The process of deposits de-dollarization slowed in July, given the mom increase in retail FX-deposits (expressed in terms of US dollars), which is probably attributed to spikes in the currency market. Corporates responded rapidly to the FX-rate changes, and its FX-deposits mom growth appeared to be more significant. On July 11 the National Bank lowered the base rate from 15% +/- 1pp to 13% +/- 1pp. However, the effect of reducing the base rate is weakly expressed.

Monetary policy and foreign exchange market. In July, the banking system had enough liquidity.  The volume of withdrawn Tenge liquidity amounted to T2.3 trln.

The national currency against the US dollar weakened by 13.6 Tenge mom to 352.2USDKZT. The volume of trade in the FX-market amounted to $ 2 251mn in July (-15.5% mom). The participation share of the National Bank in the FX-market amounted to $ 199mn of currency net sales (8.8% of the total USDKZT trades).

The banking sector's assets and deposits, depository organizations’ deposits. Banks’ assets increased by 3.9% mom to T25.4 trln (+ 6.8% ytd) due to deposits inflow (+ 5.6% mom to T17.3 trln; + 10.7% ytd).

Depository organizations’ deposits increased by 6.4% mom and 12.1% ytd to T17.9trln. At the same time, the growth adjusted for exchange rate changes was 4.1% mom and 9.7% ytd.

Probably, spikes in the currency market in July affected the households' and businesses' devaluation expectations. The de-dollarization process slowdown of retail deposits is confirmed by the mom increase in retail FX-deposits expressed in US dollar terms. Dollarization of retail deposits was 67.8% at the end of July, up from 67.5% at the end of June (80.1% in January 2016).

Since the businesses respond faster to changes in the economy, the growth of corporate FX-deposits, expressed in US dollar terms,  appeared to be more significant (+ 8.0% mom, -5.5% ytd) compared with the retail FX-deposits (+ 0.7% mom, -10.6% ytd). Dollarization of corporate deposits equaled to 52.5% at the end of July, up from 50.5% at the end of June (62.1% in January 2016).

We expect growth in client’s deposits by 10-15% in 2016, which will be supported, to a certain extent, by enhanced public expenditures and the National Bank's policy to increase attractiveness of the national currency.

The loans of the banking sector and credit to the economy. Credit to the economy increased by 2.3% mom and 0.5% ytd to T12.7 trln. The adjusted for exchange rate changes growth of credit to economy was 0.9% mom and 0.7% ytd.

The banking sector's loan portfolio amounted to T15.7 trln (+2.3% mom, +0.8% ytd). We believe that lending remains constrained by liquidity withdrawals by the National Bank, low demand for credit, high base rate and the risk of asset quality deterioration. According to the credit market survey of banks, which was conducted by the National Bank, respondents expect the retention of moderately-tight non-price terms of borrowings and, at the same time, the reduction of interest rates on loans in 3Q2016.

We expect the banking sector's loan portfolio growth to be in the range of 0-5% in 2016. However, we expect the emergence of the weak signs of lending recovery by the end of 2016 due to the effect of the base rate reduction. On July 11 the National Bank lowered the base rate from 15% +/- 1pp to 13% +/- 1pp.

Our expectation of 10% share of non-performing loans by the end of 2016 is supported by our view that lenders and borrowers started to adapt to the economic situation. The share of overdue loans in the loan portfolio of the banking sector equaled to 8.2% in July (8.0% in December 2015). The share of provisions in the loan portfolio was 10.2% in July, down from 10.6% in December 2015.

High base rate and the increase in the maximum interest rate on retail deposits in Tenge from 10% to 14% in February 2016 put pressure on the NIM (net interest margin) and NIS (net interest spread) indicators, which continued to fall in July.

Major changes in Top-10 banks.

The largest increase in assets in absolute terms was observed in Kazkommertsbank (+ T361bn, + 7.5% mom, + 2.5% ytd), which was followed by Tsesnabank (+T168 bn mom, + 8.4% mom, + 11.6% ytd). Among the top 10 banks, the assets narrowing was observed in Halyk Bank (-T78bn, -1.7% mom, + 8.4% ytd) and in Eurasian Bank (-T28.5 bn mom, -2.8% mom, -5.2% ytd).

The largest increase in deposits in absolute terms was observed in Kazkommertsbank (+ T422 bn, + 13.9% mom, + 6.0% ytd). The deposits growth in Tsesnabank amounted to T177bn, + 12.2% mom, + 21.4% ytd). The largest outflow of deposits in absolute terms was recorded in Halyk Bank (-T125 bn, -4.1% mom, + 9.1% ytd). The funding of large banks, such as Kazkommertsbank, Halyk Bank and Tsesnabank, was unstable, showing the most significant change in absolute terms In June and July.

Among the top 10 banks, the largest increase in loans in absolute terms was observed in Kazkommertsbank (+ T101 bn, + 2.6% mom, -0.0% ytd), which was followed by Tsesnabank (+ T55.5 bn, 3.6% mom, + 4.9% ytd). The credit portfolio reduction was observed in Kaspi Bank (-T4.0 bn, -0.5% mom, -9.1% ytd) and Fortebank (-T0.1nb, -0.0% mom, -4.3 % ytd).

Assets quality in ATFBank deteriorated significantly in July, showing 9.4pp spike in the share of NPLs (90+ days) in the loan portfolio over the month to 22.6% at the end of July 2016. We expect the banking sector's share of NPLs in the loan portfolio to be approximately 10% by the end of 2016 because of our view that the credit market’s participants started to adapt to the economic situation.

In July, Halyk Bank earned the highest net profit (T11.0 bn, T70.1 bn since the beginning of the year), ahead of Kazkommertsbank (T7.9 bn, T67.6 bn ytd). Eurasian Bank received T0.6 bn net profit for the month, but is still at a loss since the beginning of the year (-T57 bn).

Newly-introduced computation of regulatory capital came into effect since the beginning of June 2016, where the positive difference between the amount of retail deposits and 5.5 times equity on the balance sheet is deducted from regulatory capital (sum of Tier I capital and Tier II capital). Retail deposits (without adjustments for exchange rate) in Bank CenterCredit and Kaspi Bank exceeded 5.5 times the equity on the balance sheet, which, respectively, puts pressure on the regulatory capital.

We note the weak capitalization in Tsesnabank, Eurasian Bank, RBK Bank and Kazkommertsbank due to low capital adequacy ratios, given that the National Bank will toughen prudential normative requirements in 2017.

We also note weak capitalization in Bank CenterCredit and ATFBank, in view of the planned tightening of the requirements for regulatory ratios in 2017 and weak capital structure. Perpetual financial instruments and subordinated debt occupies significant part of the banks' regulatory capital, which will be gradually excluded from the calculation of Tier II capital since 2017 till complete elimination in 2019.

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