President Vladimir Putin was inaugurated for a second term on May 7, a term that will see reforms shift from laying the foundations for growth to implementing the new rules. If reforms continue, by the time elections come around again in 2008 Russia could boast a consolidated banking sector dominated by two state-owned banks and a handful of strong commercial banks in a second tier.
After nearly a decade of inactivity, banking reforms began again last year with the passage of a deposit insurance scheme in November, due to go into effect next year. The scheme will go someway to breaking state-owned Sberbank’s stranglehold over the retail business, but its real significance is its role as cornerstone for a raft of administrative reforms that could transform the banking system.
Banking bottleneck
Despite another 8% of economic growth over the first three months of this year Russia’s banking sector bottleneck remains: Russian banks’ capital is growing by about one-third every year, yet the share of banks’ loans in total invested capital remains stuck at about 4%-5%.
“If Russia is going to continue growing then it is going to do so through the banking sector. Reforms are going ahead, but they are going too slowly,” says Christof Rühl, the World Bank’s chief Russia economist. “The bond market took off very nicely, but one of the reasons why it did is because the banks are still not playing their traditional role.”
A shoo-in for re-election, Mr Putin took the unusual step of reshuffling his government a few weeks before he won the election. The new government structure will add some metal to the Kremlin’s efforts to beef up implementation of a sea of new laws passed since 2000.
Speaking a few weeks before being moved out of the Central Bank of Russia (CBR) to a new job as head of a new super-financial sector regulator body, Oleg Vyugin revealed that economic guru and head of the Economic Development and Trade ministry German Gref had drawn up a secret political reform plan in parallel to his much discussed economic blueprint released in 2000. The political plan was put on ice until last year while the Kremlin concentrated on kick-starting a stalled economy. The drive to overhaul the bureaucracy is now under way and the banking sector has already felt the affects of the political plan.
“I think there will be a lot of changes [to the banking sector] in the near future and we are [slowly] changing the whole system of supervision. We have already almost completed all the key legislation that affects supervision of the financial sector,” says Mr Vyugin
What this means in practice is a clamp down on administrative abuses (two regional governors were charged with corruption in May) and more concentration of power in the hands of the Kremlin.
Typically for Russia, Mr Putin kicked off his second term in office about two weeks before he was re-elected by sacking and reshuffling his whole government.
As a sign of things to come, Mr Vyugin was moved into a new and powerful Federal Financial Markets Service (FFMS), which takes over the functions of the largely toothless financial markets watchdog Federal Securities Commission, as well as adding supervision of pension funds to its portfolio. Mr Vyugin says that he wants to add insurance and banking supervision to the portfolio and vows to crack down on rampant insider trading.
The agency typifies the new Putin administration where the rule-writing powers of ministries are being separated from the rule enforcement powers of a raft of recently created agencies like the FFMS. It also ends years of sniping between the Ministry of Finance and CBR for control over financial market supervision, as the FFMS has been made directly subordinate to the prime minister.
Mr Vyugin was responsible for monetary policy at the CBR and his job goes to Alexei Ulyukayev, a well-respected economist and former head of the Institute of Transitional Economy, a government-connected think tank.
Analysts were also cheered by appointment to the CBR of Dmitry Tulin, who was poached from running the European Bank for Reconstruction and Development (EBRD) development of Russian financial institutions and is a former chairman of state-owned Vneshtorgbank (VTB).
Electoral sideshow
Despite the flurry of editorials, this year’s presidential election was largely irrelevant as the second phase of Mr Putin’s plan was already in operation. The deposit insurance law was icing on the cake, but the CBR inspectorate has already been beefed up as supervision moves away from the pro forma inspections. Over the last six months some 600 of Russia’s 1300-odd banks have been inspected and more than a 100 were found to have artificially inflated their capital, something that puts the whole banking system on wobbly foundations.
“The CBR is already half way through auditing all Russia’s bank and checking their capital, a fifth of which was found to be fictitious,” says Andrew Keeley, a bank analyst with Renaissance Capital. “Now it is working with them to write down in a collaborative way. The result is that banks will become more transparent and their ownership structure clearer.”
High transparency
A second round of even more rigorous inspections is currently underway as any bank that wants to keep its retail services has to apply for membership of the deposit insurance scheme by June 26 and must clear high transparency and stability hurdles. In effect the entire banking system is being re-licensed.
Although the CBR has given itself the chance to clear out the deadwood, it is not clear how many banks will apply for the licenses nor how vigorous the CBR will be in tossing out unsuitable applications.
The big Moscow-based banks are all expected to get retail licenses, although there are persistent rumours that one of the big banks will struggle to provide the required three years of clean and stable audited accounts.
And several regional banks will also pass. Russia’s banking sector remains highly fragmented and although the Moscow banks are well known internationally, their small branch networks – the biggest has 200 branches, mostly in northwest Russia – means each region has its own champion that will further tighten its hold on regional business in the licensing process.
No one is sure how many banks will survive this process, but it is assumed that most of the top 300 banks, that between them account for 90% of the sector’s capital, will be awarded licenses as the CBR is aiming for a bloodless transition.
The number of banks could be further whittled down when reporting to international accounting standards (IAS) becomes mandatory later this year.
Tatyana Paramonova, a former CBR chairwoman who is overseeing the IAS implementation, has speculated that one-third of Russia’s banks will disappear overnight if forced to reveal the true health of their balance sheets, but again analysts are expecting the CBR to be forgiving and will use the change to coax wayward banks back to health.
“IAS won’t lead to a sudden huge fall in the number of banks. The CBR inspectors are very thorough but the central bank is taking a flexible collaborative approach to the application of norms,” says Mr Keeley.
Finally new rules to simplify bank mergers are supposed to go through this year. Russia is over-banked and the CBR’s forgiving approach to implementing the new rules means it will probably remain over-banked after this round of reform. However, with competition already stiff, banks are straining at the leash to grow faster through mergers and acquisitions.
Rosbank has positioned itself to be the second largest retail bank in Russia with up to 500 branches after it bought First OVK, the rump of failed SBS Agro, but because of the torturous merger rules the two banks remain technically separate.
Likewise banks such as Sibacadembank, the biggest bank in Western Siberia, has been forging alliances with other leading regional banks – such as Dalvneshtorgbank in Blagoveschensk in the Far East and Severgazbank in Vologda, eastern Siberia – to build up a remote-region powerhouse by cross-selling shares in lieu of being able to merge.
Easing the merger rules should result in a consolidation of the sector as the leading commercial banks buy up regional players and take on the dominate state-owned banks, although this will take several years to complete.
In the meantime the Kremlin is pushing the state-owned banks as a faster route to increased competition for the retail behemoth Sberbank.
“Supervision is only one aspect of banking reform,” says Mr Rühl. “Another is the fact that the regulator of the banking sector also owns the biggest bank – Sberbank.”
Economists complain about the government’s involvement in banking, but this fits well with the Kremlin’s “law and order” approach to business. Mr Putin has followed a laissez-faire policy for his first term, but the new political agenda has already led to the arrest of former Yukos CEO Mikhail Khodorkovsky in October. Analysts are speculating that the Kremlin wants to take control of the “commanding heights” of the economy, which will nevertheless be couched in laws governing a free-market economy.
State-owned VTB has been expanding rapidly, but in keeping with the Kremlin’s law and order approach, chairman Andrei Kostin says that the long-awaited sale of 10% of the banks to the EBRD is two months away.
“VTB is really pushing to be the second largest Russian universal bank. It may not be state policy, but it looks state-guided, building up a competitor to Sberbank,” says Mr Keeley.
Post office services
The two state banks will not have it all their own way as talk of opening up the post office’s 40,000 branches to banks has resurfaced. Commercial banks may be allowed to sell products through post offices that will also offer basic banking services such as paying pensions.
Russia is on course to creating a three-tiered banking sector. The two big state-owned banks will compete with each other but continue to dominate the sector, while the consolidation of the commercial banks will create a second tier in which the half a dozen leading Moscow-based banks will lead.
Finally the myriad of small banks that failed to get a retail license will make up a third tier of financial institutions catering to their owners’ needs.
