Study initiated by Open Society Forum

Team Leader: D. Jargalsaikhan, MBA (Finance), Daniels College of Business, University of Denver, USA

Senior Researcher: B. Otgontugs, Master of Economics, University of Manchester (UK), Doctorate fellow of Columbia University (USA)

Coordinator: Ch. Khashchuluun, PhD in Economics, Keio University, Japan

Researcher: S. Dulbadrakh, Master of Economy, School of Economic Studies, National University of Mongolia.

Researcher T. Oyunbaatar, Master of Economy, School of Economic Studies, National University of Mongolia.

Economic freedom index in banking sector of Mongolia – 5 indicators:

Ownership of banks, Competition (local banks vs. foreign banks), Percentage of credit extended to private sector, Avoidance of interest rate falling to negative real, Government control over interests rates

Overall finding of the study Fraser’s Economic Freedom Index in

Mongolia was 5.5 in 2000 Improved to 6.9 in 2004 Credit freedom in banking sector of

Mongolia is improving

Credit market freedom in Mongolia

Year2000 2001 2002 2003 2004

Bank ownership 2 5 5 8 8

Competition - 6 6 7 7

Credit extended to private sector

5.5 5.8 5.5 4.3 5

Interest rate in negative real 8 8 8 8 8

Interest rate controls 6.5 6.5 6.5 6.5 6.5

Economic freedom index on the credit market

5.5 6.26 6.16 6.76 6.9

Credit market freedom index in transition economies

Country 2000 2001 2002

Bulgaria 5.9 6.9 7.9

Latvia 7.9 8.3 8.4

Lithuania 6.4 6.8 7.9

Mongolia 5.6 6.26 6.16 

Russia 3.7 5.1 6.0

Poland 7.1 7.7 8.1

Romania 4.6 6.7 7.2

Slovakia 7.4 7.4 7.9

Slovenia 6.5 6.7 8.0

Ukraine 4.6 5.5 6.9

Hungary 8.1 8.1 7.9

Croatia 7.7 9.1 8.9

China 4.7 4.7 4.7

Czech Republic 5.8 6.8 8.1

Estonia 7.8 9.0 9.0

Source: Economic Freedom of the World 2004 Annual Report

Credit market freedom index, rankingCountry 2002

New Zealand 9.7 (2)

USA 9.2 (8)

Great Britain 9.2 (11)

Canada 9.0 (16)

Hong Kong 8.9 (19)

Chile 8.3 (34)

Singapore 7.9 (50)

Philippines 7.6 (57)

South Korea 7.4 (63)

Japan 7.3 (69)

Turkey 6.1 (102)

India 5.9 (106)

Bangladesh 5.8 (108)

Indonesia 5.2 (115)

Myanmar 2.8 (123)

Mongolia  6.9 (83)

Mongolia’s index and rating as of 2004

Five indicators of Mongolia’s credit market freedom index did not improve in last 4 years

0

1

2

3

4

5

6

7

8

9

2000 2001 2002 2003 2004

Bank ownership

Competition

Credit extended to privatesector

Interest rate in negative real

Interest rate control

Economic freedom on thecredit market

Avoidance of interest rate falling into negative real: Difference of interest rates between credits and deposits was more than 8% annually, thus 8 points

0

50

100

150

200

250

300

350

Èíôëÿöèéíò¿âøèí, %

õ¿¿ãèéí ò¿âøèí, %

Source: Bank of Mongolia, National Statistics Office

Inflation, interest rate, real interest rate in Mongolia, (%).

Interest rate, %Interest rate, %

Inflation, %

Real Interest rate, %

2000-2004: improvement of “ownership structure of banks” indicator

As a result of rapid privatization held in recent years, proportion of foreign ownership in the banking sector has significantly increased

Number of state-owned banks reduced Total banking assets reached 141 billion tug, of

which 48.92% (one bank - 27%) owned by foreigners (in the first half of 2004)

Competition:

If foreign ownership means foreign investment, competition index would be 6 in 2001-2002 and 7 in 2003-2004

If proportion of banks with foreign ownership will be considered as representation of foreign banks in Mongolia, the competition index would remain 6 in 2001-2004

Taking into account findings of additional studies performed in finance and banking system of Mongolia, the competition index reduces to 3-4 points

Credit extended to private sector:Total amount, of which extended to private sector, million tugrugs

Years TotalExtended to private

sectorPercentage

2005.06 764,605 411,315 53.8%

2004.12 648,979 360,219 55.5%

2003.12 448,759 222,096 49.5%

2002.12 235,068 138,675 59.0%

2001.12 137,537 85,934 62.5%

2000.12 67,881 40,127 59.1%

1999.12 49,466 23,997 48.5%

1998.12 86,328 40,580 47.0%

1997.12 51,516 26,825 52.1%

1996.12 35,562 17,937 50.4%

1995.12 66,925 43,012 64.3%

Credit freedom in Mongolia decreased from 6.0 points in 1995 to 5.0 points in 2004

Is there a control over the bank deposit and/or credit interest rates in Mongolia? Is the interest rate determined by market rules? According to the Fraser Institute assessment,

the difference between interest rates of deposits and credits was as follows:

in 1995 - 8.8, in 2001 - 10.7, in 2002 - 11.4, in 2003 - 9.5, in 2004 - 9.6, or 8 points .

Additionally developed indicators

In performing Mongolia-specific calculation of Fraser’s sub-indexes, we considered not only interest rates,

But also duration of credit (short money) This indicator gained 6.5 points

Issues on the current banking market in Mongolia: Required bank reserve limit was very high. Some changes

were introduced recently. Bank of Mongolia issued bonds which are considered as cash.

Profit margin in banking sector is considerably high High demand on credits, high interest rates of Non-

banking Financial Institutions and Credit & Saving Funds Huge amounts of money is outside banking system Enterprises pay high taxes Government is the biggest buyer, but holds big amounts –

State Fund framework limits the market Large amount of “bad” loans Half of bank deposits in USD

1992-2004: “bad performance” loans increased 60 times, ratio halved

Source: Research of Bank of Mongolia, Page 676

  1992 1994 1995 1998 2000 2001 2002 2003 2004

Total assets (billion tug) 24.3 83.4 102 180 215 304.4 448 767 962

Credit portfolio (billion tug) 19.1 52.8 63.4 85.6 66.8 135.1 231 442 606.8

Total loans/total assets, % 78.6 63.3 62.1 47.6 31.1 44.4 51.6 57.7 63.1

Bad loans (million tug) 1.1 7.3 13.5 32.6 15.9 10.9 16.6 36.7 60.7

Bad loans/total loans,% 5.76 13.8 21.3 38.1 23.8 8.1 7.2 8.3 10

Challenges in banking system

Only over 20 % of total credits in Mongolia were extended for more than one year period.

Average interest rate is 30%, Maximum reaches 48% per annum

As a result, limited private investment and negative impact to economic development

Lack of resources on the Mongolian market Compared to developed economies,

financial deepening or М2 (money supply/GDP) ratio is just 50%.

Quantitative vs. qualitative developments

2000-2004: positive changes in bank ownership structure:

Rapid development of private banks Privatization of state-owned banks

However, no positive impact to “credits extended to private sector” and “interest rate control” indicators

Comparison of indicators

Rapid privatization and increased number of foreign banks:

Encourage competition, Reduce interest rates, Build up resources for long-term credit, Introducing new know-how in banking sector,

enhancing human resource capacity

These changes have no real impact

Superficial changes and reforms

Number of foreign banks increased, however it does not produce expected results.

Still no big foreign bank entered Mongolia No real competition on the banking

market. All banks accept apartments as a collateral.

Conclusion: changes in banking sector (2000-2004)

Clients, domestic businesses, individuals are yet to benefit from qualitative changes such as:

Financial sources for low-cost, long-term credits Encouragement of private investment Economic growth

Thank you