Banks in Georgia, supported by the rude health of the country's economy, have enjoyed asset growth and stronger profits in recent years, but a high level of dollar exposure remains a key risk, according to local industry figures. Meanwhile, new tighter capital requirements could drive further consolidation among the country's lenders.

Georgia, which sits between Turkey and Russia on the Black Sea in central Asia, is enjoying stronger ties with global partners having completed trade deals with the U.S., China, Turkey and a host of ex-Soviet nations. It began trading freely with the EU in 2016 and the government has forecast GDP growth of 4% for 2017, after 2.7% in 2016.

"Georgia is unique from that perspective; it has free trade agreements with two-thirds of the world's economies," said Giorgi Shagidze, CFO of JSC TBC Bank, one of the country's two largest lenders.

Local banks are set to build on recent income growth. TBC, JSC Bank of Georgia, JSC Liberty Bank, JSC VTB Bank (Georgia) and JSC Cartu Bank all posted notable year-over-year growth in total assets and net income in 2016, and have all advanced a long way from 2012. The sector has also shown a positive trend in terms of cost-to-income ratios and asset quality over the same period.

TBC, which represents 40% of Georgia's loan market, is poised to take advantage of anything that supports the economy or investment climate, Shagidze told S&P Global Market Intelligence in an interview.

In 2019, the country's banks will become eligible for a full tax break on reinvested profit that was introduced in 2017 for other corporations. This is a "very significant" initiative that has benefits beyond lower profit tax for banks, he said.

"It is more about how it affects customer behavior, how much they invest and how much more they will borrow to ensure they reach the same leverage," he said.

TBC, which floated on the London Stock Exchange in 2014, posted a net profit of 95.0 million Georgian lari in the first quarter of 2017, up from 59.5 million lari a year earlier. Full-year 2016 net profit increased to 302.5 million lari from 218.9 million in 2015. The bank acquired JSC Bank Republic, a unit of France's Société Générale SA, in October 2016.

Shagidze said he thought a few banks might merge in the future, given that, in small countries like Georgia, scale is needed to compete successfully and ensure adequate cost of funding. He said the potential for future consolidation is "limited," though.

TBC's main rival and only other sizable domestic bank, JSC Bank of Georgia, is also listed on the London Stock Exchange as part of the more diversified BGEO Group Plc, although it is working on a demerger to take advantage of growth opportunities. It will become a banking business under Bank of Georgia Group Plc and an investment business under BGEO Investments Plc, which will both be listed in London.

Bank of Georgia acquired a chunk of JSC ProCredit Bank Georgia's business in late 2016 and the local subsidiary of Ukraine's troubled JSC PrivatBank in 2015. It posted a profit of 288.0 million lari for 2016, up from 257.6 million lari the prior year.

Aside from economies of scale, another reason for more consolidation is the increasingly stringent capital requirements imposed by the regulators, said Givi Adeishvili, economic analyst at Society and Banks, a Tbilisi-based nongovernmental organization that promotes understanding about banks.

The central bank hiked minimum regulatory capital for banks to the equivalent of roughly $20 million in May 2017, from $5 million previously. Lenders now have until the end of 2017 to set aside $12.5 million and must fully comply by the end of 2018.

"This obligation could create an opportunity for small banks to merge," Adeishvili said.

Russia's JSC VTB Bank indicated recently that it might sell its Georgian business.

Dollar loans

Georgia's banks must also contend with the country's high level of dollar-denominated loans, and the associated currency fluctuation risk.

Large foreign investment relative to GDP and a reliance on exports and tourism for many local businesses have made the Georgian banking sector overly dependent on the U.S. currency, which accounted for more than 60% of loans in May 2017, according to Moody's.

Similarly, 72% of the country's deposits are in dollars, constraining banks from increasing lari lending. High dollarization is a key challenge for banks, the rating agency said.

Retail customers have borrowed heavily in dollars, thanks to more attractive rates, but many do not understand the risks, Adeishvili said. Many households earn principally in lari but, holding debt in dollars, are now vulnerable to adverse changes in the exchange rate. The lari has declined sharply in value against the dollar since 2014.

Regulators have adopted limits on dollar loans in a bid to increase local-currency borrowing, but the effects will not be visible for at least a year, Shagidze said. In the meantime, the country remains exposed to external shocks.

Investors, though, especially those who focus on eastern Europe and central Asia, are unlikely to be deterred, thanks to Georgia's reputation as a business-friendly, low-tax, low-corruption oasis in a rough neighborhood.

"The banks in Georgia have always been very active," said Benjamin Paine, a Tbilisi-based lawyer specializing in raising capital for Georgian financial companies. "It's noticeable how strong the sector is compared with neighbors."

As of Aug. 11, US$1 was equivalent to 2.40 Georgian lari.

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