OREANDA-NEWS. The clean-up of bad debt at Kazakhstan's banks is still uncertain despite the central bank's latest plans to tackle the high levels of non-performing loans, Fitch Ratings says. Nevertheless, real asset quality improvement could be moderately positive for banks' ratings, if they do not incur large additional losses in transferring the loans to the central bank's problem loan fund (PLF) or writing them off.

The extent to which the PLF can provide relief for banks is unclear, despite the proposed recapitalisation to KZT250bn (USD1.4bn) from KZT5bn and changes in investment policy to allow it to buy construction-related debt - the bulk of the sector's non-perfoming loans (NPLs). The planned changes could give the fund, which has struggled to gain traction since being established in early 2012 because of the lack of funding and restrictive investment policy, greater capacity to buy up banks' bad debt portfolios.

But even with the significant increase in size, the PLF is still small compared with banks' NPLs. Around one-third of Kazakh bank loan books were non-performing at end-1Q14, according to the central bank. Although reserves on NPLs are already substantial, we estimate that the five most affected banks would need to transfer KZT841bn of net NPLs to achieve the 10% NPL target planned by the central bank for end-2015 (see the attached file for more details).

This is over three times the planned size of the PLF, so the fund can only partly alleviate banks' asset quality problems. It is unclear whether the government would increase PLF's size later on with further capital injections, or allow it to issue public debt, potentially with a state guarantee.

Our estimate excludes KZT466bn of gross NPLs (reserve amounts are not available) of Alliance Bank ('Restricted Default') and Temirbank (unrated) because these banks may significantly increase provisioning levels as a result of Alliance's ongoing debt restructuring and potential future merger of the two banks. Other Kazakh banks with NPL ratios above 10% are either small or hold mostly non-performing consumer finance portfolios that might not be eligible for purchases by the PLF.

The benefit to banks off-loading loans to the PLF will depend on the transfer mechanism, particularly pricing. Large Kazakh banks' ability to absorb further loan loss provisions and write-downs is limited relative to the high share of restructured loans that may require additional reserves. Their profit generation and capital ratios may be weakened if material losses arise when NPLs are transferred. The due diligence process could be lengthy and delay any swift transfer of bad debt.

The impact of the latest regulatory NPL cap on Kazakh banks' credit profiles will depend on the extent to which banks genuinely reduce asset quality risk. The measure is applied to the unconsolidated balance sheet, which means that banks could transfer NPLs to subsidiary special-purpose vehicles to meet the 10% target. We would view this as cosmetic since banks would still retain the risk. Banks may also lower reported NPLs by writing off loans, but this is likely to crystallise losses and undermine already weak capital ratios.

The authorities are getting tougher with tackling NPLs with the lowering of the bank NPL limit at end-2015 from the 15% level set in February and imposition of sanctions, including more limited access to government funding, removal of management and potentially as severe as licence withdrawals, on banks that don't comply. However, it remains unclear how strictly the new NPL limits will be enforced given the challenges the bank might have with meeting them and the forbearance shown so far.