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ArchiveJuly 3 2005

Mixed fortunes

Economic growth has been lifting the banking sector over the past year but the results have been varied. Ben Aris reports from Moscow.
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A new CD has appeared on the trestle tables of the Gorbushka electronics market in southern Moscow. Among the stands selling pirate copies of music CDs and DVDs, for $100 a punter can now also pick up a disk that gives details of all Russian banks’ financial transactions for last year. It contains all the information they reported to the Central Bank of Russia (CBR) as part of the day-to-day supervision of the banking system. Analysts at Standard & Poor’s say they are even receiving spam email advertising the CD.

Security concerns

This CD is the latest sensitive data to have leaked from various government bodies. A similar disk lists personal income tax submissions for last year, including the income details of such luminaries as the president, Vladimir Putin, and the Gazprom chairman, Alexei Miller.

The porous state of security protecting financial institutions worries analysts and stymies Russian banks’ efforts to diversify their client base. Companies and retail customers are afraid of giving sensitive information about their operations and income because they fear it will end up on sale in the market.

The rising tide of economic growth has been lifting the banking sector upwards over the past year but the results are mixed. Total assets have more than doubled in the past five years and now stand at $260bn. But growth has slowed more recently: assets increased by only 2% between 2003 and 2004 to 44% of GDP.

However, the structure of their business is changing and analysts are encouraged by the increase in deposits and lending. After being stuck at 4% of total invested capital for a decade, bank loans now account for 7%.

“While the total size of the banking sector is unchanged, the fast increase in deposits and lending means the banks are increasing their participation in the economy,” says Nataliya Orlova, chief economist at Alfa Bank.

The government seems happy with the progress. The economic development and trade minister, German Gref, says he is satisfied with the rising competition in the banking sector.

“Thank God our banking monopoly Sberbank does not have an appetite like Gazprom. If [Sberbank] wanted to buy all the banks, there would be only two left [in Russia], Sberbank and Vneshtorgbank,” Mr Gref says.

But despite the progress, banks still suffer from the same list of problems: loan books are very concentrated in a few big customers; the proportion of related party transactions is high; income is not diversified; and banks remain undercapitalised.

Security concerns and commercial rivalries mean large banks continue to rely on companies associated with the industrial groups that own most of the biggest banks. The financial-industrial groups (FIGs) that dominated the bank sector in the 1990s have not disappeared but changed.

Related-party lending

Building on the solid base of their related-party transactions, these banks are trying increasingly to become profitable standalone businesses, but the concentration of loans to connected companies puts them at risk. Related-party lending has fallen among the top 30 Russian banks but it still accounts for 20%-50% of the loan portfolio, according to Fitch, against the less than 5% that is normal in the West. Gazprombank, for example, says it has reduced the concentration of loans to Gazprom-related companies from 93% five years ago to 35% now.

However, unlike in the 1990s, these banks at the heart of a FIG are starting to generate real profits and the attitude of their owners has changed.

“In the past, owners viewed their banks as treasury operations and centres for related-party transactions. Now they see them as market assets that can earn a return, and they are willing to support them and their reputations,” says Natasha Page, the head of Fitch’s Russian office. “The owners are at a new stage in their lives and are developing their banks with a possible exit in mind – either selling up or an IPO.”

The FIG structure makes it difficult to assess bank risk. Although nearly all banks report their financials using international accounting standards, analysts say there is no way of assessing all the profitability of all the companies in the group.

“You can’t say if the group is vulnerable and if the owner is really able to support the bank in a downturn,” says Irina Penkina, who covers the Russian banking sector for Standard & Poor’s.

The state-owned and foreign banks were the big winners from last year’s mini-crisis. Rather than bail out struggling smaller banks with stabilisation credits the CBR lent Vneshtorgbank (VTB) $800m to buy out loan portfolios. The definition of collateral means banks cannot use their good performing loans to raise capital – something that should change this year.

Government action

Snapping up good loans at a deep discount has increased the state bank’s share in the sector from 36% of total assets at the start of last year to 41% by the end.

The state banks continue to worry analysts. For example, Russky Standart, a leading retail bank, out-earned VTB last year, despite being 15 times smaller.

The government is continuing to build up VTB. It has already bought Guta bank, which nearly collapsed last year. It will receive a $1.5bn capital injection this year to pay for St Petersburg’s Promstroibank, a top-five bank that gives it access to the lucrative Leningrad region as well as taking on the CBR’s foreign daughter banks.

Most of the top banks are moving out in front of their smaller peers after winning the confidence of the international capital markets over the past six months. As the biggest banks undercut their smaller peers with cheap, long-term credits, the smaller banks are being pushed into increasingly risky investments to maintain their profits, which could cause another mini-crisis in the next few years.

Real estate investments are a favourite and several banks were in trouble after one major Moscow developer went bust earlier this year.

“When there is an economic downturn, the state will support the big banks but the smaller ones will be washed out in another mini-crisis,” says Mikhail Galkin, a credit analyst at Trust investment bank. “This will be more painful than last summer’s crisis but the concentration of these risks is high and only 5% of banking capital will be affected.”

Foreigners are making rapid inroads into Russian banking and bankers are expecting competition to turn into a struggle for survival within a few years.

“The threat of foreign competition is the largest incentive for Russian banks to improve themselves. They are not just cleaning up their books for the CBR but so they can survive in the face of stronger competition by the foreigners,” says Ms Penkina.

There are 36 banks with 100% foreign capital operating on the Russian market and two – Raiffeisenbank and Citibank – are in the top 10. Several more are circling the market.

With a lot of the best corporate business already lost to London and New York, the foreign banks are focusing on the retail sector, where their share of deposits increased from 1.6% of the market at the end of 2003 to 2.6% as of March 2005.

Foreign banks pay the least interest on retail deposits and Alfa’s Ms Orlova believes they are attracting customers because of Russians’ continued mistrust of their own banks. But it will be a slow process. Ms Page argues that Russian banks have a huge advantage as building up retail is prohibitively expensive and the Russian banks’ existing branch networks will keep them in the game for some time to come.

Banks for sale

The alternative is to buy a Russian bank, but this is also difficult. Rosbank, Impeksbank and MDM-bank are all rumoured to be on the block but the only banks sold last year – DeltaBank, KMB and International Moscow Bank – were small, set up since the 1998 financial crisis and part owned or founded by foreigners.

The same opacity that has deterred Russian banks from expanding through acquisition will be an even bigger headache for foreign banks trying to buy into the Russian sector. The FIG banks that want to sell may have a hard time finding takers.

“Russian banks remain very underdeveloped. Many are only now starting to contemplate changes to corporate governance practices,” says Ms Page.

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