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WorldApril 30 2015

Russian banks adapt to a new normal

Banks in Russia are feeling the force of Western sanctions, with funds from international capital markets slowing and deposits experience a lull, but some institutions are finding ways to maintain commercial relationships with foreign investors. 
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Russian banks adapt to a new normal

Only rarely do bankers choose to talk of a crisis. In Russia, there was the crisis of the 1990s and the effects of the global financial turbulence of 2008/09, and now the impact of the events of late 2014 also fits the 'crisis' description.

The country's economy faltered, sparked by a devaluation in the Russian rouble, which by the end of 2014 had lost 42% of its value year on year to fall to Rbs56.24 per $1, largely caused by a plunge in the oil price and the country’s reliance on oil as a driver of the economy.

In November, December and January, individuals withdrew Rbs45.024bn ($849m), Rbs77.472bn and Rbs187.272bn of rouble-denominated funds, respectively, according to data from the Central Bank of Russia (CBR). Foreign-denominated deposits by individuals, meanwhile, increased by the equivalent of Rbs1953bn across those three months.

“In December, there was a huge panic because people just couldn’t understand what was happening [to the exchange rate],” says Vladimir Chubar, chief executive at Credit Bank of Moscow. “People were transferring money from the banks or withdrawing their deposits, and you saw them buying everything.”

The CBR hiked the key interest rate to 17% in December and has since gradually brought it down while still making rouble deposits well-paying commodities.

Reversing trend

As of March 2015, the flows have been reversed. According to research from Alfa-Bank, in the first quarter of 2015, Rbs370bn in inflows was recorded across the banking sector. The currency has also stabilised to about Rbs50 per $1 as of mid-April. Yet the events of November, December and January affected more than just outflows.

“The sharp devaluation of the rouble against the dollar has had an impact on banks’ capital ratios, because risk-weighted assets inflated,” says Marc Luet, country officer for Russia at Citi. “If you had a lot of dollar assets it inflated; if your capital is in roubles, your capital ratios have come down mechanically. We did not breach our capital ratios – some of our competitors did.”

To accommodate some banks, the CBR introduced an exemption, allowing banks to use the rouble exchange rate of Rbs39.38 to the dollar as of September 30 to calculate their full-year 2014 results – measures that helped some banks avoid breaching the CBR-required minimum capital adequacy ratio of 10%.

A different kind of crisis

While the drastic fall in the rouble exchange rate evoked memories of Russia’s crisis in 1998, when the currency lost 27% in a single day in August, the differences are significant. At that point 17 years ago, the rouble lost more than 70% of its value over a six-month period, inflation reached 84%, the government defaulted, and banks and enterprises collapsed.

While inflation is also high today, the level of 16.9% is low in comparison. The sovereign is also in a much healthier position, with low external debts, even if its reserves have come down significantly from $420bn at the end of November to $355bn as of early April.

Today’s challenges have more to do with geopolitics and the slump in oil prices. “Previously, in crises in Russia, there was the common view that everything was going to be alright with state banks because they are owned by the state,” says Artem Konstandian, chief executive at Promsvyazbank. “Today, given the weaker economy and the sanctions story, more customers are realising that there is also some risk behind the state. People are diversifying their relationships and [private banks] are a beneficiary of that.”

Sanctions imposed by the EU and US on large parts of Russia’s economy, introduced in 2014 in response to the conflict in Ukraine, have added another layer of complexity to Russia's business environment, namely: how to service sanctioned clients.

“They are good clients and we maintain commercial relationships with them,” says Citi’s Mr Luet. “But we are complying with the sanction regime and therefore there are things we can’t do anymore for sanctioned names, especially relating to debt and equity issuance.”

Meanwhile, some state-owned banks themselves ended up being targets of Western sanctions. Institutions with strong links to the government, such as Bank Rossiya, were the first to get hit, but when restrictions were extended, groups such as the country’s two largest banks, Sberbank and VTB Bank, were also targeted.

“We believe that Sberbank did everything that was necessary not to be included on the list of sanctioned institutions,” says Alexander Morozov, deputy chairman of the management board at Sberbank. “We are fully compliant with all local and international regulations and legislation in Russia, in Ukraine and every other country in which we are present. Ukrainian authorities, including the National Bank of Ukraine, publicly commended us for good corporate behaviour and we continue to do business there.”

Sanctioned entities face a restriction on funding, both from international financial institutions as well as in the capital markets, cutting them off from international funding of longer than 30 days.

Bank deposits by individuals

Today’s challenges

Clearly, the challenges in 2015 are different to what they were in previous crises. The rate of unemployment is not soaring as it did in 2008 and the banks’ burden of risky loans is much lower. Yet the quality of the banks’ loan portfolios is likely to become one of the main problems of this latest crisis, according to Mikhail Matovnikov, the chief analyst at Sberbank.

“We [have been] in crisis since 2009 and as a result, there was no exuberance in lending comparable to that of 2007,” he says. “We don’t have a lot of borrowing that right from the beginning was extremely risky. Problems that could arise are related to banks, which managed to hide their issues after the previous crisis.”

A general rise in non-performing loans is expected. Excessive consumer lending could be a problem, but that is one risk the regulator has been trying to clamp down on since last year.

Experts foresee most problems surrounding corporate loans, because in an environment of economic contraction, business conditions for enterprises naturally deteriorate. At the same time, increased risk awareness and constraints on lending are likely to lead banks to sign fewer new credits, which, coupled with consequent quality issues with existing loans, inevitably leads to higher non-performing assets. Companies facing the need to refinance their liabilities in 2015 are also feeling pressure from high interest rates.

As of late March, Russia's key interest rate has come down to 14% and is expected to be lowered by another 100 basis points each month to 11% in July, according to Raiffeisenbank, and then kept at this still-elevated level for the rest of 2015.

“It is good that the central bank is sending the clear message that it will reduce the key rate further,” says Oksana Panchenko, deputy chair at Raiffeisenbank Russia. “When the key rate went up to 17%, the final customer rates were reaching 18% to 20%. You can imagine that ate up companies’ entire operational margin.”

Banks themselves are no exception. High rates are increasing funding difficulties and putting additional pressures on banks’ net interest margins.

CBR’s central role

If money is not coming from international capital markets, which are more or less closed to Russia due to sanctions, and deposits are only returning slowly, what is the source of banks’ funding?

“The CBR is now the biggest lender to the Russian banking sector,” says Mr Chubar. “We see that, step by step, it is allowing new types of assets to be pledged as securities for its facilities.”

Straightforward CBR funding is linked to the key rate, however. Banks owe the CBR about Rbs7300bn of key rate-linked rouble liabilities, as of the end of 2014, according to Mr Matovnikov. Some Rbs1300bn of this had already been repaid in the first quarter of 2015.

A huge relief for banks was the CBR decision to offer foreign exchange-denominated refinancing facilities in exchange for pledges over eligible securities. These funds are much cheaper and widely welcomed as banks have some $36.8bn equivalent in term liabilities scheduled for repayment in 2015, says Mr Matovnikov.

In December, the Russian government launched an additional funding programme: its Rbs1000bn recapitalisation plan. Some 27 banks are eligible for government funding and initial calculations suggested Rbs830bn would be allocated to the banks. Take-up of the funds is so far unclear and some banks have refused to accept the capital injection, says Mr Matovnikov. An additional Rbs250bn plan from the National Welfare Fund supports a small number of key banks, which will use the funds to finance infrastructure projects.

CBR governor Elvira Nabiullina suggests the government programme may be needed to support the lending capabilities of the economy, as access to conventional funding is restrained. “The idea of the programme is not to support banks that find themselves in difficulties, but rather to support the lending and leverage capability of the economy,” she says. “Should the support be fully implemented, it would raise the aggregate capital of the banks by 12.5%.”

A new normal

Ms Nabiullina does not expect a rapid recovery of Russia's banking sector but says lending should continue to grow at about 10% in 2015. “Although consumer lending in general will be slowing down, we expect mortgage lending to grow at a slow but steady pace,” she says.

The country’s largest bank by assets, Sberbank, has more than 50% of the market in mortgages and 37% in retail credits. While it saw the greatest proportion of December’s deposit outflows, Sberbank holds 45% of all retail savings in Russia. As of the end of March, the bank’s loan-to-deposit ratio was 105%, according to Mr Morozov, and plans were afoot for a continuation of repayments of external liabilities.

“We repaid $10bn of our external debt obligations over the past six to eight months – public and non-public,” he says. “Our external funding is only about 4% of our total liabilities.”

Other banks are also looking at public and private liability management, including Promsvyazbank. The third largest Russian private bank by assets also sees opportunities in the fixed-income market in 2015 – an area in which it was making cuts last year.

“You have the same risk if you lend to a client or hold their fixed-income instrument but the yield is bigger on the bond,” says Mr Konstandian. “This will not last for the whole year, but the first two months were very successful.”

And since financial markets are effectively closed to the Russian economy, banks such as Promsvyazbank, Raiffeisenbank and Citi are using the opportunity to compete for lending business with Russian blue-chips with which they did not previously do business, while Russia’s foreign-owned banks are making the most of their competitive advantage in catering for multinationals.

“There are always two sides to a story,” says Joerg Bongartz, chairman of the board at Deutsche Bank Russia. “In the current environment, we see the competitive advantage of having a global institution as our parent.”

Branching out

Raiffeisenbank has meanwhile made the decision to scale back its retail operations. On March 25, the bank stopped the issuance and refinancing of car loans, and has further decided to close offices in 15 Russian cities, leaving it with 177 branches in 44 cities.

Cost-cutting and efforts to increase fee income can be seen across Russia’s financial industry. Credit Bank of Moscow is “quite comfortable with the current net interest margin”, according to Mr Chubar, but is looking to sell more fee products such as debit cards, payments and insurance products through its branches, as well as increase plastic card transaction activity.

Even traditionally niche players such as credit card specialist Tinkoff Bank are looking to diversify and add the sale of insurance to their strategy. Tinkoff is further aiming to expand into retail banking, while still operating without any branches.

“Our core will still be credit cards, but we are adding a lot to it and are constantly developing our business to attract high-quality and low-risk customers from new segments,” says Oliver Hughes, chief executive and chairman of the management board at Tinkoff. “We will continue to introduce lighter retail products – including debit cards and deposits that are already on offer, mass affluent credit cards and small cash loans, which will be offered through an umbrella financial portal.” 

Products from external companies will also be offered through the platform, for more heavy-duty balance sheet items such as mortgages and car loans, brokerage services and foreign exchange, he adds.

The great consolidation

In a banking sector with more than 800 banks, competition in Russia is tough and requires virtually everyone to adjust – especially as only 200 banks have a market share of about 97%, according to Mr Bongartz. “It is difficult for some banks to survive in this macro-environment,” he says.

One of the main consolidators in the market is Otkritie Financial Corporation Bank. The group has grown to be the country’s largest private bank by assets after the reverse takeover of Nomos Bank and Bank Petrocommerce in 2012 and 2013, respectively.

In December, Otkritie was chosen to rehabilitate National Bank Trust (NBT). To support Otkritie and to cover the “imbalance between the fair assets value and the balance sheet value” of NBT’s liabilities, the CBR provided NBT with a Rbs99bn, 10-year loan and Otkritie with Rbs28bn for six years, according to a CBR statement. The loans were made available through Russia’s state deposit insurance agency and come with significantly subsidised rates, as is common in rehabilitation exercises in the Russian banking system.

Promsvyazbank also views itself as one of the potential consolidators. “Opportunities of organic growth are very questionable, which puts non-organic growth on the minds of a number of successful Russian banks,” says Mr Konstandian.

A different kind of consolidation is what the second largest bank by assets, VTB Bank, is planning. VTB, which has positioned itself as a corporate and investment bank with separate retail operations through VTB24 and Bank of Moscow, is planning to gradually integrate the businesses in the next five to six years. The first step will be to merge with Bank of Moscow in 2016 and divide its retail business between VTB Bank and VTB24.

While Raiffeisenbank is not looking to grow inorganically, Ms Panchenko agrees that further consolidation will take place. “It is a natural thing, not only because a lot of small banks are still present in the country, but also because the system has scope for healthy financial support,” she says, adding that the regulator is sending a clear message that underwriting and management standards will be checked at all banks.

“To build competition we need more larger players on the market,” says Ms Nabiullina. “That does not mean that we will be artificially reducing the number of banks, but we need to make sure that we have healthy and stable banks.”

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Read more about:  Central & Eastern Europe , Russia