On October 11, Uzbekistan’s Senate approved a package of financial sector laws, including a new banking law. The new banking law represents an important milestone. Its approval concludes a year of intensive technical cooperation between the World Bank Group (WBG) and the Central Bank of Uzbekistan (CBU)’s banking supervision department. The
Economic reforms started in 2017, with the alignment of the informal and official exchange rate, and the start of market-oriented reforms in the state-bank dominated financial sector. State banks’ core business was to channel funds from public sector entities to priority sectors and firms, mostly state-owned enterprises, often at preferential terms. The priority for banking regulation and supervision was to ensure compliance with government-dictated policy priorities, rather than the preservation of financial stability and the protection of depositors.
It soon became apparent that the legal framework underpinning CBU’s oversight over the banking sector was in dire need of reform. The CBU invited the WBG team to review an initial draft, that was undergoing Cabinet discussion. The review identified several important weaknesses. The WBG team offered support in drafting a new law, to support an orderly transformation and sound development of the financial sector. The CBU accepted the offer, and withdrew the old draft. Under a new project funded and staffed by the WBG’s Vienna-based Financial Sector Advisory Center (FinSAC), the work on the new law started in October 2018.
In the following half year, the CBU and the WBG project team completely redrafted every article of the new law. The technical discussions with the CBU’s supervision department helped to explain international best practices for banking supervision and sensitize the CBU to the new challenges associated with the transition from a state-dominated banking sector to one with a more prominent role for private investors.
One of the key challenges was to establish a robust “gatekeeper function”, providing CBU with sufficient powers to ensure that private investors seeking to enter the banking sector meet common fit and proper standards, de facto ownership structures are well-understood and monitored continuously, and related party lending is contained. Throughout the former Soviet Union, in countries such as Ukraine, Russia, Azerbaijan and Kazakhstan, weaknesses in this gatekeeper function bred non-transparent ownership structures, enabling the emergence of oligarchic banking that ultimately set the stage for costly financial crises.
Another priority was to legally allow CBU to exercise supervisory judgement in fulfilling its mandate in the face of dynamically evolving banking risks. This was a drastic and sometimes controversial change from the old legal framework that prioritized compliance checks with administrative requirements over the mitigation of risks. CBU’s banking supervision also needed to be shielded from political and industry pressures, while its supervisors needed better legal protection while discharging their duties in good faith. Even when CBU’s decisions are challenged, courts should defer to CBU’s discretion in making complex supervisory decisions, and only reverse in limited cases.
These concepts have broad international acceptance, but they represented a radical paradigm shift for Uzbekistan. The government used to view banks as any other commercial enterprises, and reform focused on addressing corruption and red tape by limiting inspections powers and discretion of state agencies. The WBG project team went to great lengths to reach out and explain the importance of treating banks differently. The team participated in stakeholder events with bankers, lawmakers, ministries, other public authorities and the media, including TV interviews. These events helped to address concerns and set the stage for the passage of the new law, which is now a reference for the region. Amendments did take place during the approval process, but the final version upholds the fundamental concepts and principles that the WBG team sought to establish. It also helped that submission to Parliament was a prior action under a WBG Development Policy Loan, and that WBG’s leadership voiced their strong support for the project.
The new banking law has had a galvanizing effect on financial sector reform in the country. The banking law project, as well as WBG support on a banking sector reform strategy, a national financial inclusion strategy, and upgrading banking supervision have reaffirmed the WBG’s authority in financial sector policy. The WBG is energized to build on the interest that Uzbek policymakers have taken in financial sector reform.