YANGON Every table and much of the floor at Co-Operative Bank in Myanmar's commercial capital is stacked with thick bricks of the local kyat currency. Money counting machines clatter. Workers carry sacks of cash slung over their shoulders.
A few blocks away, brokers in a small colonial-era building leaf through bundles of cash, part of an ancient "hawala" money transfer network used widely in Asia and the Middle East, and one of the only ways to get cash out of Myanmar.
"I have no doubt that the banks can catch up very fast," Serge Pun, chairman of SPA Group, a Myanmar investment company whose holdings range from real estate to financial services, told Reuters in an interview. "But we need the regulatory authorities to be ahead of us."
That is starting to happen.
On Monday, Myanmar's dysfunctional banking system took a big step into the 21st century with the floating of the kyat, the most dramatic economic reform yet by a one-year-old civilian government and one that promises to transform trade, banking and public finances at a critical time.
It coincides with a scramble at Myanmar's long-isolated banks to prepare for what many see as inevitable: a wave of foreign investment and the lifting of Western sanctions after Sunday's historic by-election catapulted pro-democracy leader Aung San Suu Kyi into parliament.
For 35 years, the kyat was pegged to the International Monetary Fund's special drawing rights at 6.4 kyat per dollar, a rate only available to state-owned companies and about 125 times stronger than the black-market rate of 800 to 820 kyat used for most transactions.
A new reference rate, set at 818 per dollar on Monday, is the first phase of a plan to gradually unify rates used by private enterprises and create a market rate, according to central bank documents, simplifying foreign trade and investment.
It could also build confidence in a banking system tainted by money-laundering allegations and cut off from the global financial system. Anticipating the changes, Myanmar's banks have quietly begun an overhaul. Some are sending staff for training in Singapore and other financial centers, rolling out new technology and plotting branch expansions.
Global banks such as Standard Chartered and Singapore's United Overseas Bank are watching closely, as the former British colony embarks on its most dramatic changes since a 1962 military coup, when it was known as Burma.
So Lay Hua, managing director of transaction banking at UOB in Singapore, senses opportunity. Her bank recently helped train Burmese bankers in currency trading and risk management, and she is encouraged by a possible end to sanctions.
"Regional banks with strong institutional franchises such as UOB will have opportunities to contribute to Myanmar's future economic growth," she says.
Standard Chartered is also considering re-entering the Burmese market. "We are watching developments with interest," said a spokesman. Standard Chartered began operations in Myanmar in 1862 but shut its representative office in 2003 during the latest of several Burmese banking crises.
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"A LOT OF HYPE"
But despite the reforms, Myanmar's banking system could remain among the world's most basic for years, blighted by decades of mismanagement, say bankers, local authorities and industry experts.
The financial system, they add, needs to be rebuilt almost from scratch. The first ATMs only recently arrived. Credit cards are barely used. The United States still bans financial transactions with Myanmar under its sanctions.
"There is a lot of hype right now about the prospects for Myanmar, but banking is very far off into the future in terms of real material growth," said Derek Ovington, an analyst at CLSA Asia-Pacific Markets in Singapore.
"It has a great potential as a growth economy, but the starting point is very low," he added. "You are talking years of development before it becomes material to anybody."
Burmese banks have a history of ill-fated optimism. Dozens of local and foreign banks thrived in the 1950s. But the industry withered after a 1962 coup introduced a disastrous "Burmese Way to Socialism" and sweeping nationalization.
In 1988, the country's former military rulers re-introduced a market economy. Soon after, in 1992, private banks were allowed. Foreign banks began opening representative offices, poised for a day when they could do business in the resource-rich country of about 60 million people.
That day never quite arrived.
Decades of dictatorship and the brutal suppression of pro-democracy activists brought layers of U.S. and European economic sanctions. Concerns over money laundering from a robust drug trade - Myanmar is the world's second-largest opium producer - eventually quarantined the financial system.
In 2003, shady money lending practices caught up with the sector, sparking a crisis exacerbated by inept decision-making at the central bank. Three banks collapsed.
Accusations of money laundering have since begun to fade but other problems are entrenched, including restrictions that prevent foreign banks from doing little more than research at representative offices.
UOB has such an office, as do about 15 other banks from countries ranging from Bangladesh, Brunei and Cambodia to China, Japan, Thailand and Singapore. In the late 1990s and early 2000s, the number of such offices peaked at around 40.
Several foreign banks, however, say they are considering opening new representative offices.
"We will transform the office into branch operations as soon as we get the license to do so from the regulators in the country," Nazir Razak, chief executive of Malaysia's CIMB Group Holdings Bhd, told reporters on Monday, referring to his bank's 17-year-old representative office in Yangon.
FOREIGN JOINT VENTURES
The government may go a step further and allow joint ventures with foreign banks within two years, said an industry source with knowledge of government plans for bank reforms.
"If things go well, joint-venture banks between local private banks and foreign banks will be allowed in two or three years first, and foreign banks will be allowed to operate on their own," said a senior official from the Ministry of Finance and Revenue who declined to be identified because he was not authorized to speak on the record.
"But I think it will take time."
Myo Oo, chairman of Myanmar Citizens Bank, one of Myanmar's 19 private banks, is less confident.
"The government seems to have some reservations about allowing the full operation of foreign banks with concerns for the competitiveness of local banks," he said. "Our banking industry will never develop if we keep worrying like that."
Myo Oo's comment points toward bigger problems.
In a recent study, Sean Turnell, an expert on Myanmar's economy at Australia's Macquarie University, laid out a list of prohibitive regulations.
Among them: a cap on deposit interest rates below the prevailing inflation rate, a ban on the issuing of credit without collateral, a ban on private commercial banks lending to farmers, and complex rules on collecting interest from loans.
Coupled with a culture of cronyism that thrived under the former military junta, Myanmar faces a stunted banking system that in Turnell's words "scarcely operates like a banking system at all".
Bank credit has been growing, but from a low base. As a percent of gross domestic product, credit stood at about 17 percent in 2009, below most other Southeast Asian countries.
Well over half of all loans go to the state which has splurged on infrastructure in recent years, although loans to the private sector have climbed, too, since a 2010 privatization wave in which hundreds of prized state assets were sold to tycoons with close connections to the military.
Bank credit to the private sector was up 63.7 percent in the 12 months to March, a recent Economist Intelligence Unit report shows. Overall domestic credit growth was 32 percent in August 2011 from the same month the previous year, it said.
Deposits are up, too, reaching 5.2 trillion kyat in September, more than doubling from the end of 2009, the EIU said. At the end of 2010, outstanding loans, including those to government, equaled about 81 percent of total deposits.
But the EIU raised a red flag over the banking sector's outstanding foreign liabilities, calling then a "cause for concern" at nearly $3.4 billion. That is almost half the country's total foreign exchange reserves, which Upper House lawmaker Aye Maung put at $7.2 billion.
The figure is all the more perplexing given Myanmar's ban on foreign currency-denominated assets.
Many businesses, however, remain starved of credit. Consider small and medium enterprises such as Technomation. Founder Htoo Myint Naung says the company commands an 80 percent share of Myanmar's mobile apps market, which could grow as the country's telecommunications sector is reformed.
While such small businesses employ the bulk of the country's workers, most have no access to bank loans. Htoo Myint Naung laughs at the very thought.
"Everybody knows you don't go to the bank for a loan. They will refuse," the 24-year-old said. "They may give you money for a laptop, for instance, but not for a business plan."
Lucky businesses turn to family or friends for money, others to underground lenders with prohibitively high interest rates.
In rural Myanmar, farmers have turned to local moneylenders for cash to pay for seeds, fertilizer and other materials. That has left a huge portion of the population in debt with double digit interest rates - a cycle that could be broken if more lenders are allowed to give credit to farmers.
Economists say the currency reforms should begin to stabilize the economy and underpin a revival of confidence in the kyat, which, in turn, could see more people open bank accounts. Less than 10 percent have accounts now.
"Reforming the complex exchange rate system is a priority to eliminate constraints on economic growth," the International Monetary Fund's mission chief in Myanmar, Meral Karasulu, said after a January visit.
The senior official from the Ministry of Finance and Revenue said the central bank had given permission this year to four private banks to do foreign remittances: Co-operative Bank in Singapore, Kanbawza Bank in Thailand, Asia Green Development Bank in Singapore and Malaysia, and Ayeyarwady Bank in Malaysia.
He said that banking services agreements had been signed with Chinese banks to enable payment in Chinese yuan for border trade, and memoranda of understanding had been signed with banks from Bangladesh and India on border trade cash payments.
Late last year, the central bank also authorized 17 local private banks to open 57 money exchange counters, and licensed 11 to carry out foreign banking services. Many of the exchange counters are open already, but the banks licensed to engage in foreign services were said to still be negotiating counterparty agreements with overseas banks.
PARADOXES AND OTHER PROBLEMS
Some new banks such as the nearly two-year-old Ayeyarwady Bank have big plans.
Its owner, Zaw Zaw, said he has already met executives from several foreign banks in recent weeks including Swiss bank UBS AG, Malayan Banking Bhd (Maybank), CIMB, and Thailand's Siam Commercial Bank. He has hired British and Malaysian consultants, sent staff overseas for training and is preparing for an end to sanctions that analysts expect could come this year.
His bank, he said, was already working to install the SWIFT cross-border payments system to initiate correspondence with foreign banks.
"We need to become stronger and stronger. After that, we can compete with others," he told Reuters in an interview.
He employs about 970 staff in Ayeyarwady, named after the rice-growing region where he spent his childhood. The bank aims to more than double branches to 45 next year from 20 and hire foreign-educated talent.
But Ayeyarwady Bank and its peers represent a paradox for Myanmar's banking sector.
Ayeyarwady is one of four banks launched after the 2010 privatization wave that are plotting aggressive expansions that could help modernize the sector.
The emergence of these banks - Ayeyarwady, Asia Green Development Bank, United Amara Bank and Myanma Apex Bank - is credited with boosting sector-wide lending. IMF data showed a 60 percent leap in private-sector lending in the nine months to December 2010, Turnell says.
Yet they are owned by crony businessmen considered close allies of the former ruling junta, all of whom are on international sanctions lists. Other Myanmar banks may not have such obvious potentially toxic liabilities, but finding international business partners will not be easy.
"These aren't banks of eminent reputation," said Rupert Haw, deputy country managing director in Myanmar for the law firm DFDL Mekong. "Local banks would be well advised to prepare themselves for rigorous due diligence."
BACK TO THE FUTURE
To understand what role Myanmar's banking system could play, one need look no further than its past, says Turnell.
Ravaged by World War Two, post-colonial Burma rebounded spectacularly on the back of effectively deployed credit. By the end of the 1950s, it was the world's biggest rice exporter.
Today, the country lags far behind world rice powerhouses Thailand and Vietnam. But that could change. Myanmar "has a high growth potential and could become the next economic frontier in Asia", the IMF's Karasulu says.
But modernizing the financial sector will be a critical part of upgrading the economy, she says.
Official data shows $40.4 billion was pledged in foreign direct investment by the end of this February. Of that, about 81 percent was for the power, oil and gas sectors. Mining, manufacturing, hotels and tourism and real estate took 17 percent combined.
Other services, which appears to include finance, was just 0.06 percent.
"All the banks are saying: We need help. We want reforms. We want changes. But how do we go about this?" said Dennis Openshaw, an emerging market bank consultant who is helping Co-operative Bank modernize.
"It all comes down to implementation and they've not got the knowledge and know-how."
(Additional reporting by Saeed Azhar in Singapore, Aung Hla Tun in Yangon and Yantoultra Ngui in Kuala Lumpur. Editing by Jason Szep and Neil Fullick)