Vasily Vysokov

Russia's regional banks are often closer to their customers than the Moscow-based giants, but they can be hampered by a lack of both capital and transparency. While a new development fund is intended to change that, some critics argue that new capital adequacy requirements threaten their very existence.

Think of Russia, and the onion domes of St Basil's in Red Square spring to mind. Moscow is still very much the country's commercial hub and its banking centre.

But outside the capital, regional banks have quietly carved themselves an important role in the Russian financial system. The two Russian state-owned giants Sberbank and VTB have branches all over Russia and can offer better prices on loans, but local banks from Ak Bars in Tatarstan, to Orient Express based on the borders of China, and Center-Invest in the southern Russian city of Rostov-on-Don can offer their customers a personalised service and a consistency that the big state banking giants cannot match.

"There is a big antipathy towards Moscow banks in the regions. In the 1998 crisis, the big Moscow banks sucked liquidity from the regions to support their Moscow operations," says Richard Hainsworth, director of Moscow-based ratings agency Rusrating.

Staying close to clients in southern Russia 

Vasily Vysokov holds out a box of macaroons in pretty pastel colours which could have come from Paris, but in fact came from the Paris Bakery, down the road from Centre-Invest bank's headquarters in the southern Russian city of Rostov-on-Don.

"The macaroons were my idea, but the owner thinks they were his idea and that is the secret of successful small business banking. If you want to teach clients about best practice you have to make them think the best ideas are theirs rather than the bank's," he says with a broad smile.

A former university professor, Mr Vysokov and his family own a 17.84% stake in Bank Center-Invest, which is the largest regional bank in southern Russia with a 37.8% share of the region's loan book. Centre-Invest has had the European Bank for Reconstruction and Development as a 27.45% stake-holder since 2002.

The bank holds almost a third of the small and medium-sized enterprise (SME) loan portfolio and a quarter of agricultural loans in the Rostov region and relationship management has been the key to the bank's growth strategy.

"Sustainable banking is the development of long-term profitability and stable business rather than speculative investment," says Mr Vysokov, who is also the chief executive of the bank.

When the financial crisis struck southern Russia at the end of 2007 and 2008, many of Centre-Invest's clients hit a very rocky business landscape. But Mr Vysokov says that sticking with his clients throughout the downturn has been key to the bank's recovery in profits and its future growth strategy.

"During the crisis I looked at my clients and told them: 'If you have only lost 30% of your turnover in this downturn then you are running a very good business.' I have been proved right," he says.

During 2009/10, Centre-Invest did not increase its interest rates to give its SME clients a chance to grow their businesses.

"Between January 2010 and January 2011, our loan portfolio grew by 30%. The bank's profits have also recovered and grown beyond their 2007 levels. I have nurtured the next generation of SMEs and increased my bank's profits," says Mr Vysokov.

While some of the bigger Russian federal banks pulled back on lending to the regions during the crisis, Centre-Invest stuck with valued clients. Mr Vysokov says the bank extended 15% more credit to local clients during 2009 than the big Russian state-owned banks.

Unlike many areas of Russia, Rostov-on-Don is not resource rich, which means that the bank's business is diversified over a variety of sectors. About 48% of Centre-Invest’s loans go to SMES, 30% to retail customers and 22% to large corporations.

The bank makes 23% of its loans to the agricultural sector, with an even split between SME and larger clients. On a year-by-year basis, agribusiness loans can be risky, but over the long term, the loans tend to be profitable.

"A farm might have one bad harvest in two, but will usually have three good harvests out of five, so if you stick with your clients it pays off,” says Mr Vysokov.

The bank runs a regular series of seminars on everything from computer skills to foreign trade to enable their small business clients to keep up with international best practice in their sectors. The bank even introduced local farms to Israeli drip-irrigation techniques.

"We visit our clients and our clients tell us their dreams and we can take that information and use it to estimate the company's global competitiveness or the risk involved in scaling up to industrial production," says Mr Vysokov.

The bank has also built a database on 50,000 local SMEs that can be used by investors in China, Russia, the UK and Europe to make it easier for their clients to tap international markets.

Earlier in 2011, before global stock markets took yet another tumble, Centre-Invest sold off most of its securities portfolio, from 15% of the bank’s total assets to 5%, with the remaining risk in the credit sector rather than the equities market

"Ratings agencies see the securities business as high risk and it is a speculative business, rather than a sustainable one," says Mr Vysokov.

Knowing how clients think in the regions is crucial. With ATMs and internet banking still seen as new-fangled, Centre-Invest operates a 24-hour banking service at its head office in Rostov-on-Don, which is used by many business travellers for currency exchange or pensioners who are not familiar with computers or pin-numbers and prefer to bank early in the morning.

They also run a premium service for clients with more than $10,000 in the bank. This is a far lower threshold than that required by Moscow-based banks, but it captures an important local market.

"The key to success is knowing your clients really well and cultivating friendly relationships with them rather than simple business relationships," says Mr Vysokov.

Russia is a country where business is conducted face to face, and because businessmen cannot rely on contractual obligations, relationships matter more than they would in a Western economy.

"Even if the services regional banks provide are more expensive, customers will pay the extra cost because they value the relationship. Despite the oceans of words written about their failure, there will always be a place for regional banks," says Mr Hainsworth.

There are more than 400 credit associations and banks in Russia, including the two state giants VTB and Sberbank, which have a 40% share of the assets in the banking system, and the regional banks which make up a slice of roughly 10% of the pie.

Regional fund boost

This year will be an interesting time for banks in Russia's regions, with new rules on capital adequacy pushing a wave of consolidation among banks at the bottom tier, while top banks in the regions look set to benefit from investment by a new fund backed jointly by the International Finance Corporation (IFC) and the Russian government aimed at supporting regional banking.

Timothy Krause, who leads the IFC's financial markets programme in Russia, is one of the driving forces behind the planned $1bn fund that will invest in the best regional banks. The fund will act as an anchor investor to attract more capital into the sector and bring foreign expertise and best practice to more remote parts of the Russian economy.

"The idea for this fund came during the 2008/09 crisis, which was fairly significant for a lot of regional Russian banks," says Mr Krause.

Eugene Tarzimanov at ratings agency Moody's says that many regional banks had begun diversifying their loan book out of retail and into investment banking and securities trading to cope with greater competition.

"These diversification strategies resulted in negative surprises. Although these banks have largely recovered their financial standing due to the support of regional governments, many of these banks have already forgotten their losses during the 2008/09 crisis and are aggressively growing their loan books, non-core assets and securities portfolios, which makes their credit profiles vulnerable," explains Mr Tarzimanov.

Real estate risk

Another risk for the regional banking sector is deflation of the real estate bubble. According to Anatoly Aksakov, a member of the Russian Duma (parliament) and head of the Russian Regional Banking Association, many regional banks are stuck with a lot of real estate collateral on their balance sheets that they cannot shift.

"Non-performing loans have accumulated on a lot of regional banks’ balance sheets because many real estate businesses cannot meet their obligations," says Mr Aksakov.

What the IFC-backed fund can do is bring more investment and expertise into the sector, fuelling its growth. The Russian government has put in $300m to the fund with $50m coming from the Ministry of Finance and another $250m coming from the Russian development bank Vnesheconombank, while a further $250m has come from the IFC.

The IFC is approaching institutional investors to drum up another $500m now and is confident that, despite the turbulence in western Europe and international markets, the Russian banking growth story will remain attractive.

"Investors are cautious, but the growth story for Russian banks in general is strong and Western investors can invest at attractive prices," says Mr Krause.

Once the fund is fully capitalised it will invest in eight to 10 regional banks that it sees as having strong management teams and a good distribution network. It will take stakes of up to 40%, moving up to a 51% stake if it can assemble a consortium with another lender such as the European Bank of Reconstruction and Development (EBRD).

"We do not want to be a majority owner on our own," says Mr Krause.

Many regional Russian banks have been owned by individuals who have been able to fund the banks' growth but now need to find new sources of capital for further expansion. The investments for a five- to eight-year period would place an experienced Russian-speaking foreign banker on the board and help the bank enhance credit risk functions and operations.

"The reputation of the IFC will attract more capital to these banks and the IFC will help them organise their business. Capitalisation will grow and in five years the IFC will be able to sell out with perhaps a 20% to 25% profit," says Mr Aksakov, who has worked closely with the IFC on the launch of the fund over the past two years.

Local knowledge

What regional banks have to offer to investors is the strength of their relationships with both retail and corporate customers. During both the 1998 and 2008 crises, the big state lenders have either drawn on their local operations to fund the centre, or simply withdrawn lines of credit and awaited instruction from head office before making loans.

Regional banks can be much more nimble in their dealings and often make a commitment to fund local businesses during economic turbulence. This in turn strengthens their ties to clients during better financial times.

"The large regional banks are crucial to the region [in which] they operate," says Mr Tarzimanov. "They have large deposit-taking franchises, and entrenched positions in servicing the local municipalities and largest local state companies. The purely regional banks focus more on the relationship, and quality of the services.”

They can often offer services that cannot be replicated by Moscow banks. For instance, when Moscow-based Nomos Bank bought a majority stake in leading Siberian lender Bank of Khanty-Mansiysk, it found the local bank offered its customers the option of paying their taxes using their bank cards because the bank was able to obtain detailed tax information from the local government, which was a co-owner of the bank.

Jean-Pascal Duvieusart, who is the head of strategy at Nomos Bank and sits on both executive and supervisory boards, says that is simply not a service that banks in Moscow can offer their customers.

Opaque practices

The downside for regional banks is often their non-transparent ownership structures, and the high proportion of related-party loans to companies with close ties to owners and senior management.

Moody's Mr Tarzimanov gave Ak Bars in Kazan, the capital of Tatarstan, a negative outlook in an assessment in August 2011. This was in large part because he felt that high single and related-party exposures highlighted the bank's corporate governance issues, and high exposure to equities added extra risk pressures.

Another risk for some of the smaller regional banks is the authorities’ decision to raise the capital adequacy requirements from January 2012 to a minimum of Rbs180m ($5.7m), which will catch some banks out. While some of the smaller banks were set up in the 1990s simply as a tax-efficient way to manage the financial operations of families or individuals, others genuinely play a vital role in their regions.

Opinions are divided. Mr Tarzimanov thinks the change will affect relatively few banks and force some small operations that fund individual businesses to register as non-bank financial institutions. But Mr Aksakov thinks this is a reform that will penalise small banks in less developed regions such as the north Caucasus, and large federal banks will not be able to fill the vacuum created by mergers and closures.

"Federal banks will not have the flexibility with borrowers and will not know their customers as well, so it will hit the economic development of an already depressed region,” says Mr Aksakov, adding that authorities should have waited to impose higher capital requirements. "They started talking about this law at the beginning of the financial crisis, but this is a difficult period for many banks so I do not know why they decided to do this now."

He adds that there had been speculation in Moscow that small banks had been used for money laundering schemes. But given the spectacular failures of two top 10 Russian banks – Mejprombank in 2010 and Bank of Moscow in 2011 – it is clear that size is no protection from related-party loan scandals. Consequently, Mr Aksakov feels the Russian government should not be harrying small banks during the downturn.

"Out in the regions, no one understands their customers like the regional banks," he says.


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