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Converse Bank makes a transition to conservative/aggressive method of lending


ArmInfo: The situation in the Armenian banking industry is improving. Having properly survived the peak of crisis and the threat of loss of profit, the Armenia based commercial banks had to seriously reconsider their approach to business processes and risk assessments. Among other large Armenian banks, Converse Bank with its new team of top managers made tough efforts to strengthen the market position since last year. The ArmInfo reporter met with Tigran Davtyan, the Chairman of Management Board of Converse Bank, and asked him to share his plans and estimates of the business environment.

Mr. Davtyan, today one of the essential problems for banks in my opinion is the accurate economic forecasting and consequently the credit risk management. You deal with money in the course of time, so how do you estimate that time, to what extent is the money exposed to risk in that time? Banks are still fighting for improving the quality of their portfolios, though the positive dynamics is observable. And the point is how and where the commercial banks are to earn profit when the market is far and away the pre-crisis status.

In principle, you are right. I believe the crisis which befell and which our country experienced badly has not passed away. In any event, its consequences were not overcome to the fullest extent. However, it is important that the banks have already adapted themselves to work in a new situation. I do hope we will avoid one more wave, which the international analysts await from Europe, since it will be much more difficult to settle up. The fact is that the European markets, according to our external economic conjuncture, are rather close and, as opposed to the first American wave, the intensity of the European wave will be considerably higher. But, let us not beat the guns. We had better create all possible conditions to "suppress' the potential threat as far as possible.

Not only the banks, but the bank clientele is the matter of concern. Those of our corporate clients that adapted their work to the conditions of crisis, promptly and masterly transformed the internal processes, the market orientation, etc, and thus strengthened their market positions; whereas those that stuck to the old style of work suffered impairment of business and loss of profits. The large business had a "stock of fat" in pre-crisis period and was generally able to survive, and is doing quite well today. Nonetheless, the crisis primarily urged on agglomeration of business, concentration of small businesses round the larger companies. It is an adverse tendency for the economy and the banks as well, since it deprives the small and medium businesses of the opportunity to work and deprives the country of its driving force.

And definitely deforms competitiveness due to the concentration of capital.

As a banker, I sense it. And so, what did we do? We reconsidered the overall risk management philosophy, and took the conservative/aggressive method of lending as the core concept. No matter how strange and absurd may it sound, I would characterize the particular approach exactly in the same manner. Regardless of our efforts to be aggressive with lending, we significantly strengthened the requirements to the customer pursuant to our new philosophy of risk management. We have made structural and procedural improvements of the internal norms to match with the new philosophy; we have also reshaped and professionally reinforced the staff of loan decision makers. Today each loan officer is accountable for a definite risk. We also introduced the concept of ongoing monitoring of existing loans and created and involved in the work a group of analysts. This is the group that comes to answer the question you asked me in the beginning of our interview. Two types of analysis are made on a weekly basis. First of all, we strengthened the requirements for stress tests and conduct the latter regularly, and secondly, a macro-economic analysis is made, which among others, includes the development trends of various industries and the customers. We perform quite an interesting work, a sort of micro research institute, where decisions are made as the result of continuous brainstorming, discussions and analyses. New risks are identified and to manage the same the lending quotas are adjusted for various industries to reach the maximum diversification of the portfolio. The creation of a strong risk management team was the clue to our success last year. As I mentioned before, considerable attention is paid to stress tests, particularly for portfolios. For instance, if certain trends are noticeable in the economy, e.g. decline or rise of prices in the real estate market or a long-term appreciation of currency, then the stress tests allow us to be ready for anything. Thus, we realize that the crisis has not come to an end and we work continuously to address the problems.

As far as I am aware, the Bank has not curtailed the lending even during the crisis.

Exactly, from the start of crisis in 2008 we have not ever stopped lending due to our continuous efforts to assess the risks adequately. Of course, it was not a point-blank objective - refuse lending and that's it. However, to stop lending means to lose profits, to weaken standards. It is dangerous and unjustified, and therefore it is necessary to manage the risks correctly. The whole line of lending was functioning then and is functioning today. We try to keep pace with our competitors, and even introduce new loan products into the market. We seem to be successful.

Not for the compliment, however the overall banking sector nearly froze the car lending due to the crisis, but not you. Were the risks worth the trouble?

Yes, we did not stop issuing car loans, moreover we executed new contracts with car dealers and even opened a branch servicing the dealer of the Russian "Lada," German "Opel" and Korean "Hyundai." We continued working in primary and secondary car lending markets. We developed a new system of financing purchases "on credit," which is radically different from the traditional products by philosophy and by technologies. We borrowed the new scheme from abroad and replenished a new team to master the new product. Certainly, we tailored the new scheme to our mentality and our reality. Financing the purchases on credit is actually one of the risk-bearing banking segments today; however we have assessed the risk and it seems we have assessed it adequately.

What are your estimations and forecasts for the Bank?

Definitely, the past years of crisis had their impact on our portfolio: we had to write off certain bad loans since the customers confronted specific challenges. Our conservative approach was straightforward - to prevent risks we had to be tough in classification of loans, and that was why we wrote off numerous loans last year. We made up our mind: either black or white, and no self-deception or delusion, and no need for disguise - it is useless; all the same the deceit will show up sooner or later. Most important is to have a good "stock of fat" to work and improve. This year we plan to further improve the quality of the portfolio primarily targeting the retail and SME financing. That doesn't mean the major corporate financing is left out of our general business line. Surely we highly appreciate the partnership with large corporate clients and will continue financing their growth; however the main focus will be directed to retail banking to become a bank for everyone. I would like to state that we have already recorded significant portfolio growth from that perspective - car loans, mortgages and SME loans.

It is not a secret that you have seriously set to expansion of agro-lending. Especially given the fact that the Government started to give much consideration to this issue and attracted international donors and launched a mechanism for subsidizing the interest rates. What do you think are the prospects of the agro-loan market given the low level of collateral? Working in that market has always been difficult and now it has become even more risky and less profitable due to the crisis.

We issue agro-loans both within the scope of international projects and from our own funds. The difference is in the interest rate, ours being a bit higher since the own attracted funds are substantially expensive. Let me state that in terms of non-performing loans the agricultural sector is in a good standing and the percentage of default is rather low. The most important thing in this respect is to refrain from "carousel," which is dangerous for both the banks and the farmers. However, given that it is next to impossible and just stupid to turn the farmers out of their house, the risk assessment gains a higher importance, as far as you give a loan to the farmer against a formally "naked" security. Actually we get uncovered loans. That is why it is difficult and costly to work in this area. You need specific approach and methods here. We have specialists in the regional centers who take professional approach to the assessment of agricultural risks having a full knowledge of the local situation. Let me explain. These people are as well and first of all agro-specialists, whose work varies fundamentally from the work of an ordinary loan officer. They have to know the specifics of the village life, seasonality, crop yield, etc. Basically, due to these novelties we are planning to gradually expand our agro-portfolio based on risk diversification among other factors. Please note that the demand for agro-loans is not high in Armenia, moreover the number of solvent customers is not large either, and the list gets even shorter when scrutinizing them in the light of risk assessment. Currently the loans are taken mainly for construction and renovation of outbuildings, construction of vegetable hotbeds and to a less extent purchase of livestock. In short, the scale is low.

Judging from the potential return on investment made in livestock farming, the latter appears to be an essential consumer of credit resources.

We need a large-scale approach. It is not simple to create large stock-farms, and I think the government interference is quite important to provide for protection mechanisms. Not only this applies to livestock farming but to the general agro-business in our country - it has to be a higher priority. No doubt, the priority-driven manufacturing industries should be further developed, but the agriculture has to be hors concours. Not only it is a matter of food security and self-sufficiency, import substitution and export from macro-economic perspective, but it is also a solution to the problems of the village, reduction of migration and other. The population of the planet is growing and that is why the agro-product market is expanding. We have to take all these factors into account when introducing the toolkit for regulation and promotion of growth.

Like what?

You may remember the abundant potato harvest two years ago when the prices went down. The excess was sold to Georgia. The farmers preferred not to risk and many of them refused from potatoes in the following season. As the result, the prices went up causing deficit. And what happened then? We went to Georgians to buy, figuratively speaking, our potato. And all this happened because there was nobody to regulate the market either from government reserves or by means of price limits. For instance, the Central Bank smoothes away the situation in the currency market when the currency fluctuates, and plays against traders; similarly the Government should take the role of the regulator. We have long been talking about the need to introduce subsidizing mechanisms for products traditionally cultivated in a particular region. For example, the Ararat valley is good for fruits and vegetables, and the Government intends to subsidize the same exactly in that region. So, if you plan to cultivate wheat there, sorry, the Government is not your friend; be so kind as to take all risks and even pay VAT. In that way the Government plans the future crops, makes forecasts for the overall agricultural sector and involves the existing land use mechanisms for the growth thereof. And no need to be ashamed: should the farmer not use or be able or willing to cultivate the land, let him give up the land to someone else, but only when the Government creates equal conditions for all farmers and builds and restores the irrigation infrastructure and revives the so-called MTS (Machine and Tractor Stations) and makes the latter equally accessible to all farmers. And only then the mechanism of subsidizing the interest rates will work. Otherwise, if the farmer borrows USD 1K or 2K for a season, the mechanism of subsidizing will practically be useless since he will just save USD 20-40. This will not have an effect on the economy; it would be better to use the funds for implementation of a large project to recreate the MTS.

When you talk with the representatives of small and medium businesses, an impression is made that in their business they less frequently face the classical market risks, which can and should be foreseen and which form the basis of business plans when applying for a loan. Most frequently they encounter unforeseeable system risks, including the violent pressure of competing monopolists, the arbitrariness of inspection authorities, the unfairness of tax administration, the barriers of customs authorities, etc. And at the same time we speak about the SME development? How do you, as a banker, take that situation?

There is no doubt that our customers are quite sensitive to all of this. The SME managers complain of the unequal conditions with monopolists and market dominants, and they are displeased with tax services, other inspection authorities and the customs. The aforementioned, along with the lack of open competition and the fullness and inaccessibility of the market, strongly destruct the economic environment. Some pay taxes while others do not. Is this meant to be competition? Those who do not pay have cheaper products, and in the course of time "take over" the entire market and become monopolists. This is the reality and a serious obstacle in distribution and successful allocation of resources for the general economy and for the banks particularly. I do believe that SME is the general driver of economic activity; if it is under-developed, then the economy is unhealthy.

The problem of long moneys inside the country... Not long ago we witnessed the partial solution of that problem by introducing certain types of mandatory insurance, particularly the CMTPL. However the problem still exists, and now the new source of long moneys is named the upcoming pension reform in transit to compulsory cumulative pension.

The issue of long moneys is one of the key problems in the Armenian banking industry. The problem is related to the bank risk, and this is why. Today the average term of attracted funds does not exceed 18 months; the deposits are mainly placed for one year. And who takes a loan for a year? Very few; generally the loans are taken for 5-year period, or a much longer period for mortgage loans. This is the "malady" of all banks. But if we go to the bottom we will understand that the unhealthy economy is the source of the problem. You might remember the privatization process: normally an infrastructure like investment funds are created during that process, but not in our case. So, what have the investment companies to work with if they do not have any instrument at hand? In the absence of the instrument and the market participants, a rather aggressive Securities Commission was established and by that the final blow was hit to the market. The investment companies only work on the government securities margin. There are no venture funds, no equity funds, no pension funds. And there is no chance for long moneys. The insurers were counted on, but to no avail. The insurers deposit the reserves from collected premiums for one year at most, since the insurance agreements are executed for one year. Furthermore, the insurers place the money on condition that they can take it away whenever they want, though the respective provision of the Civil Code does not refer to the legal entities.

We attempt to solve the problem independently, especially given the fact that the Government offers the banks such opportunity by adopting the law on voluntary cumulative pension scheme. Thus, Converse Bank was the first to introduce into the Armenian market a new, quite attractive by its philosophy, instrument - the cumulative pension deposit. Let me remind that all in all there are three types of pension savings under the particular scheme: compulsory, voluntary and voluntary bank savings. The pension funds are not in place so far, so we decided to create that system at our bank. That means, you start to accumulate funds today and you cannot use them until the pension age. Hopefully, people will understand, trust and start to use that instrument. We offer a rather high interest rate on the deposit - 14% annually, since we are speaking about long-term investments. Moreover, the interest rate is not static and is adjusted to the average deposit rate at the Bank on a yearly basis. If the deposit rate makes 12% next year, the interest rate of the pension deposit will grow by 3 points and reach 15%. Thus the instrument is associated with the market value of money and the inflation trends. Importantly, the provisions of the Law on Income Tax cover the deposit. For example, if from your salary of AMD 100,000 you place AMD 5,000 on the pension deposit, then the income tax is calculated against AMD 95,000 instead of AMD 100,000. In fact, due to the compound interest, considerable amounts are accumulated in the course of years. As opposed to the classical pension savings fund, the annuity payments are made to successors.

There is another similar but purely banking instrument - deposit "Bareketsik Apapga" (Well-to-do Future). The deposit accrues 12% earnings in USD, which is rather high. The peculiarity of the product is the two components - accumulation and allocation. You can cumulate money for 10 years and after 10 years you can have your money returned as an addition to the salary, pension, etc. Another new product, deposit "Manuk" (Kid), is meant for 16-year period. The mechanism is identical. Upon early withdrawal, the interest rate is 7% per annum, and if held to maturity (throughout 16 years), i.e. by the time when your child needs investments in education another 5% is added.

Due to the aforementioned deposit products we hope to partly address the problem of long-term funds. Nonetheless, this also depends on the economic stability in the country; people are still uncertain about the future, they do not have sufficient social and labor guarantees.

Yes, the products are not banking in a sense, though they are quite attractive. How do you plan to manage pension deposit, for instance?

We do not pursue such goal. We simply attract long-term funds and will use them by allocating in loans and in other cost-effective banking instruments. As for the classical compulsory cumulative pension scheme, it needs pension funds and asset managers in place. It is a complicated business, and I believe its development can be promoted by attracting professional foreign companies experienced in the management of pension funds. However, the question how they are going to manage those funds is still open. For the time being, they will have to make investments in bank deposits and government securities and as well in foreign companies rated AAA. And that is all for the time being. Hopefully for the time being...

Thank you for the candid conversation.

Emmanuil Mkrtchyan

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