2. Study initiated by Open Society Forum Team Leader: D. Jargalsaikhan, MBA (Finance), Daniels College of Business, University of Denver, USA Senior Researcher: B. Otgontugs, Master of Economics, University of Manchester (UK), Doctorate fellow of Columbia University (USA) Coordinator: Ch. Khashchuluun, PhD in Economics, Keio University, Japan Researcher: S. Dulbadrakh, Master of Economy, School of Economic Studies, National University of Mongolia. Researcher T. Oyunbaatar, Master of Economy, School of Economic Studies, National University of Mongolia.

3. Economic freedom index in banking sector of Mongolia – 5 indicators: Ownership of banks, Competition (local banks vs. foreign banks), Percentage of credit extended to private sector, Avoidance of interest rate falling to negative real, Government control over interests rates

4. Overall finding of the study Fraser’s Economic Freedom Index in Mongolia was 5.5 in 2000 Improved to 6.9 in 2004 Credit freedom in banking sector of Mongolia is improving

5. Credit market freedom in Mongolia Year 20002001200220032004 Bank ownership25588 Competition-6677 Credit extended to private sector 5.55.85.54.35 Interest rate in negative real88888 Interest rate controls6.5 Economic freedom index on the credit market 5.56.266.166.766.9

6. Credit market freedom index in transition economies Country200020012002 Bulgaria5.96.97.9 Latvia7.98.38.4 Lithuania6.46.87.9 Mongolia5.66.266.16 Russia3.75.16.0 Poland7.17.78.1 Romania4.66.77.2 Slovakia7.4 7.9 Slovenia6.56.78.0 Ukraine4.65.56.9 Hungary8.1 7.9 Croatia7.79.18.9 China4.7 Czech Republic5.86.88.1 Estonia7.89.0 Source: Economic Freedom of the World 2004 Annual Report

7. Credit market freedom index, ranking Country2002 New Zealand9.7 (2) USA9.2 (8) Great Britain9.2 (11) Canada9.0 (16) Hong Kong8.9 (19) Chile8.3 (34) Singapore7.9 (50) Philippines7.6 (57) South Korea7.4 (63) Japan7.3 (69) Turkey6.1 (102) India5.9 (106) Bangladesh5.8 (108) Indonesia5.2 (115) Myanmar2.8 (123) Mongolia 6.9 (83) Mongolia’s index and rating as of 2004

8. Five indicators of Mongolia’s credit market freedom index did not improve in last 4 years

9. Avoidance of interest rate falling into negative real: Difference of interest rates between credits and deposits was more than 8% annually, thus 8 points Source: Bank of Mongolia, National Statistics Office Inflation, interest rate, real interest rate in Mongolia, (%). Interest rate, % Inflation, % Real Interest rate, %

10. 2000-2004: improvement of “ownership structure of banks” indicator As a result of rapid privatization held in recent years, proportion of foreign ownership in the banking sector has significantly increased Number of state-owned banks reduced Total banking assets reached 141 billion tug, of which 48.92% (one bank - 27%) owned by foreigners (in the first half of 2004)

11. Competition: If foreign ownership means foreign investment, competition index would be 6 in 2001-2002 and 7 in 2003-2004 If proportion of banks with foreign ownership will be considered as representation of foreign banks in Mongolia, the competition index would remain 6 in 2001- 2004 Taking into account findings of additional studies performed in finance and banking system of Mongolia, the competition index reduces to 3-4 points

12. Credit extended to private sector: Total amount, of which extended to private sector, million tugrugs Years TotalExtended to private sector Percentage 2005.06764,605411,31553.8% 2004.12648,979360,21955.5% 2003.12448,759222,09649.5% 2002.12235,068138,67559.0% 2001.12137,53785,93462.5% 2000.1267,88140,12759.1% 1999.1249,46623,99748.5% 1998.1286,32840,58047.0% 1997.1251,51626,82552.1% 1996.1235,56217,93750.4% 1995.1266,92543,01264.3% Credit freedom in Mongolia decreased from 6.0 points in 1995 to 5.0 points in 2004

13. Is there a control over the bank deposit and/or credit interest rates in Mongolia? Is the interest rate determined by market rules? According to the Fraser Institute assessment, the difference between interest rates of deposits and credits was as follows: in 1995 - 8.8, in 2001 - 10.7, in 2002 - 11.4, in 2003 - 9.5, in 2004 - 9.6, or 8 points.

14. Additionally developed indicators In performing Mongolia-specific calculation of Fraser’s sub-indexes, we considered not only interest rates, But also duration of credit (short money) This indicator gained 6.5 points

15. Issues on the current banking market in Mongolia: Required bank reserve limit was very high. Some changes were introduced recently. Bank of Mongolia issued bonds which are considered as cash. Profit margin in banking sector is considerably high High demand on credits, high interest rates of Non- banking Financial Institutions and Credit & Saving Funds Huge amounts of money is outside banking system Enterprises pay high taxes Government is the biggest buyer, but holds big amounts – State Fund framework limits the market Large amount of “bad” loans Half of bank deposits in USD

16. 1992-2004: “bad performance” loans increased 60 times, ratio halved Source: Research of Bank of Mongolia, Page 676 199219941995199820002001200220032004 Total assets (billion tug)24.383.4102180215304.4448767962 Credit portfolio (billion tug)19.152.863.485.666.8135.1231442606.8 Total loans/total assets, %78.663.362.147.631.144.451.657.763.1 Bad loans (million tug) 1.17.313.532.615.910.916.636.760.7 Bad loans/total loans,% 5.7613.821.338.123.88.17.28.310

17. Challenges in banking system Only over 20 % of total credits in Mongolia were extended for more than one year period. Average interest rate is 30%, Maximum reaches 48% per annum As a result, limited private investment and negative impact to economic development

18. Lack of resources on the Mongolian market Compared to developed economies, financial deepening or М2 (money supply/GDP) ratio is just 50%.

19. Quantitative vs. qualitative developments 2000-2004: positive changes in bank ownership structure: Rapid development of private banks Privatization of state-owned banks However, no positive impact to “credits extended to private sector” and “interest rate control” indicators

20. Comparison of indicators Rapid privatization and increased number of foreign banks: Encourage competition, Reduce interest rates, Build up resources for long-term credit, Introducing new know-how in banking sector, enhancing human resource capacity These changes have no real impact

21. Superficial changes and reforms Number of foreign banks increased, however it does not produce expected results. Still no big foreign bank entered Mongolia No real competition on the banking market. All banks accept apartments as a collateral.

22. Conclusion: changes in banking sector (2000-2004) Clients, domestic businesses, individuals are yet to benefit from qualitative changes such as: Financial sources for low-cost, long-term credits Encouragement of private investment Economic growth

23. Thank you