared to other countries in the Europe and Central Asia region and compared to other lower middle-income countries (Figure 2.1). Financing is mostly short term and concentrated in a few sectors (trade and agriculture), and the cost of financing remains expensive (Yamano et al., 2019[1]).
Source: International Monetary Fund, International Financial Statistics; World Bank and OECD GDP estimates, 2020.
In the latest round of World Bank surveys with business owners and top managers in Kyrgyzstan, around 20% of enterprises identified access to finance as a major constraint for business growth (World Bank, 2020[2]).
The survey prepared by the OECD that forms the subject of this report explores in depth the reality for households rather than for businesses. The situation of households, however, mirrors conditions for enterprises in terms of access to and use of financial services in two ways. First, households and entrepreneurs face similar obstacles. Second, household members are often business owners. Almost 420 000 individual entrepreneurs were operating in the Kyrgyz Republic as of October 2020 (compared to 12 000 small and medium-sized enterprises [SMEs]) (National Statistical Committee of the Kyrgyz Republic, 2020[3]). Individual entrepreneurs contribute more than 20% to GDP and their share might be higher given the large informal sector; 60% of agricultural producers are SMEs (Holzhacker and Skakova, 2019[4]). SMEs contribute more than 40% to Kyrgyz GDP. However, their actual contribution is likely higher because of the large informal economy mentioned above and further explained below (Holzhacker and Skakova, 2019[4]).
Commercial banks dominate the banking sector in Kyrgyzstan. As of December 2020, 23 commercial banks and over 300 of their branches operated in the Kyrgyz Republic (National Bank of the Kyrgyz Republic, 2020[5]). Banks account for almost 90% of financial system assets and provide about 80% of credit to the private sector (OECD, 2019[6]). With the exception of microfinance organisations, other financial institutions such as insurance providers, securities and brokerage firms play a marginal role. In addition, capital markets are shallow, including the government securities market (OECD, 2019[6]).
The microfinance sector was established with the help of international donors (OECD, 2018[7]). Half of its credit resources for loans still comes from international donors (OECD, 2019[6]). The number of microfinance organisations has decreased significantly since 2011 (OECD, 2019[6]). This decline followed a period of consolidation, during which the National Bank of the Kyrgyz Republic withdrew licences of over 100 microfinance organisations and a few of them became banks. In September 2020, the sector consisted of slightly over 130 microfinance institutions and around 95 credit unions (National Bank of the Kyrgyz Republic, 2020[8]). Only eight credit unions had a licence to attract deposits in 2016 (National Bank of the Kyrgyz Republic, 2018[9]). Credit unions operate mostly in rural areas and small towns and their lending focuses mainly on agriculture and trade (National Bank of the Kyrgyz Republic, 2018[9]).
A number of obstacles prevent wider access to and use of financial products and services. These include lack of financial infrastructure, an informal economy, low trust and low financial literacy rates among the population. They are described briefly in turn.
First, due to high poverty rates in Kyrgyzstan, a high proportion of households do not have enough savings to justify a bank account (OECD, 2019[6]). Half of respondents in the 2017 World Bank Findex survey in the Kyrgyz Republic gave lack of money as a reason for not having a bank account (Demirgüç-Kunt et al., 2018[10]).
Second, trust in the financial system is low. People, especially the older generation, have lost their savings in the banking crises of the 1990s when several Kyrgyz banks became insolvent (Fitzgeorge-Parker, 2018[11]). Many people prefer to keep their money in traditional ways, i.e. “under the mattress” (OECD, 2019[6]). The Findex survey (Demirgüç-Kunt et al., 2018[10]) found that almost a quarter of the Kyrgyz population saved some money, but only 3% of them did so at a financial institution. According to OECD (2019[6]), the population also has limited knowledge about the deposit protection system in the Kyrgyz Republic. Established in 2008, the Deposit Insurance Agency in co-operation with Kyrgyz banks operates a deposit insurance system. This system is mandatory for all commercial banks and protects deposits up to KGS 100 000 in case of a default (Tovar-García and Kozubekova, 2016[12]).
Third, the Kyrgyz Republic has a large informal sector with two-thirds of the total workforce estimated to work informally, 80% of them in agriculture (OECD/ILO, 2017[13]). For the financial services sector, this means that most transactions are cash-based without need for a bank account. It also means people may feel they lack the needed documents to open a bank account (e.g. wage slips) (Hasanova, 2018[14]; OECD, 2019[6]). Opening a bank account, however, is free of charge and only requires a passport at many Kyrgyz banks. Therefore, a lack of a wage slip should not be an obstacle.
There are also informal financial service providers such as pawnshops, moneylenders or relatives where people borrow money (Hasanova, 2018[14]). The informality is strongly driven by the lack of trust in banks mentioned previously. Some Kyrgyz villages still practise a rotating savings and credit system established in Soviet times that involves close relatives, friends or neighbours. In this system, known as “chyornaya kassa”, members pay into a common pot over a predefined period of time (Mamadiyarov, 2018[15]; Ibraimova, 2009[16]). At the group’s regular meetings, the pot’s lump sum is given in turn to each contributor for their personal use until every member has had a turn in using the funds (Mamadiyarov, 2018[15]). The system relies exclusively on trust among its members, which can be a powerful tool to sanction misbehaviour such as default. It has been set up specifically to avoid reliance on formal banking institutions (Mamadiyarov, 2019[17]; Imami, Rama and Polese, 2020[18]).
It is unlikely these informal credit systems compete directly with those offered through formal financial institutions. This is especially true in light of the distrust towards banks and lack of access to formal financial institutions in rural areas (see point four). Rather, these informal systems suggest the need to improve the supply of formal financial products and services that are seen as viable and attractive alternatives. At the same time, these practices show that people in Kyrgyzstan do have experience with financial products and services, if not formal ones. Commercial banks and other financial operators can build on existing experience to improve financial literacy.
Fourth, access to banking facilities is a big barrier. Penetration of bank branches and services, although expanding, remains restricted (OECD, 2019[6]). Five commercial bank branches are available per 100 000 Kyrgyz adults on average (Table 2.1). Branch distribution varies depending on oblast but overall lags behind other countries in the region. In Europe and Central Asia (excluding high-income countries), 25 branches are available per 100 000 adults on average (IMF, 2020[19]). People in remote areas in Kyrgyzstan in particular have limited access to banking services, including payment and transfer services and deposit facilities. High costs associated with operating branches in rural areas pose a major obstacle to increasing access to physical banking infrastructure (OECD, 2019[6]).
In sum, the evidence to date shows that parts of the Kyrgyz population save money or have experience with borrowing money but have limited use of formal financial services. Lack of physical banking infrastructure adds additional barriers. The OECD household survey collects more evidence on the barriers. The next two sections lay out the rationale for overcoming obstacles to wider access to and use of financial products and services, as well as proposing measures to do so. Subsequently, the survey design is presented.
Wider and deeper penetration of banking services can help with economic development. Households or firms find it difficult to finance significant investments without access to financial markets because their own capital is usually limited. While not a substitute for functioning social policy and support, the ability to access financial services, including external finance, therefore can help expand opportunities for those with less financial and social capital (e.g. a social network/ connections), for poverty alleviation and for allowing new firms to access the market (World Bank, 2014[20]; Yoshino and Morgan, 2017[21]). In particular, poorer households can benefit from instruments to manage cash more efficiently and to smooth consumption (Yoshino and Morgan, 2017[21]; World Bank, 2014[20]). While credit can help households to address risks, it cannot act as a substitute for a functioning welfare state that protects vulnerable groups from social, economic and health risks (Wiedemann, 2021[22]).
Ensuring that households and firms have access to and use financial services is a precondition of an efficient economy. In addition, increased transparency associated with electronic funds transfers can help reduce corruption (Yoshino and Morgan, 2017[21]), and thus help increase trust in the (financial) system. Evidence has shown that lacking access to financial market services restrains the growth of small entrepreneurs who lack collateral, credit histories and connections (Aterido, Hallward-Driemeier and Pagés, 2011[23]; Beck, Demirguc-Kunt and Martinez Peria, 2005[24]). Empirical evidence has also confirmed this relationship holds true in the other direction, i.e. small firms grow faster in more financially developed markets (Beck et al., 2008[25]). Improving their access to finance is associated with innovation, job creation and growth (World Bank, 2014[20]). This is relevant for Kyrgyzstan with its high share of individual entrepreneurs and SMEs, as discussed above.
Financial depth, i.e. the availability of financial instruments to investors and the existence of sound financial institutions, contributes to growth (Mahmood and Rehman, 2019[26]; Masoud and Hardaker, 2012[27]). Existing evidence stresses, however, that regulatory and supervisory authorities need enough expertise to manage the expansion of the financial sector for growth to materialise (Rioja and Valev, 2004[28]). Relevant for the Kyrgyz context, higher penetration of bank branches and automated teller machines (ATMs) and wider use of loan services are generally associated with lower financing obstacles, even after controlling for financial sector depth (Beck, Demirguc-Kunt and Martinez Peria, 2005[24]).
There are multiple ways to increase access to and use of financial products and services. Some instruments increase financial literacy. Others provide affordable, targeted financial products by, for example, lowering credit risk, alleviating collateral constraints and pooling demand. Still other instruments increase trust in financial institutions and improve access to physical banking infrastructure. These four instruments are considered in turn in this section.
Increasing financial literacy
Financial literacy is the knowledge and ability to choose financial products and services that help people manage their capital adequately. Equipping users with more financial literacy can increase use of financial services. Kyrgyzstan has recognised the importance of improving financial literacy, adopting its Programme to Improve Financial Literacy in the Kyrgyz Republic for 2016-2020 in 2016. As of 2020, it was developing the National Financial Inclusion Strategy (2021-2024), which includes a component on financial literacy. As part of the existing Programme to Improve Financial Literacy, several education programmes target younger children and middle-aged adults to improve financial literacy. A website was developed (www.finsabat.kg) where people can inform themselves about different aspects of financial literacy, including budget planning and consumer protection rights. Training comics for children are accessible via the website. Employees of the National Bank travel to different regions and train teachers who give financial literacy classes at schools (Kudryavtseva, 2019[29]). As of 2019, about 500 teachers had been trained and teach financial literacy classes to students (Kudryavtseva, 2019[29]). In addition, financial education centres are being trialled in 17 rural areas in pilots run by the National Bank and the United Nations Development Programme (Kudryavtseva, 2019[29]).
When the national Programme to Improve Financial Literacy is developed for the years after 2020, it can build on and scale up these important steps. Overall, the training materials need to explain clearly why and how financial institutions are safer and cheaper to use compared to cash-based transactions or informal services. In doing so, financial literacy should be connected to other socio-economic development goals. For example, financial literacy trainings and training materials could highlight the benefits of investing in clean technology or fuels, improved energy efficiency, more resilient crops or drip-irrigation for well-being and economic development.
Cases in other countries have shown that financial education per se is insufficient to get individuals to take up formal (or informal) financial products (World Bank, 2014[20]). However, combining general financial literacy interventions with measures that allow individuals to set their financial goals and get access to individualised financial counselling has benefits. This practice significantly increases take up of financial products such as bank accounts, reduces borrowing for private consumption and improves understanding of interest rates on loans (World Bank, 2014[20]; Carpena et al., 2017[30]).
There are other ways to scale up efforts to increase financial literacy in the Kyrgyz Republic. The country could develop mobile apps for financial management or promote existing ones. This would allow people to set their financial goals and track their spending on their mobile phones. It could set up individual financial counselling, including virtually for people in remote areas. Finally, it could engage commercial banks in these efforts.
Another country-wide example has shown that training community members as trainers of financial literacy achieves more change in saving behaviour than training loan officers as trainers (Hakizimfura, Randall and Zia, 2018[31]). The Kyrgyz programme mentioned above that trains teachers is a good example of engaging local community members. The National Bank could consider engaging other community members as well, such as shop owners.
Providing targeted and affordable financial products
Efforts to increase financial literacy must be backed up by attractive financial products that cater to the demands of potential clients, are affordable and are easy to understand. Supplementary financial instruments such as movable asset-based lending or credit guarantees could help alleviate collateral constraints. These options will be explored in more detail in Chapter 5.
Access to credit also improves when the legal, regulatory and institutional framework makes it easy to create and enforce collateral agreements and to increase information about potential borrowers' creditworthiness (World Bank, 2019[32]; OECD/ERIA, 2018[33]). Lenders look at a borrower’s credit history and collateral. When reliable and relevant data on borrowers’ credit histories are available, financial institutions are more likely to provide a loan (World Bank, 2019[32]). They can also charge lower interest rates because credit risk is lower. This is why credit reporting systems play an important role. They allow lenders to retrieve the credit histories of prospective borrowers and other registries that record the ownership and value of assets, both immovable and movable (OECD/ERIA, 2018[33]).
In Kyrgyzstan, the credit reporting agency was transformed from a public entity into a commercial one in 2003. The Ishenim Сredit Bureau collects and stores data on the repayment history, unpaid debts or credit outstanding of listed individuals or firms to help reduce credit risks (Ishenim CJSC, 2020[34]). According to World Bank (2020[35]), the credit bureau holds information on credit histories of around 40% of adults in the Kyrgyz Republic. This is an encouraging number.
Expanding information collection to additional data providers could lead to more individuals and firms within the credit bureau’s data. In Jamaica, for example, non-bank entities were included in the credit reporting regime (OECD/ERIA, 2018[36]). It significantly expanded the credit bureau’s database to cover a wider section of consumers, including those without a bank account, and also increased the number of credit reports issued (OECD/ERIA, 2018[36]). In Kyrgyzstan, around 50 microfinance providers, 20 credit unions and 1 mobile service provider already contribute data to the Ishenim Credit Bureau (Ishenim CJSC, 2020[34]). Utility companies (e.g. water, electricity, telecommunications) and any other business that holds information on consumers’ (re)payment histories could feed into the credit reporting regime and therefore increase coverage and depth of relevant information. Such businesses could include mobile service providers, as well as the remaining microfinance institutions that operate in the Kyrgyz Republic.
Kyrgyzstan also has a land registry in place, as part of the State Agency for Land Resources under the Kyrgyz government. Local offices hold data on immovable assets, i.e. land and real estate. According to World Bank Group (2020[37]), it is easy to register property in Kyrgyzstan. Banks can request information on property rights by signing an agreement with the State Agency and against a fee. They can access the data on line. Overall, it seems like Kyrgyzstan has working credit reporting systems that provide a strong base for increasing depth and coverage of information. In general, credit reporting should be underpinned by a strong legal framework that provides for credit information sharing among lenders and restricts access to customers’ information without their consent (OECD/ERIA, 2018[36]).
Credit risk for lenders can be reduced in several ways. Access to reliable and comprehensive asset registries is one option. In addition, comprehensive and strong creditor rights and secured transaction frameworks will guarantee partial repayment in the event of loan default (OECD/ERIA, 2018[33]; World Bank, 2015[38]). Here, Kyrgyzstan still lacks an integrated or unified legal framework for secured transactions (World Bank Group, 2020[37]). There is also no specific, out-of-court compensation mechanism to cover for losses incurred by parties who engaged in good faith in a property transaction based on erroneous information certified by the immovable property registry (World Bank Group, 2020[37]).
Kyrgyzstan can try to improve the legal framework for creditors. Evidence from Indonesia has shown that financial institutions should be involved in the creation of a functioning transaction framework. This will ensure they see it as a useful risk-management tool (World Bank Group, 2017[39]). Awareness-raising activities with government agencies and the public are also vital to promote financing based on movable assets (World Bank Group, 2017[39]).
Building trust
High quality service and affordable products and services also help increase trust in the banking system. Promoting the Kyrgyz deposit protection system more widely among potential clients of financial institutions would also increase trust.
Improving physical infrastructure
Improving the physical infrastructure for financial products and services would allow more people to access them. As one way to overcome barriers to setting up more local bank branches, existing physical infrastructure could be used to provide banking services. Local post offices, for example, could be adapted to offer at least limited financial services (European Investment Bank, 2012[40]) With 900 local outposts, post offices have much wider geographic coverage in the Kyrgyz Republic than commercial banks, microfinance institutions and credit unions combined (Fitzgeorge-Parker, 2018[11]).
Many among the Kyrgyz population frequently use stationary self-service payment terminals. The terminals are available in shopping centres, small shops, government agencies and financial institutions across Kyrgyz regions. In 2018, 20 licensed providers were operating over 4 000 terminals (Hasanova, 2018[14]). They allow users to pay for their mobile and Internet providers, utilities and cable TV; to top up their electronic accounts, including some financial accounts (e.g. bank accounts from commercial bank Bai Tushum); and to pay back credit (FINCAbank, 2015[41]). The volume of operations with self-service terminals constituted 52% of the non-cash money stock in 2016, exceeding KGS 23 billion (Hasanova, 2018[14]). This indicates that terminals already provide an alternative to physical banking facilities such as ATMs and banking branches and also to digital services. Given these self-service terminals are widely accessible and popular, equipping them with basic deposit and transaction applications would be an easy way to increase access to financial services.
Increasing use of mobile banking (i.e. using a mobile device to access a financial account or make a financial transaction remotely) is another way to improve logistics of delivering banking services to households without building new bank branches. In remote areas of Kyrgyzstan, where ATMs and bank branches are frequently unavailable, mobile banking could increase penetration of banking services at a lower cost than physical infrastructure. This could be an option either while physical banking infrastructure is being set up or as a permanent alternative. This is particularly relevant for rural areas cut off for months at a time during winter. Currently, 4G networks cover over half of Kyrgyzstan (Paul Budde Communication, 2020[42]) whereas access to broadband Internet is still limited. Only 3% of the population had access to fixed broadband Internet in 2014 (and mainly in Bishkek) and 21% had access to wireless broadband (Digital Report, 2018[43]). While these numbers may be higher now, broadband connections will likely only be catching up with mobile networks.
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Note
← 1. Financial development is defined as a combination of depth (size and liquidity of markets), access (ability of individuals and companies to access financial services) and efficiency (ability of institutions to provide financial services at low cost and with sustainable revenues, and the level of activity of capital markets) (Svirydzenka 2016 cited in Yamano et al., 2019).