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ArchiveDecember 2 2001

Kremlin raises reform hopes

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Ben Aris reports from Moscow on renewed efforts by the Russian government to overhaul the banking sector.

For most of the past decade, Russian banks have been little more than a mechanism for stripping cash out of big companies and transferring it abroad. Then, unexpectedly, as the Duma deputies returned to Moscow at the end of their summer holidays, real banking reforms appeared at the top of the Kremlin's agenda.

Sorting out Russia's ailing banking sector will be the hardest reform that President Vladimir Putin has attempted, and it is already bogged down in infighting. But he seems determined to do something about the country's mess of a financial system. The trouble is that the government is undecided about what action to take.

Government makes plans

Some clarity came at the end of October when the government announced two plans for state banks: it said the European Bank for Reconstruction & Development (EBRD) is to buy a 20% stake in Vneshtorgbank (VTB), Russia's biggest bank by assets, and that Vnesheconombank (VEB), its sister bank, would be restructured. The EBRD has not yet officially commented on the proposed deal but has been a fan of VTB since the financial crisis of 1998 when, almost uniquely among Russian banks, it met its forward contracts obligations following the rouble's devaluation. VTB is 99% owned by the Central Bank of Russia (CBR).

The main problem of reforming Russia's ailing banking sector is what to do with the state banks, which dominate the business. VTB and Sberbank, the former People's Saving Bank, which has a virtual monopoly over the retail business, also account for more than one-third of the banking sector's assets. The young commercial banks say they cannot compete and the state banks stymie the development of the sector.

Selling a stake in VTB would be the first step in privatising Russia's state banking giants. But the CBR also wants to beat off an attack by VEB, which handles Russia's international debts, such as sovereign eurobonds. The finance ministry owns VEB, which was set up at the same time as VTB. Despite it having no banking licence, it has earned half its income from commercial banking business since 1998, when blue-chip companies flocked to any bank with state backing.

VEB chairman Andrei Kostin has been lobbying for years to create a real bank from the commercial part and spin off its debt functions into an agency under the finance ministry. Plans to create a commercial bank from VEB - with the provisional name Vnesheconombank of Russia, not Vnesheconombank of the USSR, which will be the debt agency - were announced in October.

Mr Kostin and CBR chairman Viktor Geraschenko are rivals and are battling over controls of these big banks. Mr Kostin is an old friend of prime minister Mikhail Kasyanov and wants to merge VEB with VTB eventually, to create a massive state bank under his own control. At the same time, the CBR and the finance ministry are old enemies, each attempting to extend as much control over the banking sector as they can.

"It is not clear what the outcome of the showdown will be," says Dmitry Kormilitsyn, president and chief executive officer of TransCreditBank. "But it is clear there is a fight between the different lobbies in the government and this is because they don't have a clear idea of what they want to do."

Firms sell their firepower

So, playing to their strengths, the accountancy firms promote their advisory role and their ability to draw on a range of tax, legal and due diligence skills to structure and transact deals - mergers and acquisitions, management buyouts, asset disposals, privatisations, capital raisings - in the private markets. On the relatively few occasions that the deals involve a public issue, the firms help their clients to select the investment banker or broker that will most competitively undertake that end of the operation.

"We are a classic intermediary, selling our intellectual firepower. We survive on our native wit and cunning," says John Griffith-Jones, head of corporate finance at KPMG in London.

Draft reforms under discussion

The government has postponed the thorny question of what to do about the state banks, and is getting on with the rest. At the end of September, the Kremlin's banking reform kicked off with a meeting between Mr Geraschenko and Mr Kasyanov, where they discussed a draft version of a reform plan. Many of the key problems were identified but the process still has a long way to go.

"The draft plan for banking reform is good but it avoids asking the hard questions," says Yevgeny Ivanov, chairman of Rosbank. "There is a general consensus on what needs to be done but there are no dates, no time frame. It is all very vague."

Tellingly, while the draft plan addresses key issues of the long-promised introduction of international accounting standards and hiking the minimum capital requirement for banks, it ignores the question of the state bank's dominance of the sector.

Even the measures on commercial banks, especially the question of hiking minimum capital requirements, caused a blazing row among the meeting's participants, according to reports. The meeting ended with an announcement that a revised plan would be presented on November 2, which came and went without any change.

It was never going to be easy but the government does seem committed to taking some action. The World Bank presented the government with a report on the banking sector in September and the draft version that was on the table between Mr Geraschenko and Mr Kasyanov contained many of its recommendations.

"It seems that the government is taking the advice of the World Bank," says Richard Hainsworth, chief executive of RusRatings, a bank ratings agency in Moscow. "The bank sector is being rationalised."

Lack of recapitalisation

The first issue that needs to be addressed is how to recapitalise the commercial banks. Russian banks are too small: their assets are equivalent to about a third of GDP while US banks' assets are 10 times as much. That is not taking into account that most US blue chip companies are worth more than the Russian economy.

In the past two years, the most successful banks have been those connected to Russia's biggest industrial companies, which are mostly in oil and metal. Using the solid businesses of their parent companies as a foundation, they have attempted to diversify. But the companies are unwilling to invest in their banks as there are better returns to be made elsewhere in the economy. Rosbank, which is owned by Interros, one of Russia's biggest corporations, suffers from this problem.

"There is no incentive for Russian banks to capitalise as the legislation that governs banks is still the same as that for casinos," says Rosbank's Mr Ivanov. "The time of huge profits - the mid-1990s - has passed and there is little to offer shareholders as a result."

Mr Ivanov says Rosbank's credit portfolio is about $1bn but it has requests for another $2bn of loans that it would be willing to grant and cannot because of the lack of capital.

A way through this problem is to open the banking sector to foreigners. The CBR has already dropped the internal instructions that limited foreign banks to 20% of the total banking sector capital and has made noises about easing restrictions further.

In a newspaper interview last month, CBR first deputy chairman Tatyana Paramonova said the central bank was going to lift restrictions on foreigners buying into Russian banks. He said it would allow foreign banks to open branches without restrictions sometime after 2004, when Russia's banks are due to change over to international accounting standards.

Ripe for consolidation?

Another way of boosting the capital is to reduce the number of banks. Russia had 1322 banks at June 1, 2001. The top 12 dominate and approximately 300 are reasonably sized, with average capital of about $8.5m. The smallest 1000 are tiny with average capital of about $800,000 and collectively account for less than 6% of banking sector assets. Getting rid of them would make little difference either to the banking sector or the economy.

"There is not enough business for so many banks," says Mr Ivanov. "The big banks are checked regularly but the small ones are ignored. To win business, they offer illegal services - money laundering, capital flight and so on. To compete, the big banks have to offer the same, which infects the whole banking sector." However, the CBR opposes hiking minimum capital requirements, one of the topics most hotly debated at the September meeting. It already hiked minimum capital requirements to $5m earlier this year but the new measure applies only to new banks.

The leading bankers clubbed together in the summer to lobby for a hike to $100m but the idea was subsequently dropped. The CBR has been forced to accept a compromise figure of $20m and the banks have been scrambling to boost capital in recent months, assuming the limit will be raised to at least $10m. But some analysts think the debate misses the point.

"The whole minimum capital issue is a red herring because banks can fudge their minimum capital too easily," says Kim Iskyan, a bank analyst at Renaissance Capital in Moscow. "Minimum capital requirement will work only if you have more aggressive bank regulation."

Deposit insurance scheme

Regulation is also the key to the second big change that the draft banking plan would bring: a deposit insurance scheme.

Part of the reason that the state banks dominate is the government has promised to guarantee the deposits of any bank in which the state has more than a 50% stake. A law that would create a mandatory deposit insurance scheme is scheduled to go through the Duma soon and is supposed to go some way to undoing the state banks' advantage. However, analysts are worried it could make things worse. "A deposit insurance scheme will be a disaster," says RusRating's Mr Hainsworth. "All that will happen is depositors will no longer worry about the health of the bank and will put their money with whichever bank pays the highest interest, by definition the most risky banks."

Call for CBR to act

Rosbank's Mr Ivanov also believes that, even if the scheme is put into effect, it will not accumulate enough money in 10 years to bail out even one of the top 20 banks if any of them should go bust. The scheme may help persuade the Russian population to trust banks with some of the estimated $40bn they are thought to keep in cash (another problem) but, as it stands, it will not be effective unless the CBR significantly beefs up regulation - something it has been notoriously bad at.

"The CBR's first priority is to protect the exchange rate. The second is to keep inflation under control," says Mr Ivanov. "But creating a strong banking sector is not among the CBR's priorities. It thinks the needs of the economy can be met by the state banks."

Andrei Ivanov, a bank analyst with Moscow-based investment bank Troika Dialog, said: "This is the first step towards privatising the banking sector and is very positive. It shows the government does not support Mr Geraschenko's idea that the state banks should dominate the sector, and means the Kremlin wants to see commercial banks increase their role in the sector."

The Kremlin's concern with banking reform is a leap forward. Russia is entering the second phase of reform and trying to make the first complex changes. Even if the Kremlin thrashes out ideas, the reforms will be meaningless without other measures to fix the judicial system, introduce clear property rights and stamp out corruption. There is progress on all these fronts but it could take years before there is a noticeable improvement.

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