Although it has improved, Russia’s banking system still has some way to go before it can fully recover from the financial crisis of 1998. Torrey Clark asks Rosbank’s president Evgeny Ivanov for his views.Russia’s banking system is continuing to grow in strength, with syndicated loans taking off and a high demand for capital. However, raising resources remains difficult.

“The demand for long-term financing is really high and Russian banks are already providing the credits for trade and short-term projects,” says Evgeny Ivanov, president of Rosbank.

Exporters have well-established business contacts and have few problems raising money from Russian banks. The problems arise when they are trying to raise money for new projects, such as the construction of a new factory, or the renovation of an old one.

Companies looking to raise long-term credit have two possible sources they can tap. The first is the savings of the domestic population, but here little progress has been made and the slow pace of banking reforms has made it difficult for commercial banks to attract significant deposits.

Internal resources

Despite the booming economy, Russian banks are still constrained by a lack of long-term financing. The public has lost trust in the banking sector following at least two banking crises in recent years which hit the public hard. Public confidence in the banking sector has never fully recovered. As a result, nearly 70% of household savings – the only source of long-term finance in Russia – are deposited with Sberbank, 60% state owned, where deposits enjoy a government-backed guarantee.

“It will take quite some time for the public’s confidence to recover,” says Mr Ivanov, “but since 1999 the pace of progress has begun to pick up. In 1999, 1% or 2% of all deposits were placed for more than one year, now it is more than 30%. However, these figures are distorted by Sberbank’s monopolistic position.”

The proposed deposit insurance scheme will go a long way towards reassuring household depositors, but bankers fear that the laws will never be passed by the Duma.

“The deposit insurance scheme has been talked about for nine years already, and they are still talking. I doubt that it will ever make it through the Duma,” says Mr Ivanov.

The law was supposed to be adopted by the start of this year but has become a victim of election season, as politicians are distracted by the upcoming parliamentary elections, slated for December, and presidential elections that will be held early next year.

“The Duma elections on 7 December mean this law will not be easy to pass,” says Mr Ivanov. “Currently 67% of retail deposits are with Sberbank and because the size of deposits are small, the majority of people going to vote are clients of Sberbank. That’s why I believe many deputies will try to play populist games with the draft law making serious discussions difficult this autumn, although this law is the key to creating long-term resources in the Russian economy.”

The reforms could free huge resources that are currently lying idle. The deposit insurance scheme would allow commercial banks to attract more household deposits, but the general dearth of financial instruments means that a lot of capital is lying idle as both banks and companies prefer to maintain strong cash positions as insurance against surprises thrown up by what is still a volatile economy.

“I am very fond of internal sources because the potential is there. We may very easily raise $60bn–$80bn, which is now outside both the banking sector and bond market,” says Mr Ivanov. “This is money which is not being used for financing economic growth but is very difficult to bring into the banking sector.”

This is the so-called ‘mattress money’ and having learned some painful lessons over the last decade, the average Russian still prefers to keep the bulk of their savings at home, rather than in a bank.

However, a new source of financing is on the horizon. Russia’s first private funds were created this year and legislation was passed in the summer that underpins a private pension system. From next year, Russian workers can choose to pay part of their obligatory pension payments into a private fund. This will create a market estimated to be worth $2bn a year. It will be a new long-term resource for the Russian economy.

Bankers believe that 80% of contributions to the private pension funds will go into bonds and equities with the remaining 20% ending up on the accounts of banks.

External resources

The second source of finances available for companies looking to raise long-term financing is to turn to the external capital markets.

A financial pariah since the devaluation of the rouble and default on debt during the 1998 financial crisis, Russia’s image has almost fully recovered in the last two years. However, with the sovereign credit ratings still just below the sought after “investment grade”, Russia still has a little way to go before western bankers feel entirely at home in Russia.

“We have to wait for an improvement in our credit rating to investment grade. We also have to wait until after the presidential elections before we can demonstrate to the world that Russia is a very stable country,” says Mr Ivanov.

However, the risks remain real. Despite a revolution in corporate governance, Mr Ivanov says that the change is still limited to a handful of well-known blue chip companies.

“The majority of Russian companies do not pay enough attention to corporate governance and, as a result, potential long-term creditors – like direct investors – see them as opaque and the shareholders as unhelpful,” says Mr Ivanov.

The blue chip companies are blazing a trail that is already reassuring foreign creditors and demonstrating to domestic companies the benefits of getting their corporate governance act together.

However, maturities are still short, with the average term being only one to two years, making it difficult to use this to fund long-term investment projects. Corporate eurobonds have been a popular way of raising longer-term money, but it is an option open to only the top dozen companies. The concentration of activity among so few companies has also created its own problems.

“It’s a pity that this process is not going through the financial markets. The choice of where to invest is made by the same people who are very good in oil or metals, but their individual likes and dislikes influence their investment decisions,” says Mr Ivanov. “There is no open competition of investment projects, which are processed by the financial market, the banking sector for the best and most effective projects get the funding.”

Project financing

Western banks are still timid in their lending as Russia’s weak judicial system and top-heavy politics increase the risks. An alternative to syndicated loans is project financing, where a deal is structured to try and reduce the country and corporate risks to a few well-defined areas.

Rosbank is involved in project financing, but because of the lack of long-term resources, Mr Ivanov says banks normally insist on taking a large equity position as part of the financing deal.

“The situation reflects the lack of long-term resources. If you are able to provide long-term resources, you have such a strong negotiating position that you may substantially increase your equity position,” says Mr Ivanov. “Providing funding for periods of more than five-years is very rare.”

Foreign project financing is also rare because it is difficult to secure collateral. As wealth remains concentrated in a few industries and companies, Russian banks have taken on the role of trying to intermediate between their clients with resources and those who require them.

“As a Russian bank, we suffer from the same problem of a lack of long-term financing. We try to be an intermediary between the project initiator and those who have funds – corporate clients and investment funds, such as the private equity fund established recently between Interros and AIG.” says Mr Ivanov. “But again these funds are more likely to want to take an equity position.”

Those with longer-term resources have the pick of projects. Offered the choicest projects, they tend to want to be an equity participant, rather than simply settling for a 15% annual rate of return.

“This will change only when we have a balance between demand and supply of long-term funding. And it will be balanced if and when we have the retail money in the financial sector,” says Mr Ivanov.

Other problems

Russia is on the edge of sustained recovery, but as the election season approaches, the government must still fulfil its promise of change. Problems persist, but Mr Ivanov is optimistic about the future. Reforms may be moving slowly, but they are moving. In the meantime, the leading enterprises are roaring ahead with investment and development plans and the economy has been growing at an average 6.5% a year since 1999.

However, the Russian banking sector is still not fulfilling its traditional role as financial intermediary and is the only mechanism in the economy that can cope with the thousands of projects that need evaluation and funding, says Mr Ivanov.

Support from the state budget and the equity markets have a role to play, but in themselves are not enough to ensure that the economy meets the challenge, thrown down by president Vladimir Putin in his May ‘state of the nation’ speech, of doubling GDP by 2010. Along with bank reform, the laws ensuring property rights need to be beefed up to reassure creditors that they can get their money back should projects fail.

“Creditors are not protected properly by Russian law and banks suffer the most,” says Mr Ivanov. “If bankruptcy procedures are started, which was quite easy to do, all the collateral will be eliminated. The new bankruptcy laws [passed in 2002] should make abuse of the bankruptcy rules more difficult, but they have not been tested and they are not perfect.”

The banking community is still lobbying the Duma for change, and it will come. Other draft laws, such as a bill on securitisation, are also in the works and will probably be pushed through in the Duma’s next term. Mortgage bonds are also in progress that will improve the collateralisation of loans.

Despite the difficulties, like many of the more progressive banks, Rosbank has moved beyond simply what is required by regulators and is imposing greater transparency on itself than is required by the Central Bank of Russia and desired by its customers. As a result, the bank has already built up a $1.5bn credit portfolio, one of the largest in Russia, which is well diversified. Rosbank moved over to international accounting standards in 1998, and this year started reporting audited accounts twice a year.

“The key point is transparency. We want our clients and potential clients to understand what we are doing and what risks we have in the bank,” said Mr Ivanov. “Our credit portfolio is diversified and not just dependent on energy exporters. The board of directors has a risk policy and constantly monitors transactions as part of our risk control system.”

Rosbank is a leading player in the rouble bond market and has issued more than Rb50bn worth of these instruments. It has set up a successful leasing company, which is supported by a wholly-owned subsidiary based in Switzerland, to support trade financing business and equipment imports to Russia by the bank’s clients.

In another sign of increasing confidence, the export credit agencies are also returning to Russian commercial banks and are prepared to accept their guarantees when organising trade financing, says Mr Ivanov, something they were not prepared to do in the years after the financial crisis.

New directions

At the start of the year, the bank published a new strategy that will take Rosbank into the retail sector – a top priority for Rosbank.

Mr Ivanov says that the quickest way to grow in this already competitive sector is through mergers and acquisitions. The bank is bidding for the First OVK group (the rump of the SBS Agro branch network, that collapsed in the 1998 crisis) which has the biggest network of branches in Russia, after Sberbank.

“The price tag is quite high at $200m,” says Mr Ivanov. “We turned to our shareholder, Interros, to finance the deal and will be finished by the end of next month so we will be able to consolidate the assets of OVK and Rosbank, plus the insurance company and pension fund, which is part of Interros already, to form one financial group that will provide all our customers any type of financial service imaginable. The retail section will be much more aggressive and we aim to become the number one retail bank in Russia, after Sberbank.”

The details are still being thrashed out, but by boosting its retail operations Rosbank is hoping to capture some of the currently untapped household deposit resources.

“We will look through the product line of OVK, to expand and adjust it to changing market conditions, but it is clear that consumer lending, mortgages and leasing will be the flagship product lines of the retail part of the financial group,” says Mr Ivanov.

There is still much work to do for both the banks and the government, but the mood in Russia is that success is just over the horizon. The government finances have never been so healthy, companies are investing and production is growing. The population’s income is rising, which has created a vibrant consumer-based market. And, despite the slow pace, the government has promised to press ahead with badly needed reforms. Taken all together, Russia is moving in the right direction.

“If we solve the problem of public confidence in the financial system, diversification, monetary stability, political stability and everything goes well, I think 2005 will be the year the gates are opened for foreign investment and financing to enter Russia,” says Mr Ivanov.


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