Newspaper headlines on Russian banking this year may have given the impression of a sector in turmoil. The reality, however, is far more complex, with an underlying story of growth and optimism.
In the same month that Sergei Ignatyev, governor of the Central Bank of Russia (CBR), appeared on the evening news to reassure Russians that a mini-banking crisis would not spin out of control, a string of foreign banks made multimillion dollar investments into the Russian banking sector: buying leading consumer credit banks, opening investment banks and setting out their stalls to sell mutual funds to small investors.
The crisis has masked a boom in retail banking, driven by a relentless rise in personal incomes and ballooning consumer lending. At the same time, strong economic growth and huge pent-up demand for investment capital has made investment banking irresistible to big foreign banks.
New rules
The crisis has also kick-started the long-awaited bank reform. Indeed, this summer’s crisis was sparked by the CBR’s decision to apply the new rules for the first time, when it withdrew medium-sized Sodbiznesbank’s licence in May.
“For the first time after four years of discussion we are seeing implementation of the bank reform,” Economic trade and development minister German Gref told investors at the end of October. “Everyone was waiting for this reform and when it started there was a lot of criticism, saying it had caused a shock to the banking system. But this reform must continue and the CBR has learned its lessons from the summer. We must continue to reduce the administrative burden on the banks and make sure the rules are enforced so that private deposits are guaranteed.”
As the dust settles, Russia-watchers are concluding that the mini-crisis was a good thing. The upshot is a concentration of the limited resources among the best banks. Analysts are now expecting accelerated consolidation in the sector as the 1000-odd smaller banks, which account for only 10% of bank sector capital, start to wither away.
Crisis, what crisis?
Russia’s mini-banking crisis was officially over by the start of October, but it has triggered far-reaching changes to the sector. High international oil prices meant big banks have been awash with liquidity all year and were unaffected by the collapse of the interbank market over the summer, which selectively hurt the smaller banks that rely on credits from their peers to fund their operations.
As fears of a systemic meltdown gathered pace, the CBR reacted quickly, injecting about $1.5bn of liquidity into the sector by slashing obligatory reserve requirements from 10% of liabilities to 3.5%.
Daily volumes on the interbank market have since recovered to $10bn a day, from the pre-crisis level of $15bn a day, but only 10 banks remain active. In effect, smaller banks have been shut out of the market.
“The CBR supported the general banking liquidity rather than saving specific banks, which confirms our view that it now intends to cull the banking sector. We expect the number of small and mid-sized banks to decline by 100-200 over the next 12 months,” said Natalya Orlova, a bank analyst at Alfa Bank, in a recent report.
Commercial profits
Big banks did not need rescuing, so CBR’s liquidity injection – coupled with a flood of capital arriving in their coffers from wobbly smaller banks – have given leading commercial banks a fillip.
Profits at Russia’s 30 largest banks jumped by just over a third between July and September. Alfa Bank was the only big commercial bank to experience runs on its accounts but has recovered and its profits rose seven-fold in the third quarter, while competitors Rosbank and Mezhprombank enjoyed more modest, four-fold increases.
Talk of a crisis has obscured a boom in retail banking. After the years of hyperinflation in the early 1990s, Russians used to keep most of their money in what Sberbank chairman Andrei Kazmin calls “the mattress bank”. But household deposits overtook corporate deposits two years ago and bank deposits now account for more than two-thirds of Russians’ savings, according to the state statistics committee.
As the numbers from the summer were unveiled, analysts were surprised to discover that withdrawals from retail banks were much lower than had been expected: retail deposits shrank by Rb12bn ($414m), just under 1% of the total deposits held on account, in the first six months of this year. Now Russia is back on a track that has seen household deposits rise by a massive 80% to $61bn over the past 18 months.
And more of this money than ever is going to commercial banks. Most commentators assumed Russian depositors would make a beeline for Sberbank and its 100% state-backed guarantee, but it did worse than most leading commercial banks in the crisis. Its share of total household deposits fell by just under 1% to 61.9% in the first six months of this year.
Alexei Moisseev, an economist at Renaissance Capital, says: “Sberbank did not do nearly as well out of the run on retail deposits as expected. In fact, in July, its retail deposits increased by just 0.8%, or by Rb8.4bn, which, rather incredibly, is well below its monthly average increase in the first five months of the year.”
The main winners of the crisis were Vneshtorgbank (VTB), with a flow of $100m into its vaults in July, a 9% increase – double the sector-wide monthly growth rate in the past year – and Austrian-owned Raiffeisenbank, whose deposits increased by more than 9% in July.
Rich pickings
The increasingly rich pickings in Russia’s banking sector have sparked a raft of foreign buy-outs and mergers, which continued throughout the worst of the summer’s upheaval. Deutsche Bank was the first to commit when it took a big minority stake in Russian investment bank United Financial Group at the start of the year. Its mutual fund arm, DWS, followed in September by opening an office to sell international funds to Russian retail investors. Dresdner Kleinwort Wasserstein set up a brokerage in July. UBS has agreed to a buyout of its joint venture, local investment bank Brunswick. And Germany’s HVB Group announced that it would acquire a controlling stake in Russia’s International Moscow Bank in September.
But the real fight will be in the retail sector. France’s Société Générale is rolling out a branch network and intends to spend up to $1bn over the next 10 years, according to sources at the bank. BNP Paribas, also of France, bought the leading consumer credit bank Russky Standart in July, while GE Capital of the US has joined Citigroup and Raiffeisenbank in the increasingly competitive retail sector.
Rocketing retail deposits are attractive, but it is the exponential growth of consumer lending (and parallel hopes for investment banking and equity markets) that has convinced foreign bankers to move off the sidelines in the past few months. Consumer lending has grown 245% from a tiny base in 2001 to become a $16bn business by the start of this year. Renaissance Capital predicts that retail banking deposits will increase from the current 11% of GDP to 19% ($173bn) of the projected GDP in 2008 and expects consumer loans to grow five-fold to about $84bn in the same period.
Reform and enforcement
Russia’s financial sector was already doing well on the back of sparkling macroeconomic performance but, after a decade of dithering, the Kremlin has made a start on real reform to the industry. The keystone to this reform is legislation to create a deposit insurance scheme that was rushed through the Duma in two days at the end of August.
Initially, the CBR has promised to guarantee the first Rb100,000 of deposits in all banks to calm fears and has slapped a temporary ban on smaller banks opening new deposit accounts or doing hard currency operations. But this guarantee will only apply to members of the deposit insurance scheme once the CBR has finished processing the 1000-plus applicants sometime next year. By the start of November just over 60 banks – almost all of them small banks – had been admitted to the scheme.
Analysts were hoping that the CBR would take the opportunity to cut some of the dead wood during what is, in effect, a relicensing of the whole sector. The decision to allow nearly all banks to apply has introduced the danger of moral hazard: banks, sure that they will be bailed out if they go bust, could be tempted to take bigger risks to earn higher returns that will attract more depositors. Deposit insurance will be a failure unless it is accompanied by tougher supervision.
CBR takes action
Vladimir Safronov, deputy director of the regulation and supervisory department of the CBR, admits that the bank’s governance system is inadequate and the management at many banks is below par. But, he says, the CBR had checked the capital of 859 banks from a total of about 1200 by the start of November and is taking action against the 188 found guilty of artificially inflating their capital.
The CBR decided to close Sodbiznesbank after inspectors found that 80% of its capital was fictitious, while Alfa Bank’s Ms Orlova estimates “virtual capital” makes up a quarter of the total reported capital.
The inspections started at the beginning of this year, but by autumn the CBR began the more subtle process of making existing regulations work better. Transparency received a significant boost in October with the introduction of mandatory reporting to international accounting standards (IAS) and the CBR has introduced a system of “curators” – inspectors charged with getting to know their allotted banks rather than just collecting forms.
“The supervisory body will appoint curators for every bank. The curator will be obliged to report to the central bank quicker about any problems existing in the bank, to facilitate quicker decision-making, and provisions will probably be made for rotation of curators to prevent the bank from ‘getting too used’ to the representative of the central bank,” Mr Safronov told Russian newspaper Novye Izvestia in early November.
The flip side of introducing a deposit insurance scheme for commercial banks was the removal of the state-backed guarantee for deposits at Sberbank. Individuals who opened an account at Sberbank after October 1 will only enjoy a 100% guarantee on the first Rb100,000 of deposits, although those who already had accounts will continue to have all their savings guaranteed until 2007.
Reform proposals
New reporting and inspection regimes are obviously welcome, but the government went a step further to address the biggest problem facing the bank sector at the start of November. No matter how well commercial banks work, they remain dwarfed by state-owned giants Sberbank and VTB, which enjoy competitive advantages through their close association with the state.
At the start of November, the Federal Antimonopoly Service and the CBR submitted a concept for the next round of bank reform, calling for the government to reduce its ownership in all state-owned banks – including Sberbank and VTB – to 25% plus one share by 2007 before getting out of banking altogether by 2012. The draft concept has already been sent to the Duma and is supposed to be adopted before the end of this year.
Russian prime minister Mikhail Fradkov put bank reform at the top of the Kremlin’s agenda this summer and is keen to get the sector working better as part of the Cabinet’s drive to deliver on president Vladimir Putin’s promise to double gross domestic product by the end of the decade.
Adopting the plan will be the easy bit; selling the stakes will prove more difficult. Mr Putin signed off on the proposal to sell up to a fifth of VTB in two tranches to the European Bank for Reconstruction & Development (EBRD) and International Finance Corporation in December 2002, but negotiations collapsed because of a row about money: the government is holding out for $300m for a 10% stake, whereas the EBRD is offering only $250m.
In November, VTB CEO Andrei Kostin, who was frustrated by the slow pace of negotiations, opened the sale to anyone. Rumours that VTB was in talks with Italian bank Mediobanca and Deutsche Bank as potential bidders have been confirmed by a senior VTB source, who says a deal with one of the commercial banks could be struck by the end of the year.
Mr Gref says that the government has softened its position on foreign banks’ participation in Russia’s financial sector but it plans to cap their share of the market. Analysts concur that while the Kremlin is keen for foreigners to introduce some competition into the sector, it will never allow its banking sector to be sold off to foreigners (as happened in the countries of central Europe).
Credits grow
The increasingly active foreign banks are already beginning to make an impact (see table). Bank credits as a proportion of total invested capital have been stuck at between 4% and 5% for most of the past decade but have recently risen to 8%, with one in every eight roubles lent by a foreign bank.
Still, lending by Russian banks remains a fraction of lending in Organization for Economic Co-operation & Development countries. And the same increase in risks that prompted big banks to cut off credit to smaller banks has led them to cut smaller companies off, too, hitting the construction sector the hardest.
The state statistics committee’s figures show that retained earnings in the third quarter accounted for 73% of fixed investment, up from just over half at the start of the year.
“Companies still fund most of their investments out of their own pocket, while external sources account for 15% – up 10% from a few years ago,” says Ruben Vardanian, president of investment company Troika Dialog. “There is a positive trend, but it is still very feeble.”
Bank reform is supposed to concentrate resources among the best banks but this will bring little economic benefit if they then only lend to the biggest companies.
“Bank lending totals just 18% of GDP so bank credit’s impact on growth is not substantial. However, a number of small and mid-sized enterprises are experiencing problems with liquidity, as the risk premium for their borrowing has increased substantially,” says Ms Orlova in the Alfa Bank report.
Help for small firms
As the first snows arrived in Moscow, Mr Gref and deputy prime minister Alexander Zhukov were emphasising the need for administrative reform, which should contribute towards the reduction of small company risks. Mr Gref admits, however, that it will take several years before administrative reforms have any real effect – if they happen at all. The government is in the initial stages of trying to implement the administrative reforms that will lead banks to lend to smaller companies more.
Meanwhile, the best banks are taking advantage of the coincidence of their improved position and the global economic pall that has driven down interest rates on international capital markets to raise more and cheaper money, thus widening the gap between big and small banks. After a slow summer, Russia’s leading banks and corporations have returned to both the Eurobond and syndicated loan markets in force.
Standard & Poor’s now rates nearly 100 Russian companies, with the average rating in the speculative grade category of B-. Credits raised from foreign banks have grown from $1bn in 2001 to a total of $28bn last year, the bulk of which was raised in the past two years.
Loan business picks up
The number of syndicated loans passed its pre-1998 financial crisis levels, with 107 deals last year raising a total of $10.48bn. This year was set to be even better, with 75 deals signed in the first six months raising $10.57bn, according to Adrian Walker, head of syndication at Standard Bank in London.
“In September, things began to move again with Russian syndicated loans but it has turned into a country of haves and have nots,” says Mr Walker. “The crisis has passed but investors are more focused on who has or does not have oligarch risk.”
State-owned bank VTB had no problems raising a syndicated loan in September and ‘neutral’ commercial bank UralSib was also well received when it went to market in the same month. But everyone is watching what will happen with two issues announced at the start of November from Rosbank and Promsvyazbank, which are owned by powerful businessmen.
Eurobond growth
Likewise, Eurobond issues this year by big Russian companies are likely to beat last year’s record $6.1bn, according to data management company Dealogic. Corporate Eurobonds now make up half of Russia’s outstanding international bonds, up from 15% in 1999.
Banks are running about 18 months behind the leading corporate Eurobond issues but the state-owned banks are still the biggest players. Sberbank made its debut on the international capital markets last year with Russia’s first investment-grade rated bond, a $1bn three-year Eurobond at Libor plus 1.75%. And VTB has issued the biggest banking bond this year, a $325m 12-month floating rate bond issued in April as part of a $2.5bn mid-term borrowing programme.
Now confidence has returned, several leading commercial banks have followed the state giants. Alfa Bank, Bank of Moscow, Russky Standart and MDM Bank all issued Eurobonds in September on the back of falling international interest rates while crisis-inspired domestic interest rates rose at home. Russian banks had placed a total of $1.6bn worth of Eurobonds by September against the $2.5bn raised in 2003.
“The focus [for international bankers] is now on who is your partner. It is clear that consolidation will take place in Russia’s banking sector – maybe not at the pace you would like – and the CBR is going to get tough and close banks in a systematic way,” says Standard Bank’s Mr Walker.
“This will be easier to do with deposit insurance up and running, but there will be winners and losers in the process. The time for drastic action has come as bank reform has lagged behind and oil-driven growth cannot last forever.”
