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Competitive disadvantage

The low capital base of the Russian banking sector is a serious concern; it could hamper the country’s ability to achieve its ambitious growth targets. But there is growth.Stephen Timewell reports from Moscow.The Russian economy may be growing strongly, with latest GDP growth estimates put at 5.8% in 2004, but Russian bankers are concerned about the low capability of Russia’s banks and their lack of access to long-term funds.
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“We don’t have a competitive, level playing field with foreign banks,” says Andrei Kazmin, chairman of Russia’s biggest bank, Sberbank, which has a massive 62% of the deposit market.

Speaking to The Banker in Moscow, Mr Kazmin is seriously worried about the low capital base of the banking sector and its inability to meet the demand for credit expansion, which is critical to the country’s ambitious growth targets. Although Russia’s banking assets doubled between December 2001 and June 2004 to reach R5733bn ($198bn), Mr Kazmin is concerned by “the lack of access to long-term funds to be able to provide long-term credits such as mortgages”.

Alexander Popov, chairman of Rosbank, which now has the second largest branch network after Sberbank, agrees that, although the banking sector may grow by 30% in 2004, Russian banks do not have long-term funds and are at a competitive disadvantage to foreign banks.

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Alexander Popov: foreign banks have the competitive advantage

Two-track financing

In many respects, Russia’s financial sector operates in two ways, leading to a situation in which large blue-chip companies can raise large amounts of capital more easily than the banks.

Large blue-chip companies’ financing is largely done offshore through foreign institutions. Recent discussions of the E10bn for energy giant Gazprom were through six foreign major banks, which have the balance sheets to finance such massive loans at the spreads that the blue-chips can command. This offshore financing, however, is vastly different from the environment in which most Russian banks operate at present.

The Russian banking sector is growing fast, but the banks are relatively small by international standards and are limited in what they can do in the domestic market. In The Banker’s Top 50 Russian Banks listing, the aggregate Tier One capital of the 50 banks amounts to $17.5bn, a little less than the size of Italy’s Banca Intesa. Aggregate assets of $128bn (Sberbank accounts for 39.2% of the total) reflect the fact that Russian banking assets are still very low as a percentage of GDP, compared with more than 100% for countries such as the UK and the US and more than 50% for many countries in central and eastern Europe. Although there are 1277 banks in Russia, most of them are very small: the 50th largest bank in our listing, Web-Invest Bank, has Tier One capital and total assets of only $76m and $264m respectively (see The Banker, December 2004, p65).

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The size issue reinforces Mr Kazmin’s view that banks need to build up their capital significantly if they are to grow. The question is how to do it. Again, the aggregate pre-tax profits of the Top 50 are relatively small at just over $3bn (Sberbank accounts for 18% of the total). Bankers suggest that more needs to be done than just ploughing back profits. Sberbank produces a healthy 25% return on equity but investors tend to shun the banking sector, seeking better returns in other sectors, such as the oil and food industries.

Investors are not attracted to the banking sector, bankers say, and the legislative environment is not regarded as friendly. Some suggest that the banks need to be given tax breaks to help stimulate the sector. But whether the authorities accept the argument and make separate tax and legal arrangements for the banking sector remains to be seen and seems at best unlikely (see page 20).

Given the perception that banks are already rich enough and they managed to survive the 1998 crisis, the legislative environment may not change and no special conditions will apply. Bankers, however, argue that if the government wants GDP to reach $1000bn by 2015, as opposed to 2010 which was its former target, then banking assets will need to reach $500bn just to match the (banking assets/GDP) levels already achieved by countries in central Europe. Again, the $500bn in assets would indicate capital levels (using a 10% capital adequacy ratio) of about $50bn. So, using this broad model, there appears to be a long way to go to achieve these overall targets.

Credit and retail boom

Consumer credit and retail are booming. Sberbank’s 62% of total deposits amounts to $40bn and it has dramatically increased its role in the consumer credit market in the past four years. From 4% of the market in 2000, it achieved 110% growth last year to claim 50% of the market; consumer credit is now 20% of the bank’s credit portfolio.

At Rosbank, which has 570 branches and plans to add another 50 this year, the integration of the OVK Banking Group has provided a broader platform for growth. Mr Popov notes that consumer lending has doubled in the past year to $1bn and his bank has captured 10% market share in the sector, with 600,000 customers. Rosbank has also achieved strong growth in private banking: 800 high net worth individuals have provided $500m in deposits.

With its 1.6 million customers, Rosbank is keen to expand but prefers organic growth rather than acquisitions. “For us it is easier to establish greenfield sites rather than acquire local banks, which is time consuming and difficult,” says Mr Popov.

Sberbank, which has more than 20,000 branches and sub-branches, is concerned about the costs of expansion, especially in terms of staff.

Foreign observers have criticised the need for more than 1200 banks, but bankers explain that local communities across this vast country desperately need banking services that are not necessarily available through national networks. Therefore, many of the small local banks serve a clear purpose and the number of banks in Russia is likely to remain high.

Unlike in central Europe, the direct role of foreign banks based in Russia is relatively small and, perhaps surprisingly, is in decline. According to Interfax/Austria’s Raiffeisen Bank (RZB), the total assets of the Top 15 foreign banks fell to 5.05% of the market in June 2004; retail deposits of the 15 rose, but only to 1.61% of the retail total.

Unlike many foreign banks that deserted Russia after 1998, RZB has stayed, accepted the risks of a young market and built up a 130,000 customer base, with 1% of the deposit market ($700m) and a $400m lending book. RZB takes a positive view of Russia and the shareholders of its Russian subsidiary are keen to expand the bank’s capital by $200m in 2005 to reach almost $500m, to take advantage of the opportunities in the Russian market.

Mortgage sector growth

The development of mortgages is an important growth area for all banks in Russia. President Vladimir Putin has said that by 2010, one-third of the population will have access to modern accommodation through mortgages. Legislation is in process and bankers suggest that a comprehensive legal structure will be in place within six months. But, while the German mortgage banks are understood to be interested in Russia’s mortgage and securitisation potential and RZB is financing $100m in mortgages with support from the World Bank’s International Finance Corporation, local bankers emphasise the lack of access to long-term funds – a rather critical aspect of developing mortgage finance. Again, the issue of ambitious government targets is in conflict with core structural factors in the financial sector.

Nevertheless, there is plenty of activity in Russian banking. Strong growth is there, although bankers acknowledge that there is not necessarily a bonanza taking place in retail. The newness of the market and the lack of effective data creates an abundance of potential dangers. However, bankers believe that there is an increased willingness to borrow among an inherently conservative populace and the trends are positive. The specific details of how the sector will develop – and what actions the authorities will take – remain unclear.

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Read more about:  Central & Eastern Europe , Russia