JUSAN BANK: FROM A CORPORATE BANK TO A FLOURISHING DIGITAL ECOSYSTEM Part 1

The establishment of a Western-style university in Kazakhstan had unexpected yet profound effects on the emergence of a robust banking ecosystem. Through the university's investment arm's private equity investments, crucial support was provided to the struggling third-largest bank. This support led to the development of a pioneering banking strategy, rooted in ecosystem and technological platform approaches. By harnessing the expertise of the investment arm and leveraging the university's resources, the once-failing bank underwent a remarkable revitalization, transforming into a dynamic and innovative financial institution. As a result of this new recovery strategy and business model, Jusan Bank achieved $1.2 billion in profits, acquired one million new clients, and paved the way for an IPO in London.

This groundbreaking business model has become a significant trend that warrants close attention from other financial markets, as it embodies the future of banking. The model places strong emphasis on the integration of financial and non-financial services with cutting-edge technologies, creating a seamless and efficient banking experience for customers while harnessing the power of big data analytics for continuous innovation and efficiency.

By embracing and studying this trend, other financial institutions worldwide can gain invaluable insights into establishing sustainable and prosperous banking ecosystems. This model underscores the importance of collaboration, the strategic use of technology, an unwavering commitment to customer satisfaction, ethical banking practices free from corruption, and adept management of risks and conflicts of interest. As the banking industry continues to evolve, the success of this model serves as an inspiring example for others to adapt and thrive within the dynamic financial landscape of the future.

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NU Group – Western-style educational institutions and their endowments

One of the fundamental pillars of the Western-style university, Nazarbayev University (NU), which was introduced in Kazakhstan in 2009 together with the international secondary school system, Nazarbayev Intellectual School (NIS), set up in 2008, was the establishment of the endowment fund, Nazarbayev Fund (NF) and other smaller endowments, designed to ensure sustainable financing for the Nazarbayev University Group's operations (NU Group). International prominent scholars with successful academic backgrounds and other high-profile figures filled the positions in the Boards of Trustees NU Group. Over the years, up until 2015, the NU Group had diligently accumulated a substantial amount of assets, comprising private donations and its own savings, which served as the solid foundation for the creation of endowments and laid the groundwork for future growth and development of these western institutions customized for the Kazakh soil.

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Precarious macroeconomic environment and the ongoing banking crisis: the loss of part of the endowment

However, the unstable macroeconomic environment prevailing in the country after the 2007-2009 financial crises posed a significant threat to the safety and security of these accumulated assets. The volatility, fragility in the financial sector and economic uncertainties made it increasingly risky to rely solely on traditional investment and banking approaches to preserve the value of the endowments.

Faced with this challenge, the NU Group recognized the critical importance of implementing proactive measures to safeguard the assets and ensure their longevity. This involved adopting innovative strategies, prudent risk management, and seeking alternative avenues to preserve the endowment funds' value and sustainability.

The NU Group's leadership and the Board of Trustees were driven by the commitment to protect the long-term financial viability of the institution. They closely analyzed the evolving economic landscape and sought expert advice to make effective investment diversification and risk mitigation decisions. Emphasizing transparency and accountability, they engaged in thorough due diligence when exploring various investment options to minimize exposure to potential risks.

In 2016, a banking crisis struck, posing a significant threat to NU, NIS, and the entire financial sector. This crisis became evident after two critical events unfolded, causing widespread concern, and prompting the need for immediate action.

The first event that brought alarm bells was the near loss of endowments with Kazcommerz Bank. NF, a crucial financial institution, was in a precarious situation as Kazcommerz Bank, its primary bank, faced a severe financial crisis. The risk of losing all its endowments became a pressing reality for NF, which could have resulted in a catastrophic impact on NU's financial stability.

Fortunately, the government demonstrated its understanding of the seriousness of the situation. It promptly intervened by offering a bailout to Kazcommerz Bank - that time, the biggest bank in the country. This decisive action played a crucial role in preventing NF from facing a total loss of its endowments, thereby ensuring a certain degree of financial stability.

However, the second event worsened the crisis. Through smaller endowment funds, NU and NIS suffered significant losses due to their deposit accounts held in Delta Bank and Kazinvest Bank. Unfortunately, these two banks declared bankruptcy, leading to the irrevocable loss of assets, including deposits and cash. The magnitude of these losses impacted the overall asset portfolio of NU and NIS, necessitating urgent measures to mitigate further damage and ensure the security of the assets.

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The diversification strategy: an own corporate bank

To further protect against potential risks and losses, NU and NIS explored diversification of their investment portfolios, spreading their assets across various financial instruments and institutions, including abroad. This approach aimed to reduce overreliance on any single bank or sector and increase overall financial stability - the crisis of 2016 served as a sobering lesson for NU and NIS, highlighting the critical need for continuous vigilance and proactive risk management in safeguarding their financial stability.

Implementing the diversification strategy in the international financial markets and banks proved relatively straightforward. However, the task became significantly more challenging when it came to local Kazakhstani banks due to the prevailing conditions in the domestic financial sector. The alarming situation revealed significant flaws in the country's banking system, characterized by corruption, reckless lending practices, and undue influence exerted by local oligarchs who held ownership of these banks. This situation underscored that depending on existing banks in Kazakhstan for financial needs was an unsustainable long-term solution.

To protect their assets and ensure greater financial stability, NU and NIS explored the option of establishing their own Credit Union type of financial institution. However, this approach faced regulatory limitations as Kazakhstani regulations required such financial organizations to have corresponding accounts only with commercial banks, not the Central bank. This restriction rendered the credit union option ineffective in addressing their exposure to weak and risky financial institutions.

After careful consideration, the decision was made to acquire a small, but financially sound bank - the former ABN-AMRO and then Royal Bank of Scotland branch in Kazakhstan. This strategic move allowed NU and NIS to control their assets directly and reduce their dependency on the unstable banking system. By acquiring a reputable and clean bank, they could ensure that their funds were managed responsibly and independently of the issues that had plagued other financial institutions in the country.

The strategic move to acquire a reputable bank showcased NU and NIS's dedication to financial prudence and risk management. By securing their assets within a stable and transparent financial institution, they effectively shielded their interests and mitigated the potential risks associated with weak banks engaging in bad and corrupt lending practices prevalent in the Kazakhstani financial sector. This decision safeguarded their assets and set a commendable precedent for other organizations in the country to embrace responsible financial practices. In other words, the assets were saved, and now the question was how to manage and multiply them.

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The bank’s new strategy

The initial move involved rebranding the bank as First Heartland Bank abbreviated as FHB. This step embraced both domestic and international aspects of the institution. Incorporating the word "heartland" in the bank's name established a meaningful connection with Kazakhstan, a country situated at the heart of the Eurasian continent. This association was executed in a Western manner, adhering to the traditional naming conventions seen in countries like the USA, aiming to implement the best international banking practices.

This approach continued in the future when the final brand, First Heartland Jusan Bank, was introduced, further reinforcing the Kazakh identity within the brand. (Jusan means in English - sagebrush - or Artemisia dracunculus in Latin. This is an endemic plant for the endless steppes of Kazakhstan whose smell is known to every Kazakhstani). The successive developments strengthened the bank's position as a symbol of Kazakhstan's financial prowess, combining global standards with a distinctive local essence.

The rebranding process played a vital role in implementing a larger strategic vision aimed at constructing a new business model. This first phase was of utmost importance as it served as the foundation for the future business model centered around an ecosystem and technological platform approach.

The initial business model focused on the security and safety of deposits and assets, investments, and adopting the best technological solutions. Considering the precarious situation with other domestic banks, the safety of deposits was a particularly important aspect of the new business model. In this volatile environment, FHB committed to maintaining its safety and solidity by employing the best international sound banking practices, especially concerning lending.

The investment pillar was also innovative, especially considering the very low-interest rates in the mid-2010s. FHB planned to establish an effective security broker and set up different types of mutual funds, which were either absent or underdeveloped at the time in Kazakhstan. These new financial institutions would provide access to international securities markets and enable domestic equity investments, offering an alternative to traditional bank deposits, which at that time yielded a very low return, close to zero. This policy led to the development of First Heartland Security and First Heartland Capital and allowed to channel the nation’s savings into productive investments both domestically and internationally.

The final building block of the emerging business model was the establishment of Almanit, an IT company intended to be the center of excellence and a new technological capacity builder for the Group.

For each of these pillars, careful consideration was given to developing and employing Key Performance Indicators (KPIs). By the end of 2018, the new business model had been implemented, and the FHB group emerged as an innovative and disruptive new player in the Kazakhstani financial and banking sector.

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The bailout of Tsesna bank

At the start of 2019, the persistent banking crisis due to precarious local banking practices and the lack of regulatory supervision had pushed Tsesna Bank into insolvency - at that time, the third-largest bank in Kazakhstan. Despite previous efforts to rescue the bank and reinstate its financial stability, all attempts had proven futile. The Kazakhstani Government and the Central bank faced a daunting dilemma: either permit Tsesna Bank to declare bankruptcy, risking severe repercussions for the entire financial system or seek a suitable investor capable of effectively resolving and stabilizing the bank's precarious situation.

In search of a solution, the Central Bank approached several other banks, urging them to consider buying out Tsesna Bank, but their efforts did not yield any results. During this time, the Central Bank took note of the innovative and solid policies employed by the FHB Group through its new business model. Recognizing the potential of FHB to turn around the failed bank, the Central Bank made an offer to the FHB Group to invest in Tsesna Bank.

Given the success and reputation of FHB, the offer from the Central Bank presented an opportunity for the FHB Group to expand its operations further and contribute to the stabilization of the Kazakhstani banking sector. After careful evaluation and due diligence, the FHB Group accepted the offer and invested in Tsesna Bank. With their expertise and experience, FHB worked diligently to implement their proven business model and best practices within Tsesna Bank.

The strategic decision taken by the NU Group, with the backing of the Central Bank and the Government, not only rescued Tsesna Bank from the brink of bankruptcy but also instilled a renewed sense of confidence in the financial system. This move showcased the efficacy of FHB's business model and its capacity to positively contribute to the stability and advancement of the banking sector in Kazakhstan. The successful transformation of Tsesna Bank under the management of the FHB Group firmly cemented its position as a pioneering and influential entity in the Kazakhstani financial and banking landscape.

After thoroughly analyzing the failed bank's financials, it became evident that more than 90% of its assets were non-performing. Additionally, the bank's IT system was in a deplorable condition. The situation worsened further due to the departure of qualified personnel. In 2018, a series of client withdrawals resulted in the bank being left by good clients and with a substantial deposit base with no ability to repay depositors if demanded. Consequently, the bank was deemed bankrupt and in a dire state.

Recognizing the gravity of the situation, the FHB Group engaged in negotiations with the Central Bank and the Government to find a viable resolution. The Government was keen to avoid the collapse of the third-largest bank as it could have had severe ramifications for the financial sector, leading to economic turmoil and potentially sparking social unrest. The FHB Group also could not afford to bear losses if Tsesna Bank's liabilities were taken into their balance sheet.

After extensive negotiations, a decision was reached, according to which the Government agreed to provide Tsesna Bank with long-term and low-interest loans to address its cash shortage and create profitability on the bank's balance sheet by capitalizing on the difference between low-interest rates and prevailing market rates. Following this, the FHB Group committed to injecting the required capital into Tsesna Bank's balance sheet once its losses were brought to zero.

The agreement, signed and approved by the Government and the Central Bank in February 2019, marked a significant step towards stabilizing the failed bank's situation and averting a financial crisis. The collaborative effort between the Government and the FHB Group showcased a prudent approach to resolving the banking crisis and restoring confidence in the financial sector. This resolution allowed Tsesna Bank to undergo a much-needed recovery and positioned it on a path towards potential growth and sustainability.

After extensive negotiations and the completion of the transaction, First Heartland Security (FHS), the investment arm of the NU Group and the shareholder of FHB, successfully acquired ownership of Tsesna bank. FHS injected the agreed-upon additional capital into the bank as part of the agreement. Following the acquisition, a fresh Board of Directors was introduced, comprising distinguished professionals like Mr. Shigeo Katsu, a renowned financier, and President of NU, who assumed the role of Chairman. Another notable addition as the Deputy Chairman of the Board was Mr. Yerbol Orynbayev, a prominent public figure and advocate of the Western-style educational system in Kazakhstan, along with other accomplished individuals from the well-established FHB Group.

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First Heartland Jusan Bank and its new business model: a “Bad” bank

With the acquisition completed, the two banks, FHB and Tsesna Bank, underwent a merger and were consolidated under the new brand name of First Heartland Jusan Bank (FHJB).

The situation surrounding Tsesna Bank posed a formidable challenge due to past mismanagement. The bank's reputation had suffered significant damage, leading to the loss of critical revenue-generating clients and the departure of crucial staff members. Upon closer examination, it became evident that the bank lacked a sound banking business model, had primarily functioned as a “pocket” financing vehicle for certain stakeholders, and had zero accountability towards its creditors and depositors.

Addressing the lack of a robust risk management culture and adherence to best corporate governance standards were critical for the recovery and survival in the market. The deficiency in these areas had created an environment susceptible to corruption, especially in the loan approval and loan restructuring processes. Borrowers who were reluctant to repay their loans would resort to offering bribes, ranging from 5% to 30% of the loan amount, in exchange for favorable changes to the loan terms, such as reduced interest rates, extended maturity, or altered payment schedules. As a result, these loans rarely reached full repayment, leading to substantial losses for the banks.

To address these issues and achieve timely results, the Board decided to undertake several bold measures which were novel for the Kazakhstani market but proved to be highly effective.

First, it was decided to split the bank into two distinct divisions - a "Bad Bank" and a "Good Bank." The primary focus of the "Bad Bank" was to maximize the recovery from non-performing assets. At the same time, the "Good Bank" was tasked with developing a sustainable banking strategy that could lead to profitability within a two to three-year timeframe. This strategic separation allowed the “Good bank” to channel its efforts towards regaining trust and improving its financial position without being burdened by the “Bad bank” challenges.

One senior team member who deserves separate recognition is Mr. Aibek Kaiyp. Initially appointed as the Head of the "Bad Bank," his role marked a crucial turning point in the recovery process. Under Mr. Kaiyp's leadership, the team collaborated with the "Good Bank" to establish new risk management standards and develop a client profile targeted to the new business model.

Together with his dedicated team, Mr. Kaiyp meticulously streamlined all processes and implemented a new organizational structure and operations. Each "Bad bank” client underwent a thorough analysis based on the new standards. Remarkably, only two clients were found to be in full compliance with the new standards and were deemed eligible for transfer to the "Good Bank." This revelation highlighted the dire state of Tsesna Bank and emphasized the urgency of accelerating the development of the new model to survive in the market. The rest of the clients were categorized based on the stages of their debt default and financial situation, and an intricate process of asset recovery began for them.

Second, acknowledging the detrimental impact of corruption, the Board of Directors of Jusan Bank and FHS, the mother company, took a courageous and decisive action by putting an end to it, firmly forbidding any form of loan restructuring, except for early repayment of the entire loan amount. By eliminating the possibility of loan restructuring, First Heartland Jusan Bank took a proactive stance against corruption, ensured a fair and transparent approach to handling defaulted loans and sent a clear message that it was determined to recover its non-performing assets and protect its financial integrity.

Initially, some borrowers expressed skepticism and tried to offer various "proposals" to the bank's management and board members, seeking leniency, a usual and widespread banking practice in Kazakhstan. However, as they came to realize the bank's unwavering commitment to upholding this policy, a substantial number of borrowers opted to step up and repay their loans in full. This resolute stance by Jusan Bank sent a clear message, fostering a culture of accountability and encouraging borrowers to fulfil their financial obligations without resorting to corrupt practices.

The strategic framework implemented during the recovery process surpassed expectations, resulting in significant achievements for the bank. By reducing the level of non-performing loans within a two-year period from 90% to 10% of the total loan portfolio and swiftly stabilizing its financial situation, the bank was able to provide essential banking services.

The bank's strict adherence and unwavering commitment to the new policies inspired confidence among stakeholders, leading to a notable increase in new clients – both depositors and borrowers. The successful recovery of non-performing assets bolstered the bank's financial position and set a positive example for the entire banking sector, emphasizing the significance of ethical practices, good corporate governance, and accountability within the industry.

With the strategic transformation and stabilization efforts in full swing, First Heartland Jusan Bank gradually regained trust in the market and attracted new clients, due to the improved quality of its products and services and a robust capital base. The bank's journey from a struggling institution to a profitable and customer-centric entity highlighted the effectiveness of the new business model and management strategy, positioning it as a leading player in the Kazakhstani financial and banking sector.

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The end of part one.

To be continued - the second part is arriving soon.

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