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WorldAugust 27 2013

New regime loosens grip on Russian banks

The Central Bank of Russia’s new governor has overseen a relaxation in the capital requirements proposed to implement the country’s version of Basel III. 
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What’s happening?

The Central Bank of Russia (CBR) published Regulation 395P in December 2012, which set out its implementation of Basel III capital requirements, including the definition of capital, the minimum ratios allowed, and the legal framework for equitising subordinated debt, as an alternative to permanent write-down provisions. The regulation came into force in March 2013, and banks had until October 2013 to comply with the new capital requirements.

However, in July 2013, the CBR amended the proposals, delaying full implementation to January 2014 and reducing the capital requirements. The initial capital adequacy ratios proposed were 5.6% for core Tier 1 and 7.5% for total Tier 1. The new minimum ratio for core Tier 1 is set at 5% and for total Tier 1 the minimum ratio will start at 5.5%, rising to 6% in 2015, much closer to the international Basel requirements. The total capital ratio (including Tier 2 capital) will remain at 10%, compared with the Basel requirement of 8%.

Why the change of heart?

There has been a change of leadership at the CBR, following the retirement of Sergey Ignatiev after more than a decade at the helm. His replacement as governor is Elvira Nabiullina, who was economy minister from 2007 to 2012. In early July 2013, Russian president Vladimir Putin summoned Ms Nabiullina and other economic policy-makers for a meeting to discuss how to stimulate affordable credit to small businesses in Russia.

“There has been a lot of work around how to increase the safety and perceived safety of the banks without inadvertently provoking a cut-off in lending of some kind. Growth is below potential at the moment, and there are concerns about a possible hard landing for the economy,” says Geoffrey Nicholson, partner in the consulting practice at PricewaterhouseCoopers in Moscow.  

Does it matter?

Yes. Accounting firm KPMG produced a study that estimated a shortfall of Rbs300bn ($9bn) in the capital of the top 50 Russian banks if the CBR implemented its tough original proposals. The new proposals bring that figure down to just $100m in 2015, says Michael Kunisch, a director in financial risk management at KPMG.

“Most of the top 10 would have failed the higher capital requirements, not on core Tier 1 because they have high levels of common equity, but on total Tier 1. Russian banks have not traditionally issued significant amounts of Tier 1 subordinated debt, and that seems likely to change as they replace instruments that are no longer eligible,” says Mr Kunisch.

What do investors say?

Acceptance

Although banks had been lobbying hard for the CBR to relax the capital requirements, its stance had been firm until Ms Nabiullina’s arrival, and the dilution of requirements came as something of a surprise to outsiders. Even so, investors appear to be sanguine about the delayed and less demanding capital rules. Russian banks are on average highly capitalised, and the major investor concern is around governance.

“A lot of failed banks had formally good capital ratios but misrepresented their financial statements, risks and asset quality. Therefore, the issues of reliable reporting, proper risk management procedures and limitation of related-party lending are of substantial concern for investors and for the regulator,” says Olga Belenkaya, banking sector analyst at local boutique investment bank Sovlink.

In this context, she welcomes other CBR reforms that will strengthen the responsibilities of bank management and supervisory boards, and give the regulator more powers to challenge ties between banks and their borrowers. Meanwhile, the lower capital triggers for write-downs or equitisation of subordinated bonds will make hybrid issuance more attractive to investors. Credit Bank of Moscow in March 2013 issued the first hybrid in Russia to integrate the CBR’s new eligibility requirements, and more issues are expected in the second half of 2013.

What's next?

If capital requirements needed delaying, then the implementation of Basel III liquidity rules is even further down the line. Russian banks already report 30-day and one-year liquidity ratios (N3 and N4) that are similar in logic to the Basel Liquidity Coverage and Net Stable Funding ratios. But their content is simpler owing to the more limited asset mix available in Russia. And banks currently use international accounting standards only for their public reporting, with daily balance sheet management still conducted using Russian definitions.

The two processes will need to converge to make Basel III implementation more efficient, and all this adaptation has to take place in the context of a marked shortage of relevant expertise. Although not explicitly presented as such, Mr Nicholson says the new CBR rules may well contribute to its efforts to shrink the long tail of more than 900 banks in Russia. Private owners are likely to find the compliance costs outweigh the benefits of operating a bank to serve their non-bank businesses.

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