Russia’s financial-industrial groups were the bane of the 1990s. The banks were set up by well-connected oligarchs to strip factories of cash and generate shell companies by the dozen, creating Russia’s ‘virtual economy’. Eight years on and financial-industrial groups are back, but this time round they are firmly based in the real world and are earning real profits.
Russia’s economic revival has transformed the banking business, which was easily outstripping growth of the economy last year: banking sector net assets were up by just less than one-quarter over the first eight months of 2005 to $290bn, against gross domestic product (GDP) growth of 7% for the whole of 2005. There is no sign of this growth abating.
Growth in the sector’s loan portfolio was up by almost one-third last year to Rbs5000bn ($178bn) and bankers are expecting similar results this year as mortgage lending takes off.
Banks have become profit centres in their own right, fuelled by rising incomes and strong economic growth. Banks raked in Rbs21bn of profits over the first half of 2005, the second best result on record.
The profits have attracted the attention of owners, who have started investing in their banks and, by extension, become more interested in reducing risks.
Related-party risk
Russia’s banks have not lost all of the bad habits developed in the 1990s. In the past few years, the leading banks pioneered a successful model of tying up with big industrial concerns and using this platform of solid related-party business to pull ahead of their peers. Concentrating assets in one company owned by the parent group is a very risky strategy, but after six years of strong economic growth, this banking bluff has yet to be called.
Conscious that their good fortune cannot last forever, bank managers have begun to use the rewards of this growth to reduce risks. Last year was a watershed year for Russian banks as they gained access to international capital markets. Larger banks can tap into large amounts of long-term and relatively cheap credit, giving them a huge competitive advantage over their smaller peers and allowing them some room to manoeuvre. Most of Russia’s leading banks are taking this opportunity to wean themselves off risky related-party business.
Consolidation forecast
Stiffer competition is leading to more pronounced tiering of Russian banks. “The narrowing of interest margins, disappearance of exceptional trading gains, rationalisation of businesses in financial-industrial groups, search for critical mass and the implementation of regulatory initiatives will accelerate sector consolidation in the medium term,” said Standard & Poor’s in a report.
Banks are trying to strike an equilibrium between the lucrative related-party business and reducing the risks of concentrating assets in related parties. Banks that are part of an industrial group are reducing their exposure to the companies in the group and diversifying risk by taking on new, independent customers. However, the related-party business model has been so successful that banks without any industrial assets are trying to hold their own by building ties with corporations.
The change is most noticeable among the sector’s leaders, which are already well ahead of the second-tier banks and work very closely with the country’s leading companies.
“If you look at the loan and asset mixes of these banks, the mix is diluting. Three or four years ago there would have been a concentration to one company or one business entity of between 80% and 90%, on either the loan or deposit side,” says Paul Timmons, co-head of research at Moscow Narodny Bank.
“But now the top 20 banks are making a concerted effort to a more even balance or less concentration,” he adds.
There are still plenty of exceptions to this rule. While Gazprombank says it has managed to reduce the concentration of its parent (the state-owned gas monopoly Gazprom) in the loan portfolio from 93% five years ago to 35% today, other banks remain little more than a treasury department for their parents.
The re-licensing of the entire banking sector following the introduction of the deposit insurance scheme last year also contributed to a shake-out in the banking sector and it has made explicit the difference between bank and de facto treasury operation in a few cases.
For example, Forpost Bank was one of the 53 top-200 banks that did not bother to apply for membership of the deposit insurance scheme and consequently was stripped of its general banking licence. Owned by the management of fighter jet-maker Irkut, Forpost Bank stopped pretending to be a real bank. However, it remains registered with the Central Bank of Russia (CBR) as a more restricted ‘credit institution’ and reapplied for its right to operate on the stock exchanges so that it can continue its role as treasurer and custodian for Irkut’s shares.
Pure banks lag
A few banks grew to prominence in the 1990s by simply being good banks without leaning on cash-rich industrial companies. The best of the pure banks were catapulted into the top tier after the 1998 financial crisis destroyed their main competitors, but the success of the related-party model means they are belatedly scrambling to build up industrial empires.
MDM Bank is the most striking example. Founder Andrei Melnichenko built the bank up to become one of Russia’s top two commercial banks without being part of an industrial group, although he worked closely with aluminium oligarch Oleg Deripaska in the early days. However, six years ago Mr Melnichenko tied up with steel trader Sergei Popov and the two subsequently founded the MDM Group.
The arrival of Mr Popov, who bought half of MDM Bank in 2000, marked a turning point. Together the two have built up a sizeable industrial group that dominates Russia’s coal and pipe-building industries.
It is a story that is repeated at several other banks, such as BIN Bank, which after being a standalone operation for years has tied up with Russia’s fastest growing privately owned oil company, Russneft.
Along with the new balance between business and banking have come changes in the ownership structure. As banks are expected to stand on their own two feet, their oligarch owners no longer see the need to keep them on such a tight leash. The past few years have seen a growing volume of mergers and acquisitions.
LUKoil has been reducing its stake in Petrocommercebank, and state-owned rail monopolist Russian Railways was trying to sell off its captive bank TransCreditBank completely in August.
On the other side of the fence, the well-connected telecoms holding Sistema found itself without a bank at all after it was forced to abandon Guta Bank during 2004’s mini banking crisis. It quickly reversed plans to sell off its 99% stake in Moscow Bank for Reconstruction and Development and was put in the uncomfortable position of buying back shares it sold in 2004. It now owns about 60% of the bank.
These changing relations will be taken a step further with the first banking initial public offerings (IPOs) and Rosbank will lead the way with a flotation this summer. Rosbank chairman Alexander Popov says that consultants have already been hired and two independent directors – still a rarity in Russia’s banking industry – are waiting to join the bank’s board.
State-owned banks Gazprombank and Vneshtorgbank (VTB) have also both announced similar plans for late 2006 and early 2007 respectively.
Moves to float
The biggest state-owned banks are moving fast towards flotations because they have no need to build up industrial groups, thanks to political ties to the increasingly state-dominated economy.
While commercial banks have to buy a company to force it to use their bank, state banks can win the same sort of business for the price of one well-placed call to the Kremlin.
Gazprom is on the cusp of completely cutting its ties to Gazprombank (to the surprise of Gazprombank’s directors, who apparently were not informed of the decision). It has already transferred a blocking stake in the bank worth $800m from its 87.5% share to Dresdner Bank before increasing its capital with an IPO by 50% later this year.
And after years of talk, fully state-owned VTB received a $1.2bn injection from the state in December, which it has used to buy out the CBR’s overseas daughter banks. Economic development and trade minister German Gref has indicated that the government wants to sell 20% of VTB in 2007, although just how this will be done is still being worked out.
“There is financial revolution happening in Russia,” says Roland Nash, head of research at Renaissance Capital.
“The demand for banking services is exploding, but the state-owned banks remain in a league of their own. They were already big, but these capital injections by the state mean they can steamroll over the commercial banks, whatever they do.” ALFA BANK- COMMERCIAL GIANT ROSBANK-LIFE AFTER MERGER
