Moody's: Outlook for Mongolia banks remains negative on challenging operating environment

Moody's Investors Service says the negative outlook for Mongolia's banking system, unchanged since 2013, reflects the challenging operating environment, leading to continued deterioration in asset quality and capital, while funding and liquidity will also remain tight. However, the pace of deterioration will moderate compared to 2015.

"Although we have seen a moderate pick-up in economic growth in Mongolia, the operating environment remains challenging for banks, with risks skewed to the downside," says Hyun Hee Park, a Moody's Assistant Vice President and Analyst.

"Specifically, we expect domestic demand will remain subdued against a backdrop of tight macroeconomic policies and high real interest rates," adds Park. "The greatest downside risk for the banks is a faster drop in commodity prices and a sharper slowdown in GDP growth in China, which we currently forecast at 6.3% in 2016."

Moody's conclusions were contained in its released annual outlook for Mongolia's banking system.

Moody's analysis is based on five drivers: Operating Environment -- deteriorating; Asset Quality and Capital -- deteriorating; Funding and Liquidity -- stable; Profitability and Efficiency -- deteriorating; and Systemic Support -- stable.

Asset quality will remain under pressure, says Moody's, although the pace of deterioration will be significantly slower than in 2015. The system's non-performing and past-due loan ratio doubled to 14.4% in 2015, and will continue to rise in 2016.

Reported capital metrics improved in 2015, supported by a decline in loans outstanding, and will remain stable during this outlook. Mongolia's credit cycle will continue to deleverage for a second consecutive year, with weak loan growth in all but some subsidized segments.

Moody's expectation for stable capital ratios is in line with its forward-looking solvency analysis, which suggests that banks will maintain their current capital metrics under Moody's baseline scenario.

Funding and liquidity conditions will moderately improve, says Moody's, as foreign direct investment inflows should pick up on the resumption of the second phase of the Oyu Tolgoi project. This development, plus ongoing deleveraging, will bring relief to the current tight liquidity conditions, following policy rate hikes and the unwinding of the government's Price Stabilization Program.

Profitability will remain under pressure due to contracting loan volumes combined with elevated credit costs. Furthermore, loan recovery rates are likely to be lower than in previous cycles due to weak commodity and real estate prices, with the result that costs related to balance sheet clean-up will be higher.

Moody's assesses Mongolia as a low-support system, and expects the current economic situation will affect the government's capacity to support banks in the coming 12-18 months. Nonetheless, Moody's expects the government will support deposits at banks it considers of high systemic importance to the economy.

Moody's rates eight of the 14 commercial banks in Mongolia and one government-related policy bank. The rated commercial banks accounted for 90.0% of total system loans and 87.6% of total system deposits at end-2014.