The Russian banking sector was created just over 15 years ago, its two-level structure replacing the handful of state banks that operated during the Soviet era. The sector evolved alongside the development of the Russian economy and experienced many of its growing pains. However, this ‘zero starting-point’ allowed the swift introduction by domestic banks of the most advanced technologies and products based on tested global experience and practice, both in staff expertise and in banking supervision.
Big bank failures
The initial boom in the number of banks (of more than 2000 banks, less than 1300 survive today) – and their enthusiasm for speculating in the foreign currency and state securities markets – was curtailed by 1998’s financial crisis. At the time, more than a half of the 20 biggest banks ceased operations and failed to meet their obligations to thousands of private depositors and many small and medium-sized enterprises, which in turn also crashed. All the assets of these banks, no matter how valuable, were transferred into hastily established bridge banks, and creditors had no choice but to hold mass-meetings and calculate their losses. The barely emerged confidence of domestic companies, Russian citizens and foreign investors in the young banking system was undermined substantially and has yet to be restored.
Against that background, the largest state banks, such as Vneshtorgbank and Sberbank, as well as banks that had not indulged in financial speculation, such as Gazprombank, Industrial and Construction Bank (St. Petersburg) and Bank of Moscow, acquitted themselves with the most dignity. They have strengthened their position in the market. Particularly after the crisis, client operations have become the principal source of profits for the banks.
So what problems concern Russia’s government and banking community at the start of the 21st century? After all, the banking sector has considered the bitter lessons of the past and recovered its position (see figure 1 download), and by 2002 it had dealt with the consequences of the crisis.
Until 2002, minimum demands were made on the banking system, requiring it only to be restored to its pre-crisis level. Reform was mainly from the bottom up, through the natural selection of the most professional and experienced participants, and through background discussions of the possible ways in which to restructure the system. When the sector’s modest role in the economy increased, the government was forced to speed up its regulatory activity and the adoption of necessary legislation.
Long-awaited law
Probably the most important and long-awaited document was the law “On retail deposit insurance in the banks of the Russian Federation”, which was designed to overcome the public’s systematic distrust of banks. The law guarantees depositors a refund of about $3500 in case of a bank failure. The amount, while not large, is likely to be increased in future. More than 1100 banks wanted to enter the Retail Deposit Insurance System, but not all of them passed central bank scrutiny. The first selection stage, in March, revealed that only 72% were ready to handle the money of individuals.
But the law has also caused some problems, which need to be addressed carefully. First, the banks are required to pay the State Insurance Fund roughly 0.6% of total deposits, pushing up the cost of attracted funds. Moreover, the Civil Code allows a depositor to withdraw their money from a term account on first demand, which automatically shifts such accounts into the on-demand category. Second, not only does the law make a depositor indifferent to the problem of selecting a reliable bank but it also reduces a bank’s motivation to maintain reliability. In pursuing the goal of expanding their clientele, the banks participating in the Retail Deposit Insurance System may set the rate of profitability on their deposits too high, thus increasing their operational risk. Hence, the central bank’s and the Retail Deposit Insurance Agency’s supervising role is crucial and they must ensure the rules are complied with.
Credit information
The law “On credit histories”, which came into effect recently, is equally important. It has been a long time in the making: work on the draft began in 1997. The law enables the formation of a credit bureau system, with the data managed by the central bank at the core of the system. As early as September 1, 2005, the banks will have to submit credit information about their borrowers (with their consent) to at least one of the credit bureaux. As the system accumulates more information, banks will be able to obtain reliable and up-to-date information concerning the financial condition of borrowers on a national scale.
The balance sheet structure of the Russian banking sector reveals that long-term liabilities (over one year) exceed the volume of long-term loans by approximately 25%. It shows the current lack of high-quality borrowers while the banks possess enough resources to satisfy their funding needs.
Recently, many major decisions were made in the sphere of currency control liberalisation. However, this new legislation not only creates new opportunities but also new risks. The selective liberalisation of foreign trade relations, particularly the removal of limits for cross-border banking services, has been conducted without the adequate liberalisation of the domestic financial market. Due to the insufficient competitiveness of domestic banks, this may have adverse consequences for all Russian banks. Russian companies currently have the right to open accounts with foreign banks and manage funds in those accounts, which may lead to:
the most reliable and solvent customers moving to foreign banks;
the extra growth of foreign banks’ capital due to commission income gained from services to Russian clients;
a drastic decline in cross-border cash flows due to their transfer abroad;
a decrease in the resource base and lending volumes of Russian banks.
Such threats are unavoidable while the levels of development between Russian and foreign banking systems continue to differ. Effective tools should be devised for international tax administration and protection of lenders’ rights abroad. Meantime, although the principal laws and other regulating documents addressed in the 2001 Banking Sector Development Strategy have either been or are being realised, the planned figures of the banking sector development are yet to be achieved. And although the pace of recovery is impressive, the role of domestic banks in the national economy remains inadequate.
Long-term funding
Lack of long-term funding remains an urgent concern. Banks have nothing to rely on except the deposits of individuals, which have become a battlefield since the introduction of the Retail Deposit Insurance Law. Most banks have no access to the longest-term resources – pension and budget funds. There are still limitations set by the supervisor on the issue of bonds and certificates, which otherwise could also act as a source of medium and long-term finance for banks. Just a few top-five banks with higher reliability and reputations are able to draw long-term and relatively inexpensive funds in foreign money markets.
Despite the boom in lending – the most distinguishing feature of recent years – this business also has some unresolved questions that restrain further expansion. For instance, legislation is pending concerning creditor protection in case of collecting assets pledged as collateral when a loan goes bad. The poor financial condition of borrowers (about 35%-40% of Russian industrial enterprises are considered unprofitable) is the most significant obstacle to the development of lending. Small companies have even less opportunity to obtain a bank loan due to the lack of transparency of their business and their often doubtful financial reporting.
Mortgage lending is also one of the most promising businesses for Russian banks. However, this sector is underdeveloped. Mortgage loans in Russia currently amount to about $500m while in the US the figure is $4000bn, and in Europe more than $3000bn. According to expert estimates, only 1.5% of housing is purchased using a mortgage, compared with about 90% in developed countries.