Fitch Ratings highlighted at its recent conference on Uzbekistan in Tashkent that since the publication of the country's comprehensive banking sector reform strategy in May 2020, state-owned banks had made some notable progress in shifting the emphasis towards a more market-oriented approach at the heart of their business models. While, achieving further positive changes may take longer due to deep structural weaknesses and new risks in the sector.
The basis of this reform is the privatization of most state-owned banks after transforming their business models in order to shift the emphasis from directed lending towards the development of commercial activities. The Uzbek authorities intend to sell at least three banks to foreign strategic investors by the end of 2025. This would increase the share of non-state banks in sector assets to 60% (end 2023: 32%). This reform also involves revising the approach to corporate governance and risk management systems in banks, as well as improving prudential regulation.
Since the announcement of the start of reforms, the country's authorities have sold a controlling stake in Ipoteka Bank (BB-/Stable), Uzbekistan's fifth largest bank, to Hungarian OTP Bank. However, the sale dates of two other large banks, the Uzbek Industrial Construction Bank and Asakabank (both rated BB-/Stable), were recently postponed until the end of 2024 and the end of 2025, respectively, and we believe that further delays are likely.
Both banks continue to transform their business models and remain heavily reliant on low-margin corporate lending, despite efforts to diversify their lending. Prospects for bank sales may improve if international financial institutions such as the European Bank for Reconstruction and Development or the International Finance Corporation become minority shareholders, as this could signal to potential investors that pre-sale preparations are largely complete.
Asset quality will continue to be a key factor influencing the agency's assessment of the standalone creditworthiness of Uzbek banks in the short term. We estimate that the sector's impaired loan ratio (Stage 3 loans under IFRS 9) has increased to over 10% of total loans in 2023, and we expect this figure to increase further this year as banks recognize non-performing loans inherited from previous periods. We view state-owned development banks as the most vulnerable given their involvement in high-risk, subsidized development lending.
The rapid growth of retail lending over recent years may create additional risks in the medium term. Retail loans doubled as a share of sector loans between 2018 and 2023, reaching 32% at end-2023, and we expect retail loan quality to deteriorate in 2024 and 2025, particularly in riskier segments such as such as unsecured consumer lending and auto lending, which have provided the bulk of recent growth in the retail lending segment. Recent regulatory restrictions introduced by the Central Bank of the Republic of Uzbekistan should mitigate the risks of overheating in the retail lending segment, but it will take time for the measures taken to have the desired effect.
Profitability of Uzbekistan's banks should improve over the medium term due to an increased emphasis on high-margin retail lending, with net profit figures being significantly affected by the cost of risk. Government capital support has become more selective since the reforms began, with development banks receiving the bulk of new Tier 1 capital contributions. The agency assesses the funding profiles of state-owned banks as weak, given their high dependence on state funds and funds raised on capital markets (including from international financial institutions), and limited liquidity reserves.
