DB & GTS LLP publishes article for the IBA on Bank Recapitalization Law

Abstract

The asset quality review of Mongolian commercial banks has revealed a system-wide capital shortfall equal to 1.9 percent of Mongolian GDP as of the third quarter of 2017. On 22 June 2018, the Banking Sector Stability Law was enacted by the Parliament as one of the measures addressing the re-capitalization of the banks with capital shortfall. Notwithstanding the generality of its title, the Banking Sector Stability Law is solely focused on enabling the re-capitalization of commercial banks with public funds. This article discusses the key aspects of the Banking Sector Stability Law.

Keywords: Mongolia, commercial banking in Mongolia, Government recapitalization of banks, banking sector stability, capital shortfall

1. Overview of the banking sector in Mongolia

As a former socialist country, Mongolia reformed its banking sector in 1991 and has been successfully transforming its mono-banking system into a two-tier banking system over the course of past 28 years. By the end of 2007, Mongolian banking sector was fully privatized and consisted of 16 privately owned commercial banks operating under the regulatory supervision of the Bank of Mongolia, the central bank of Mongolia (the “BoM”).

However, with the rapid growing economy and the instable politics, the solvency of banks has remained as one of the key challenges faced by Mongolian banking sector. Over the course of past decade, Mongolian economy witnessed insolvency of three major commercial banks in the country, Anod Bank in 2008, Zoos Bank in 2009 and Savings Bank in 2013. The resolution of the insolvent banks was resulted in establishment of a new state owned bank which received assets and liabilities of these banks.

At present, there are 14 commercial banks in Mongolia: 13 privately owned and 1 state owned. In addition, there is a development financing arm of the Government called Development Bank of Mongolia which is largely out of the regulatory outsight by the BoM.

2. Enactment of the bank recapitalization law

In early 2018, an asset quality review was completed at Mongolian commercial banks. As a result, the system-wide capital shortfall was determined at 1.9 percent of GDP as of the third quarter 2017.[1] After a consultation with the IMF, adoption of the bank recapitalization law was identified as a major policy action to deal with the capital shortfall in the banking sector while maintaining the stability in the financial sector in which the commercial banks currently play the most critical role.[2]

On 22 June 2018, the Parliament of Mongolia passed the Law on Ensuring Banking Sector Stability (the “Banking Sector Stability Law”) and created the legal framework for recapitalizing the banks with the State funds (the “public-funded recapitalization”). The Banking Sector Stability Law took immediate effect on the same day of its enactment.[3]

a. Eligibility and pre-requisite requirements for public-funded recapitalization

The public-funded recapitalization mechanism offered under the Banking Sector Stability Law is available to the banks that are deemed:

• having systemic impact[4];
• ‘viable’ in the medium – 5-year term; and
• unable to recapitalize itself through raising capital from private sources.

Also, as pre-requisite requirements, the undercapitalized banks are required to have taken certain compliance measures that include, among others, the creation of general and special risk funds and the conversion of tier 2 capital into tier 1 capital.

b. Form of public-funded recapitalization

The Banking Sector Stability Law allows the injection of public fund into the bank capital in the form of either cash or government bonds. The public funds can be injected into the tier 1 capital in the form of shares and into the tier 2 capital as subordinated debt convertible to shares.

The price for the shares being issued to the State in connection with the recapitalization will be the price same as agreed with private investors in case of the private investors injecting capital in an amount no less than 50% of the required funding. If the private capital injection is less than 50% of the required capital, the price will be determined jointly by the Minister of Finance and the Governor of the BoM.

c. The management of the public-fund injected into the bank capital

The Ministry of Finance is the authorized government body under the Banking Sector Stability Law to manage and oversee the public funds invested in the banks for the purpose of recapitalization. In this regard, the Ministry of Finance is authorized, amongst other things, to conclude a cooperation agreement with the bank being recapitalized with public-funds and to exercise the rights of the bank’s shareholder. Also, it is permitted to sell the public fund invested in the bank capital through a public or private offering at the purchase or market price.

d. Repayment of the public-fund

According to the Banking Sector Stability Law, the public funds invested in a bank capital must be repaid to the state budget in accordance with a plan that is to be approved by the Minister of Finance on consultation with the Governor of the BoM (the “Repayment Plan”). The Banking Sector Stability Law requires the public-funds injected for re-capitalization purpose to be fully repaid within 5 years from the enactment of the law (which seems to suggest that the law is intended, with or without a deliberate purpose, to serve as a one-time measure, instead of being able to be used from time to time when necessary). However, it remains silent on the exact form and nature of the repayment of public-fund to the state budget. Hence, it is concluded that the repayment of the public-funds will be made in a manner specified in the Repayment Plan approved by the Minister of Finance.

3. Conclusion

Currently, there has been no incident where any of the banks in Mongolia has used the public-funded recapitalization. However, the Banking Sector Stability Law ensures stability in the banking sector by keeping the banks solvent and preventing the spillover effects of their failure.

[1] Official information on the asset quality review released by the Bank of Mongolia in English is available at  https://www.mongolbank.mn/eng/news.aspx?id=1866&tid=1

[2] See the Staff Report for the Third Review under the Extended Fund Facility provided by IMF to Mongolia:  https://www.imf.org/en/Publications/CR/Issues/2018/04/04/Mongolia-Staff-Report-for-the-Third-Review-Under-the-Extended-Fund-Facility-Press-Release-45783

[3] The full text of the law in Mongolian is available at https://www.legalinfo.mn/law/details/13523?lawid=13523

[4] A bank with an impact on the banking system is defined as a bank whose total assets has accounted for more than 5% of the total assets of the banking system for the last 6 months