Mongolia: Banking Sector Rehabilitation and Financial Stability Strengthening Program

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Lessons

Implementation of finance sector reforms is a long process requiring the commitment and coordination of many stakeholders.

The program underlined some key realities of finance sector reform. It is a long process requiring the commitment and coordination of many stakeholders. Benefits of policy actions and reforms are unlikely to appear instantly. Completed steps often need additional support for the reform process to progress and/or to be built upon before the full positive results will emerge. To illustrate, the program’s nonperforming loan (NPL) ratio reduction target was not reached within the initial 2-year reporting period, although the legal and regulatory frameworks to achieve this had begun to be put into place. The draft law for creating an asset management company to clear such loans from balance sheets was introduced in Parliament, thus meeting the policy action requirement, but the effects on NPL levels and the impact on financial intermediation and economic growth cannot be felt until it is approved by the government, and the mechanism is actually in operation. The program helped steady the banking industry and build some resilience to shocks, but Mongolia’s economy and finance sector will remain vulnerable to shifts in volatile commodity prices.

Project Cycle Stage:

Preparation

Implementation

A well-considered, deliberate, and cumulative approach, built on lessons learned, and continued engagement by ADB, are needed to sustain the banking reform process in Mongolia.

ADB must continue to work closely with the government and other stakeholders as Mongolia moves to fully adopt international best practices and standards for its finance sector. ADB is considered the lead development partner in finance sector reform and has built solid relationships with sector stakeholders. These relationships were key to quickly identifying risks and promptly formulating this program’s policy actions and outputs. They can continue to inform effective intervention designs in the future. The program’s relevance and efficiency were built on lessons from previous ADB operations in Mongolia, and this should also be the case for any future ADB interventions.

Project Cycle Stage:

Preparation

Implementation

The complex challenges involved in reducing the NPL ratio in Mongolia’s banking sector require continuing dialogue and close coordination and cooperation among development partners.

Progress on legal reform to allow Mongolia’s banks to deal with NPLs more rapidly was slow, in part because the political will to pass the needed legislation declined. Underlying factors include the negative overall public perception of the banking industry and the cyclical upturn in the economy which reduced the urgency to resolve matters holistically. Addressing these complex challenges would require continuing dialogue and close coordination and cooperation among development partners. It is particularly important that ADB, the International Monetary Fund, and the World Bank build consensus on how to approach the problem so that the advice they provide the government is sound and coherent. This cooperation should include data and information sharing to ensure that all partners are analyzing problems and formulating solutions and recommendations using the same basic knowledge and understanding.

Project Cycle Stage:

Preparation

Implementation

The One ADB approach facilitates the preparation of successful programs.

The One ADB approach proved critical in the successful design of this program. The program team included staff from ADB’s Economic Research and Regional Cooperation Department (ERCD) who participated in the reconnaissance and fact-finding missions and the loan negotiations. ERCD’s extensive research on previous approaches to high NPL levels taken elsewhere in Asia and globally highlighted the key elements of success that the program incorporated from inception.

Project Cycle Stage:

Preparation

Implementation

Background

Mongolia’s economy is heavily dependent on mining and vulnerable to shocks. It experienced a rapid downturn in 2016 due to the declining commodity prices and decelerating growth in the People’s Republic of China, the country’s neighbor and largest trading partner. These and other factors precipitated a steady decline in gross domestic product growth, from 17.5% in 2011 to only 1% in 2016. The weak economy threatened the solvency of the banking industry, depressed business conditions, and led to a rise in nonperforming loans (NPLs).

At government’s request, the Asian Development Bank (ADB) approved a $100 million policy-based loan for the Banking Sector Rehabilitation and Financial Stability Strengthening Program in May 2017. The program was designed to help stabilize and restructure the banking industry, strengthen financial stability, and enhance competition among banks. Its intended impact was aligned with the objective of the government’s Economic Restructuring Program to achieve a well-developed, stable finance sector that helps the poor and vulnerable. Its intended outcome—a strengthened and stabilized banking industry—was to be achieved through the delivery of three outputs: (i) a framework for bank restructuring completed, (ii) financial stability enhanced, and (iii) competition and governance strengthened. These outputs were to be achieved through 12 policy actions, complied with before loan disbursement.

Under output 1, a draft law was submitted to parliament to create an asset management company (AMC) that would enable rapid NPL resolution, but this has not yet been approved. The legal framework was updated to support bank efforts to collect on loans. However, international experience has shown that banks facing NPL ratios as high as those in Mongolia have been unable to solve the issue on their own and have instead needed to transfer bad loans from their balance sheets to AMCs.

Bank recapitalization undertaken mostly under an International Monetary Fund (IMF) program has been challenging. The banks identified for recapitalization reported new capital infusions in June 2019, but the IMF raised questions on the propriety of the funding sources and the regulatory compliance. While the ADB and IMF programs had differing primary emphases—ADB on reduction of NPL levels, and the IMF on bank recapitalization—these are complementary objectives and challenging to achieve in the short run. The debt restructuring concept introduced under the program was found by an associated ADB technical assistance (TA) to be likely ineffective in Mongolia because too few of the corporate NPLs were syndicated. The concept entailed allowing major corporate borrowers and their multiple lenders to reach feasible uniform resolution of large debts through an inter-creditor framework

Under output 2, an amendment to the law that governs the operation of the Financial Stability Council (FSC) was supported. Among other things, the amendment enables the FSC to expand its membership to include the Deposit Insurance Corporation of Mongolia (DICOM). Amendments were likewise made to banking regulations to bring them into compliance with international standards.

Under output 3, the government took steps toward the privatization and restructuring of the State Bank. The required resolution was adopted by parliament, and a step-by-step plan for the privatization was agreed between the Bank of Mongolia, the Ministry of Finance (MOF), and DICOM. Options on how to proceed, based on a full feasibility study completed under the associated TA from ADB, were presented to the MOF. The government has yet to prepare the details of the privatization plan. With a new government in place after the June 2020 elections, this matter is expected to be taken up as part of the draft Banking Sector Reforms that will be submitted to parliament.

Because of the incomplete delivery of many output targets, the project was able to only partially achieve its intended outcome. As of program completion review, the industry’s loan growth was again positive—the biennial rate to December 2018 was 38.1%, up from –1% in December 2016. However, the other outcome indicator of a fall in the NPL ratio was not met: the NPL ratio was 10.4% in December 2018 and 10.1% in December 2019, exceeding both the 2016 baseline (8.5%) and the target for December 2018 (8.0%). Further work is required to deal holistically with NPLs, bank recapitalization, and bank supervision and risk management practices. The banking sector has been strengthened and instability reduced, but more time and effort are needed before it can be considered strong and fully stable.

Overall, more time is needed before a full assessment of the project outcome can be made. The changes that came about through the policy actions to the legal and regulatory framework and environment should reduce NPL levels in the longer term, but other reforms must happen before the full effects can be realized. A full rebound in financial intermediation is also unlikely until NPLs are further resolved

The MOF was the executing agency responsible for overseeing and coordinating the timely implementation of all policy actions, although this responsibility was shared in some cases with the BOM.

Project Information

Project Name:

Banking Sector Rehabilitation and Financial Stability Strengthening Program

Report Date:

July, 2020

Main Sector:

Finance

Country:

Mongolia

Project Number:

51054-001

Report Type: