US embassy cable - 04YEREVAN1745

UNCLAS SECTION 01 OF 02 YEREVAN 001745 
 
SIPDIS 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, EAID, AM 
SUBJECT: ARMENIA'S BANKING SECTOR: IT NEEDS MORE THAN 
REGULATION 
 
 
1. (U) Sensitive but unclassified.  Please protect 
accordingly.  Not for internet distribution. 
 
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SUMMARY 
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2. (SBU) Armenia's Central Bank (CBA) has outlined a new 
reform program to strengthen the banking sector.  But bank 
officials caution that legal and regulatory reforms alone 
would do little to improve bank intermediation.  Despite 
significant consolidation and the recent closure of 
insolvent banks, Armenia's banks still struggle to attract 
deposits and are even worse at lending money.  Improving the 
banking sector is a priority for the government and the 
international donor community, as high lending rates and 
poor access to capital hamper small enterprises and raise 
costs for all businesses.  While touting reforms, CBA 
officials cite not the regulatory environment but cultural 
resistance to banking and a strong reluctance of businesses 
to open their books as the greatest impediments to a strong 
intermediating banking sector.  End Summary. 
 
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CENTRAL BANK SETS OUT REFORMS TO IMPROVE INTERMEDIATION 
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3. (SBU) Armenia's banks do a poor job of attracting 
deposits and lending money:  the assets of Armenia's 19 
solvent banks equal only 17 percent of GDP (compared to 70 
percent in the U.S.).  We met recently with CBA Board Member 
Vache Gabrielyan to discuss the CBA's reform strategy to 
increase intermediation by raising the confidence of 
depositors in banks, and of banks in borrowers.  In 2004 the 
CBA will continue measures that force banks to be stronger 
combined with new legislation to strengthen creditor rights 
and a new deposit guarantee program.  The CBA will propose a 
draft law on the registration of collateral along with 
legislative amendments to allow non-judicial foreclosures in 
order to encourage collateral based lending.  Currently the 
difficulty of foreclosing on collateral, due to court 
inefficiencies and inadequate laws on collateral and secured 
transactions, discourages banks from lending to unknown 
borrowers. 
 
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SOUNDER BANKS STILL MUST WORK TO ATTRACT DEPOSITS 
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4. (SBU) Over the last two years, the Central Bank 
strengthened the banking sector by liquidating insolvent 
banks and raising statutory capital requirements.  Even 
though banks are now sounder, they still must work to 
attract deposits.  As banks expand services and 
technologies, and as insolvent and uncompetitive banks are 
weeded out, Armenians should become more willing to save 
their money in banks.  Persistent, if unjustified, worries 
over the soundness of banks combined with privacy concerns 
and the fear of government monitoring keep much of Armenia's 
savings out of banks and in the cookie jar. 
 
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BANK LENDING REMAINS WEAK 
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5. (SBU) Banks are even worse at lending money than they are 
at attracting deposits:  the safest commercial banks like 
HSBC are flush with cash.  While businesses cite high 
interest rates (averaging  19 percent) as the primary 
obstacle to borrowing, banks cite the lack of good 
borrowers.  Nick Gilmore, the CEO of HSBC, comments that 
Armenian firms don't want to share their books with their 
banker.  "Armenians keep several sets of books," he says, 
"one for the tax authorities, one for their partners -- 
because they are all cheating their partners -- and one for 
their wives.  We want the real books and ultimately they 
don't want anyone to have real records.  They will offer 
collateral, but we are not in the collateral business.  We 
don't want property, we want to know our client." 
 
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TRUST, BUT HOW TO VERIFY? 
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6. (SBU) In Armenia, knowing your client can be hard to do. 
In a culture where entrepreneurs look to family, clients and 
personal connections -- not banks -- for working capital, 
potential borrowers lack reliable financial records and 
adequate business plans.  The fact that many Armenians are 
paid in cash, have no bank accounts and have likely 
misrepresented their incomes on any government forms gives 
banks very little verifiable information on which to base 
decisions.  Banks lack expertise in evaluating risk anyway, 
and base their decisions on their own histories with clients 
rather than the clients' ability to service the loans. 
 
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COMMENT: IT'S A QUESTION OF TRUST 
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7. (SBU) The greatest burdens on Armenia's banking sector 
are cultural.  Historical mistrust of banks persists and 
accurate bookkeeping is anathema to local businesses. 
(Note:  In 2003 Armenia had only 1 percent profit tax 
revenues despite 14 percent GDP growth.  End Note.) 
Paradoxically, potential borrowers would rather risk 
collateral than provide information:  Armenia's largest 
enterprises eschew borrowing from HSBC, the bank with the 
lowest lending interest rates.  Armenia is a cash economy, 
and people and businesses are reluctant to submit their 
accounts to scrutiny.  Banks understandably balk at lending 
money to consumers who keep no bank accounts and to 
businesses who show no profit.  The dearth of lending to 
small and medium size enterprises deprives banks of the 
broad portfolios, not mention experience and expertise, 
which would make lending at lower rates profitable. 
 
GODFREY