Report by ARDFM Deputy Chairperson Olzhas Kizatov

Good afternoon, dear deputies and participants of the round table!

Draft Law of the Republic of Kazakhstan "Banks and Banking Activities in the Republic of Kazakhstan" is submitted for your study.

The new Law is being developed within the instruction of the Head of State voiced in the Address to the people of Kazakhstan "Fair Kazakhstan: Law and Order, Economic Growth, Public Optimism" dated September 2, 2024.

The new Law is designed to enhance sustainability of the banking sector, develop innovations and stimulate an increase in the role of banks in financing of the real sector of the economy.

Main areas of the legislative innovations:

1. Improvement of the banking regulation;
2. Implementation of a basic and universal banking license model;
3. Development of Islamic finance and expansion of its provision formats;
4. Enhancement of behavioral supervision in conditions of digitalization and expansion of financial technologies;
5. Introduction of a new mechanism for regulation of activities of problem banks;
6. Support for the fintech sector and ensuring the safe implementation of innovations (including within the National Bank of the Republic of Kazakhstan).

Structure of the new Law:

The new Law "Banks and Banking Activities" includes 9 sections, 23 chapters, 134 articles. Key features of the new version are presentation of the Law in line with the life cycle of a bank: from foundation and licensing to the stages of termination of activities and liquidation. This architecture ensures consistency, clarity and flexibility in application of the laws for all participants in the financial market.

The first direction – improvement of the banking regulation is a set of initiatives designed to maintain financial stability and create an effective and advanced regulatory framework for the banking sector for years to come.

The changes are structured into the following three broad blocks:

The first block is designed to improve corporate governance in banks. In particular, additional requirements are set for heads of key blocks: risk management, internal audit and compliance control. These positions are equivalent to executives with relevant qualification and reputational requirements.

In addition, role of the independent directors institution is being strengthened. A number of initiatives are provided for to increase their professional independence and effectiveness of their participation in management. Restrictions on term of office, requirements for absence of business and other ties with the bank and persons associated with it by special relations (PASR), as well as exclusion of conflicts of interest are being introduced. For example, participation in capital of the bank or receiving extra compensations from the bank or structures associated with it will be unacceptable. A rule is also being introduced according to which actions that may entail a conflict of interest must be accompanied by a positive opinion from independent directors.

The second block includes development of a regulatory framework to maintain financial stability, within which the following initiatives will be implemented:

It is planned to expand the use of motivated judgment. Such approach will allow the regulator to flexibly assess compliance of employees and members of the board of directors with the established requirements. In particular, it is envisaged to recognize a bank employee as a manager, which will entail application of the relevant qualification standards. An opportunity is also provided to assess independence of a member of the board of directors and, if the criteria are not met, remove him from his position. Additionally, regulator's powers to assess presence of a conflict of interest that could affect reliability of the external audit are expanded, with the right to replace the auditor if necessary.

Moreover, the scope of persons associated with the bank by special relations is expanded. The current criteria are supplemented by the features used in the international financial reporting (IFRS). In particular, such persons include legal entities controlled by major participants of the bank, as well as individuals and legal entities that can significantly affect the made decisions, including contractual or other grounds.

In order to reduce the level of non-core activities of banks and accelerate return of assets to economic circulation, a limit is introduced on the maximum period for which recovered property can be on the balance sheet of a banking group – not more than three years in total for a bank and an organization managing special assets.

The third block is connected with optimization of the regulatory framework and elimination of outdated and duplicate regulations.

The new Law will unify requirements for shareholders and executives, with their subsequent transfer to a separate law “State regulation, control and supervision”, which will provide larger legal certainty and ease of application of the rules for market participants.

Along with that, outdated and duplicate provisions are removed.

The second area covers upgrade of the licensing system and streamlined access to the banking market. Main initiative in this block is introduction of a basic banking license, which creates more flexible regulatory conditions that facilitate entry of new participants and increase competition in the sector.

Base license differs from a universal license both in the volume of permitted transactions and in regulatory requirements. In particular, restrictions are set on the maximum size of assets at the level of 500 billion KZT. The minimum capital for banks with a basic license will be 10 billion KZT, while for universal banks this threshold will be increased to 20 billion KZT. Also, requirements for the risk management and reporting system are reduced, the supervisory burden is cut, while the basic principles of sustainability are preserved.

In order to limit risks, backbone banks will be barred to provide loans and other credit products to non-residents, as well as issue loans to persons associated with the bank by special relations. Moreover, a limit is being introduced on the total amount of fixed-term and saving retail deposits – no more than 10 million KZT. Activities related to brokerage and dealer operations on complex or high-risk financial instruments will also be prohibited.

One of the key potential users of the basic license is microfinance organizations that seek to expand their business and obtain the right to mobilize retail and corporate deposits. Today, 12 MFOs already have capital exceeding 10 billion KZT, and two of them – KMF and BNK Finance Kazakhstan – have received permission to transform into a second-tier bank.

The third area is related to creation of conditions for development of Islamic banking. Currently, the current laws require establishment of a separate Islamic bank to carry out relevant activities. Despite the fact that Islamic banking has been provided for in the banking laws of the Republic of Kazakhstan since 2009, its share in the banking sector remains insignificant – less than 0.5% of the total assets.

In order to stimulate development of the Islamic finance, the Agency comes up with introduction of a mechanism of "Islamic windows" –provision of the Islamic banking services within a traditional bank. This format will facilitate entry of new participants into the market, including foreign investors with experience in similar models. It will also ensure scalability of the business, expansion of regional presence due to synergy with the existing banking infrastructure.

Meanwhile, availability of the Islamic financial products for clients who prefer compliance with the Sharia principles will increase. An important condition for traditional banks that open the Islamic windows will be separate accounting of transactions and strict compliance with all requirements of Islamic finance.

The fourth area is related to development of behavioral supervision and enhancement of protection of rights of consumers of financial services.

The approach rests on the principles of responsibility for management of financial products at all stages – from development to monitoring. Requirements for disclosure of information will be enhanced, unfair practices will be prohibited, and financial institutions will be held responsible for development of financial literacy of clients.

Target model of behavioral supervision includes two key components. The first is a mechanism for prevention of violations of consumer rights which rests on the obligation of financial institutions to offer high-quality, suitable and clear products, focus on customer satisfaction, as well as on formation of a legal framework and risk-oriented supervision by the Agency. The second is an effective system of pre-trial dispute resolution, which includes three levels: study of complaints within a financial institution through a special independent unit, an appeal to the financial ombudsman with a binding decision, and, if necessary, the Agency's intervention to take systemic measures.

The fifth area concerns development of mechanisms for regulation of insolvent banks. The Law "Banks and Banking Activities" was supplemented with a number of provisions minimizing the need for government support for banks. State support is allowed only in relation to systemically important banks.

A three-tier anti-crisis regulation system is being introduced: an enhanced supervision regime, a financial stability restoration regime, and an insolvency resolution regime. Each stage is fixed in the laws, including activation criteria, a list of regulator measures and steps taken by the bank.

The law also defines requirements for recovery plans, which are mandatory for all banks. These plans must be developed and updated annually by the banks themselves, and the regulator will assess their quality, completeness and relevance, as well as monitor the triggers that activate the plan.

Duty of the authorized agency to develop regulation plans for banks recognized as insolvent, defining strategies and procedures for assessing viability, is separately established. In case of systemically important banks, it is envisaged to have a sufficient capital reserve (TLAC) to ensure the ability to absorb losses by converting liabilities into capital.

It also clearly defines conditions and mechanism for state participation. It can intervene only if two conditions are met simultaneously: recognition of the bank as systemically important and complete exhaustion of private resources through TLAC and related parties.

In addition, the law clearly delineates the roles of all involved government agencies. The Agency for Regulation and Development of the Financial Market is responsible for monitoring and implementation of the anti-crisis regimes. The Financial Stability Council makes decisions on settlement measures and appropriateness of the state support. The government gives consent to participate in capital or provide guarantees, and the National Bank determines the systemic importance of banks and provides a loan of last resort. Kazakhstan Deposit Insurance Fund ensures payments to depositors within the guaranteed amounts.

The sixth area concerns formation of a modern digital financial infrastructure and regulation of the digital assets. This block is designed to create a legal and technological framework that will facilitate further digitalization of the financial sector and formation of a sustainable digital ecosystem. Detailed information on this issue will be provided separately by the National Bank of the Republic of Kazakhstan.

All the changes offered within the draft law have been developed with active involvement of international experts, including representatives of the European Bank for Reconstruction and Development, the International Monetary Fund, as well as participants of the local financial market.