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Lean and liquid

Andrey Stepanenko, head of retail banking at Raiffeisen BankThe Russian consumer lending boom came to an abrupt end in late 2008, but convergence between consumer finance and traditional retail banking is providing the tools for sustainable growth. Writer Philip Alexander
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Lean and liquid

Before September 2008, the twin pillars for consumer finance in Russia were low market penetration relative to developed markets and ample wholesale funding. Retail loan growth of at least 70% per year drowned out other considerations. The funding dried up after the fall of Lehman Brothers, and a sharp (though temporary) slide in oil prices saw gross domestic product (GDP) decrease by almost 8% in 2009. But that did not, in theory, change the economic fundamentals of the Russian retail banking catch-up story.

In practice, however, the market has changed and the banks are changing with it. First, credit risk has asserted itself, especially on loans in the 2007 and early 2008 vintage. The 3% to 4% non-performing loan (NPL) rates of the boom years, healthy even compared to the western European consumer finance industry, have jumped into double figures.

But not all banks have been equally affected, as some acted in mid-2008 ahead of an expected economic downturn, even if they did not know how severe the GDP contraction would be. "We have exchanged portfolio growth for portfolio quality, and NPLs in January 2010 were actually better than in January 2008. Most consumer loans are short duration, so the vintages with lower underwriting standards have already matured," says Dmitry Levin, the CEO of Russian Standard Bank, which controls 40% of the retail credit card market.

Home Credit, another leading player in credit cards and point-of-sale (POS) lending, has seen its cost of risk return in 2010 at the same level as January 2009, after a tough first half last year.

"Part of it was because the economy improved, part of it was down to improved collections and because our underwriting became tighter - our credit scoring is adjusted every week. The average duration of loans in our portfolio is about six months, so we had rolled over most of pre-September 2008 by mid-2009," says Home Credit's CEO Ivan Svitek.

The short average maturity of consumer lending is a significant element for the whole sector. David Jones, the chairman and co-founder of leading debt collection agency Pristav, questions how far retail and small and medium-sized enterprise (SME) delinquencies actually rose in 2009, given the high portfolio turnover.

"As soon as new lending stops, the loan book begins to shrink. Good loans get paid down, so you are left with the bad loans that increase as a percentage of that vintage, even if they are not rising absolutely. The older they become, the more they have been washed by several rounds of collection efforts, so collection rates fall and there is little residual value," says Mr Jones.

Lower loan demand

If delinquent loan rates are under control, however, that only solves half the problem for banks. The other half of the equation is how to rebuild loan growth. That depends partly on the turnaround in the wider economy, which bankers are not taking for granted, despite signs of improving business sentiment and falling unemployment.

Vozrozhdenie Bank (V-Bank), one of Russia's most successful privately owned SME and retail lenders, which generated Rbs1.2bn ($40m) in net profit in 2009, has kept NPL provisioning on hold at 10% in 2010. Andrey Shalimov, head of treasury and a management board member at V-Bank, says this is partly driven by continuing concerns over microeconomic conditions in Russia, as opposed to the macroeconomic recovery.

"We felt it would be unwise to reduce provisions until not only GDP but also company balance sheets are showing improvement," says Mr Shalimov.

Even if the economic recovery is sustained, there has been a marked change in the behaviour of Russian households. Despite the higher unemployment rates and the steep pay cuts many workers took to keep their jobs, savings rates have soared - from about 10% of salaries before the crisis to as much as 25% in early 2010. This has had a knock-on effect on consumer spending, especially for unsecured general purpose loans or auto finance.

"Before the crisis, there was an assumption of ever-growing retail loan portfolios, based on models of where Russia is in terms of retail finance to GDP, which suggested about 15 years of growth to catch up with western Europe. The crisis taught us to redesign and outsource processes, to move from unplanned to efficient growth," says Andrey Stepanenko, head of the retail and private individuals directorate at Raiffeisen Bank.

Mr Stepanenko also aims to increase cross-selling of banking products, which had been neglected due to huge client inflows. Not only does selling more products to each client drive up income, it is also more efficient because it is easier to evaluate the credit risk of existing rather than new customers.

Deposit surge

There are ways for lenders to turn a higher savings rate to their advantage, especially when wholesale liquidity is much more volatile. With retail deposits rising about 25% in 2009, both the consumer finance banks and the foreign-owned banks that had previously relied on parent liquidity have sought out a slice of the extra retail funding available.

"Deposit-taking has been our most successful project, with deposits tripling since the start of 2009, to hit 140% of our business target. Clients like our products, thanks to the variety we offer in line with international standards. We have also invested in clients rather than in advertising and marketing, we have higher interest rates on deposits and lower television spend," says Russian Standard Bank's Mr Levin.

The bank mainly focuses on the mass market, but premium sales are also growing and Mr Levin does not exclude any segment. "It is surely a positive sign that many Russian bank managers deposit their money with Russian Standard," he says with a smile.

Home Credit had collected Rbs9bn (17% of its funding base) by the end of 2009, a year after starting its deposit drive, and that had already risen to Rbs11bn in the first quarter of 2010. Mr Svitek says deposits could provide as much as 30% of the bank's funding by the end of 2010, with the majority of new customers acquired by recommendation rather than marketing. He recognises this effectively puts the consumer finance lenders on a convergence course with traditional retail banking.

"One of the key lessons of the crisis is the need to become a full-service retail bank. This was already our plan before the crisis, but the need has intensified. At the moment, deposit funding is more expensive, but six months ago it was the other way around, and it could be again six months from now, so diversifying funding is appropriate on a long-term view," says Mr Svitek.

Conversely, the model of traditional retail banks such as V-Bank, which was historically 90% funded by (mostly retail) deposits, needed little adjustment to cope with the changed environment. Much of its retail banking business was with the employees of SME clients, helping to ensure customer loyalty and giving the bank good visibility on income when making underwriting decisions. This is reflected in good credit quality on its retail mortgage portfolio - only 4% have been restructured and there are no mortgages in outright default. Close customer relationships and financial strength also facilitated deposit growth well above the market average in 2009, at 34%.

"It looks as if we chose the optimal distance from the sun, not too close to the centre of these events that we got burnt, but also not so far that we got cold. Our key philosophy has remained intact - we positioned ourselves as a universal bank without substantial involvement in large investment projects, and we identified SMEs as our key target audience," says Dmitry Orlov, chairman of the management board and the largest shareholder of V-Bank.

For Raiffeisen, the need to establish closer relations with customers and more products per customer prompted the division of its retail directorate into two separate sub-segments in 2009 - one for private individuals and one for the affluent market. Tailoring products more closely to customer needs and improving quality of service is important to distinguish private banks from the large state-owned banks that have been lending aggressively in response to government calls to stimulate economic recovery.

Outsourcing costs

In addition to boosting revenues per customer, Mr Stepanenko says Raiffeisen is keeping tighter control on the absolute size of its cost base, thinking about how many POS it needs and the size and cost of any new branch, rather than simply projecting the break-even point for each branch based on the high growth rates of the past.

There will also be an incentive to improve the collections process to bring down the cost of work that is not inherently productive for the bank. Debt collection agencies are angling for a larger share of the collections process, seeking to prove their status as the most cost-effective means of tackling delinquencies. Elena Dokuchaeva, CEO of the largest agency, Sequoia Credit Consolidation, says selling NPL portfolios makes financial sense for the banks in an environment of tighter regulation and scarcer capital resources.

"Banks have to place reserves with the central bank equal to any overdue amounts, tying up funds they could use for new lending. If you work on these debts on the balance sheet, you spend money without bringing in anything and you have to pay profit tax on the interest accruing, even though you are not receiving the interest because the debtor is in default," says Ms Dokuchaeva.

Most of the top banks already make some use of collection agencies - Sequoia has about 280 clients - but there is widespread caution about how much of NPL portfolios should be transferred off the balance sheet. Mr Shalimov of V-Bank remains concerned about the reputational risks associated with collection agencies.

"We still consider it is better to keep bad loans on the balance sheet and to disclose, so investors can see it all clearly. Regulation and legislation is pretty mixed and a recent court ruling could be considered as meaning that individual borrowers should be protected by consumer protection laws, in which case selling a loan to a non-bank entity such as a collection agency could be illegal. So we are still reluctant to sell material pieces of the loan book to the agencies," he says.

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David Jones, the chairman and co-founder of leading debt collection agency Pristav

Going in house

The leading consumer lenders have also built in-house collections capacity as part of their business model. Home Credit has 1200 staff working in this area, well above Sequoia's 800. Mr Svitek says the use of agencies only makes sense for his bank in about 5% of cases, usually in the more remote regions where the bank's own network is limited.

Launched in 1999, Russian Standard's experience of collections goes back further than any collection agency, with an in-house credit bureau to assist the process. Mr Levin says its record on collection rates was the best in Russia in the second half of 2009.

"Our efficiency is higher than competitors, and it is also about the reputation of the bank. We want to control the whole collection cycle because these are still our clients, not our enemies," says Mr Levin.

As a result, the most enthusiastic users of the collection agencies tend to be the foreign-owned banks, which have more experience of the industry from their home markets. They may harbour concerns about making use of the Russian legal system for hard collections, and several US and UK banks affected by the worldwide financial crisis are also in the process of running down local retail portfolios as they reposition their global strategy.

Raiffeisen keeps collection on mortgages fully in house, as these are big-ticket loans with a borrower who wants to repay to keep their place of residence, so the opportunity-cost of losing the customer is higher than any efficiency savings from outsourcing collection. In any case, restructuring repayments, for example, by reducing annuities and extending tenors, is the most effective method of collection for mortgages. By contrast, the bank has used agencies for unsecured consumer and auto lending.

"We find the best strategy is to keep the early delinquency buckets internally, outsource collection for later stages and sell the problematic cases," says Mr Stepanenko.

All the right cards

The final piece of the puzzle will be identifying the best prospects for growth as the economy recovers. There is a general consensus that auto loans and unsecured lending are less appealing, due both to weaker demand and because credit quality in these segments has underperformed. Attention is turning to the credit card segment, which was the only one to grow for the sector as a whole in 2009, by about 10%.

"We expect auto loans and unsecured consumer credit growth to be slow in line with the whole retail market for about three years including 2009, and we intend to keep a stable market share. On the other hand, credit cards, current account overdraft facilities and settlement credits should all rise more quickly," says Mr Levin.

And just as consumer lenders are converging with retail banks on the funding side, so the traditional retail banks are waking up to the potential of the credit card business that has been well demonstrated by card specialists such as Russian Standard. V-Bank has acquired 1.5 million cardholders since 2002, mostly the employees of SME clients in line with its usual model.

"The initial purpose of issuing these cards was to pay salaries to these workers. But that was only the first step, as the cards have much wider functionality, for example, paying telephone bills, apartment rents or consumer credit. However, since people were not accustomed to such universal card functions, we have been conscientiously educating people about the advantages of using these cards for other services - and about 20% to 25% now do so. As that number grows, it will generate more revenues for the bank," says Mr Orlov.

Russia retail banking statistics (Rbs bn)

Russia retail banking statistics (Rbs bn)

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