Mongolian Economic Forum: Governor’s speech

Distinguished guests, esteemed colleagues and valued participants,

Let me express my sincere appreciation to all of you for coming here today. It is with great pleasure that I welcome you to the World Economic Forum 2023, and I would like to take this opportunity to give you a brief update on the current economic trends and outlook of Mongolia, as well as the banking sector, its history, regulatory framework, and investment opportunities.

Mongolia’s economy made a swift and robust recovery from the pandemic, and the outlook looks promising with strong potential for growth.

The Covid-19 pandemic has adversely affected economic activity and financial stability in all countries around the world including Mongolia. As tail risks of negative external shocks began to materialize, the Bank of Mongolia took a comprehensive set of policy measures to mitigate their economic impact, ensure financial stability and support economic recovery. For example,

• In 2020 and 2021, the Bank of Mongolia cut its policy rate four times by a cumulative 500 basis points to a historical low level of 6 percent.
• The central bank reduced the reserve requirement ratio and introduced a longer-term liquidity instrument.

As a result, the economy has recovered well from the recession. Then, policies started focusing on stabilizing the economy. So,

• The forbearance measures have been effectively phased-out.
• Monetary policy now aims at containing the rising prices and managing inflation expectations, supporting external balances.
• Thus, the central bank raised its policy rate five times by a total of 700 basis points to 13 percent. As a result, inflation is expected to stabilize within the central bank’s target in the near future.

The medium-term growth outlook remains favorable, sustained by substantial improvements expected in the mining sector.

• In 2023, economic growth is expected to accelerate to 5 percent, driven by a rapid recovery in mining production and by continued recovery from the pandemic in other sectors.
• The robust growth will be maintained in the medium term. Infrastructure investments and mega projects will expand economic capacity and lead to higher economic growth. For example, the successful launch and implementation of major railway and auto road projects has expanded export capacity.

Moving on to some quantitative evidence, key indicators suggest that the domestic banking sector remains resilient. As of the end of the first quarter of this year, total regulatory capital adequacy ratio of banks stands at 16.3%, well above the 12% minimum requirement. The capital conservation buffer is 7.3%, also well above its 2-4% minimum requirement. Liquidity and leverage ratios stand at 41.2% 9.3%, respectively. In terms of composition, as you can see, liabilities are evenly composed of retail and wholesale funding. Although the return on equity (ROE) is moderate, with the 5-year average ROE at 11.6%, we expect a significant increase in this figure in connection with the medium-term reform program.

Mongolia’s banking sector has undergone significant transformation over the past 3 decades. The first domestic, state-owned commercial banks were established in 1990, laying the foundation for the two-tiered banking system that was officially formed in 1991 with the ratification of the Banking Law. The two-tiered banking system consists of the central bank and commercial banks. The former is responsible for policy formulation and implementation, while the latter conducts financial intermediation in the economy.

Since then, the Bank of Mongolia has been developing the regulatory and supervisory framework for commercial banks with the objective of ensuring financial stability. Each change or amendment in the legislation has presented fundamental changes to the sector itself. For example, in the 2003-2006 period, large state-owned banks were privatized, and in 2008 some were liquidated. This resulted in the comprehensive revision of the Banking Law in 2010 and the adoption of a deposit insurance scheme in 2013. I should mention that even though an informal scheme was established in 2008, it was a blanket guarantee by the government for depositors of failing banks.

The experiences of boom and bust cycles over the years led the Bank of Mongolia to develop the “Banking Sector Medium-Term Reform Program” in 2020, the first of its kind in Mongolia. This reform program aims to strengthen the resilience and stability of the banking sector. It will enhance the regulatory framework and fundamentally change the ownership structure of banks to ensure prudent governance. This reform program is currently being implemented with great success.

For instance, the initial public offerings, which are a mandatory requirement for all systemically important banks (SIBs), serve as one of the key outcomes of this reform program. The IPOs have not only improved governance and transparency of banks, but they have also had considerable positive spillover effects on the domestic capital market. Stock market capitalization increased severalfold as a result of banks going public. Furthermore, banks are expected to dilute their ownership down to 20%. We expect this enormous change in ownership to have a positive impact on banks’ governance, particularly on those with high ownership concentration.

Let me talk about investment opportunities in the banking sector now.

Foreign investors have several options to participate in the Mongolian banking sector, namely through the following 4 routes: (i) by establishing a representative office; (ii) by establishing a banking branch; (iii) or directly investing in the already established commercial banks; (iv) and, finally, either establishing or investing in an investments specialized bank. The last route has become the “trending” topic, but I will talk more on that later.

If you would please divert your attention to the “Stats” section of this slide. The Return on Equity and Net Income of the banking sector has seen a tremendous rebound, exhibiting an impressive growth of 97% and 148%, respectively, reaching 18.9% and 921 billion tugriks by the end of 2022. We expect the sector to maintain these levels as the economy recovers.  

Now let us take a closer look at two possible investment routes: establishing a banking branch or investing in specialized banks.

The Bank of Mongolia has recently revised its bank branch licensing framework in order to accommodate and facilitate foreign investment and participation of foreign banks in the domestic sector. For example, the previous regulatory framework for bank branch licensing was unclear. However, the new framework has removed previous prerequisites such as the existence of a representative office and has well defined the conditions for establishing a branch.

Another investment option is an investment specialized bank. Any person, domestic or external, may establish such a bank as their subsidiary. Unlike traditional commercial banks, investment specialized banks are not subject to ownership limitations. Their regulation will be geared towards their area of specialization, which is financing mega projects. These banks will be subject to a relatively flexible regulatory and supervisory framework.

On another note, the Bank of Mongolia has been working to reform the payments and settlements system, which is an essential infrastructure for the economy. Modern technology and arrangements have the potential to substantial reduce costs and enable instant payment settlements. Therefore, reforms in this area not only benefit financial services firms and society, but also contribute to overall economic development.

The Bank of Mongolia has issued Payment System Strategy (NPS) for the next 5 years (2022-2026) to address remaining gaps and reach a historic milestone in the payment ecosystem. The payment and settlement landscape has been changing rapidly, driven by innovation in technology, new business models, and new types of payment service providers. Novel risks, such as cyber security threats have emerged, posing new challenges to the NPS. The COVID19 pandemic has also had a dramatic impact on demand, calling for more efficient, safer, and inclusive payment services.

The NPS Strategy 2022-2026 will advance Mongolia on the path towards greater digitalization of payments. The Time is right for Mongolia to build on the high level of account ownership of the population and the upgraded infrastructure. We are setting an ambitious objective to ensure that most payments in the country are made digitally within the next 5 years. Digital payment services, including cross-border retail payments, should become increasingly available throughout the whole country and accessible at relatively low cost. Fostering innovation in the market will be critical for this, as providers will have to find user-friendly ways to serve a diverse set of use cases. The government’s efforts to increase digitalization will be a critical enabling factor in building citizens’ trust for digital payment methods. This will have to be supported by resilient, safe, and secure payment systems infrastructure that is ready to withstand increasing cyber risks as well as the challenges of the post-COVID19 world.

Therefore, the Bank of Mongolia will continue to support innovations in payments and will assess and implement the appropriate form of innovation facilitators for Mongolia. We are aiming to promote the emergence of new payment solutions in the market. In fact, the Bank of Mongolia, together with the Financial Regulatory Commission, Ministry of Finance, and Deposit Insurance Corporation, has been running regulatory sandbox environment since 2021. The regulation was revised in 2023. Moreover, the Bank of Mongolia operates an innovation office where fintech firms that provide payment services can discuss innovative product, service or business models and can have a productive dialogue with the regulator. This also provides an open space for both the regulator and service providers to exchange knowledge, information, and feedback.

This brings us to the end of my presentation. Let me conclude by emphasizing that the Mongolian banking sector welcomes and encourages foreign investment. I would like to thank you, once again, for your attention. Please feel free to ask me questions, if you have any.

For the presentation slides click here