The Russian Banking Sector Is More Closely Resembling Those Of Developed Markets, As It Focuses On Building Up Profits From Fee Income. But Banks Face The Thorny Issue Of How.
Russian banks and bankers are coming of age. In every way they are looking and sounding more like mainstream banks in developed markets rather than new banks from an emerging market.
In the old days, Russian bankers made huge profits quickly by trading and steadier earnings by lending to a handful of blue-chip corporates. Most other kinds of conventional banking business they considered far too risky and stayed away from.
Focus on SMEs
These days, Russian banking has become a lot more ordinary. Banks are focusing their energies on capturing small and medium-sized enterprises (SMEs), growing retail, moving out to the regions where there is huge untapped demand, cutting costs and reducing staff turnover. They are keen to reduce the proportion of revenue coming from trading and increase the amount of fee income. They are debating the merits of bringing in a strategic investor against doing an initial public offering (IPO). They are preparing for Basel II and considering securitising parts of the balance sheet. They are expanding overseas.
Like bankers everywhere, one of the critical challenges they face is escalating costs. «Russia is the only country in the world where expatriate staff can be cheaper than the locals,» says Helmut Bernkopf, a director of International Moscow Bank, referring to the difficulties of finding senior managers.
The bigger human resource issues facing Russian banks, however, are halting the rising cost and rapid turnover of general staff and finding sufficient people at all in the regions. Staff turnover in Russian banks can be as high 20% to 30% a year, although some banks, such as Raiffeisen, claim to have brought it down to 15%. Adding to the cost difficulties are massive rises in real estate prices.
«The prices and rents of real estate are extreme and there is a lack of transparency. It may not be clear who the real owner is. This makes finding suitable locations for branches very difficult,» says Mr Bernkopf.
IMB was the first foreign-owned bank in Russia and is 95% owned by Bank Austria Creditanstalt (BA-CA), now part of Italys UniCredit group, and 5% by the European Bank for Reconstruction and Development (EBRD). In December, BA-CA bought the institutional business of Russian investment bank Aton. Two years ago, IMB itself was purely a corporate bank but mirroring the trends in the market it has built up a retail network.
Other Russian banks face the same cost challenges.
Alexander Popov, chairman of Rosbank, says: «One of our big concerns is costs. Salaries rose by more than 20% last year and rents went up 25% to 30%. Its especially painful for a bank building up a network.» Rosbank has started a branch network optimisation project with the aim of concentrating efforts on big industrial centres, re-engineering the back office and introducing multichannel facilities.
Building up a regional network is precisely what most Russian banks are doing at present, attracted by the fact that the majority of people living there dont have bank accounts, let alone use other financial services.
«The regions have become attractive to banks,» says Mr Bernkopf. «In Moscow and St Petersburg you see lots of bank branches whereas in the regions the picture is very different. But whereas you can start with five or six people in a Moscow branch, you need to find 30 people in a region as you have to set up payments and accounting systems. The approvals process is also complex.»
Rushan Khvesyuk, chairman of the executive board of Alfa-Bank, says: «Our focus at present is on the regions. We are expanding in the regions and we have ambitious investment plans. By the end of 2007 we want to have 300 various kinds of branches. At the moment we are expanding organically but we have never excluded the possibility of purchasing a local bank.»
Dmitry Sokolov, president of Nomos Bank, the 14th largest bank in The Bankers Top 50 Russian banks (see The Banker, November 2006), says: «Salaries are rising geometrically. As a bank owner I can say that there is nothing good about this but we are trying to make our business more efficient and more profitable.»
Nomos is also pushing into retail, having started out as a corporate bank, and plans to have 100 outlets in 21 regions by the end of 2008. It has hired Boston Consulting to advise it on its retail strategy.
Mr Sokolov is keen to emphasise that Nomos does not belong to a financial industrial group (FIG), as some Russian banks still do, and also has not benefited from the deposits or other help of a state organisation again, as many Russian banks have.
«We are not a pocket bank [a term once commonly used to describe banks that did most of their business within their own financial industrial group]. We started from scratch 15 years ago and built the bank up. Our shareholders are serious businessmen,» he says.
Nomos, which is among the three largest gold and silver traders in Russia, is majority owned by the St Petersburg-based ICT Group.
While Nomos has never been part of a FIG, the general trend in Russia anyway is for the FIG structure to gradually weaken over time another sign of impending normality. «Further consolidation, although expected to be only gradual in the near future, will be driven more by increasing capital constraints and rationalisation of FIGs than by regulatory pressures,» says a recent Standard & Poors report on Russian banking.
It adds: «The business profiles of many Russian banks are gradually focusing on real banking business, moving away from opportunistic and pocket-bank type development.»
That means worrying about more humdrum issues such as Basel II. Michel Perhirin, CEO and chairman of MDM Banks management board, says: «Although there are no requirements for Russian banks to be compliant with the Basel II Capital Accord, nor Basel I for that matter. MDM Bank has been implementing best practice approaches relating to risk management for the past several years.»
Mr. Perhirin points out that the Basel accords put a lot of emphasis on regulatory requirements, whereas in a Russian context the important thing is to understand the risks.
«It is our strategy to develop an enterprise-wide risk-management system that will allow MDM to efficiently identify, analyse and manage risk and at the same time be fully compliant with any future regulatory requirements when and if they become obligatory,» he says.
As Anton Khodko, deputy director of Sberbank, asks: «How prepared are the regulators to accepts the kind of flexible approach to risk management implied by Basel II?»
Sberbank does intend to introduce the advanced model, however, and is planning to develop new IT systems for risk management. But like every Russian bank, Sberbank is held back by lack of historical data. «Our historical experience is limited and the majority of our customers dont have credit ratings. For some we estimate the likely rating ourselves,» says Mr Khodko.
Similarly, Russia lacks credit bureaus. «For the time being, they dont play a particularly important role and are only just getting established.»
In the quest to conquer the Russian regions, Sberbank has a natural advantage it has more than 20,000 branches so is the only bank that can claim truly national coverage. Indeed, the branch network had been reduced but now Sberbank is starting to open new branches again as it looks for new opportunities in the hot areas of consumer finance and SMEs.
«Now we are opening branches where business is growing fast and in these new branches we need new technology and services,» says Andrey Trusov, director of Sberbank.
It is interesting that banks are suddenly so interested in the SME sector and opinions differ as to the risks involved. For years, the EBRD pushed the banks to lend to SMEs, seeing this as a catalyst for economic development, and provided them with lines of credit specifically for the task. Now, suddenly, the banks see it as a natural business focus.
«In Russia, lending to SMEs is less risky than retail lending. Our aim is to have less than 1% of bad loans in the SME sector compared to 2% in retail,» says Alexander Levkovskiy, president and chairman of the management board at Promsvyazbank, which is placed 19th in The Bankers Top 50 Russian banks listing based on Tier 1 capital strength.
But Nomos Mr Sokolov is more cautious. «SMEs is a risky sector and we are fairly cautious. Experience elsewhere tells us that it really needs some form of government support for the sector to flourish.»
If SMEs and regions are both hot, a bank with both credentials must be boiling and, indeed, Center-Invest, based in Rostov on Don in the south of Russia, is sufficiently attractive to have in its shareholder structure the EBRD; Germanys Deutsche Entwicklung Gesellschaft, a subsidiary of KfW; Raiffeisen Landesbank Oberosterreich; Firebird Investment Fund; and a financial institutions fund set up by Renaissance Capital.
Dr Vasily Vysokov, president and chairman of Bank Center-Invest, says: «SMEs have become more effective in Russia than larger companies. They have improved their technology and are alert to market conditions. While some big companies are sleeping, SMEs are powering ahead.» Center-Invest is providing SMEs not only with funding but also with other banking services, auditing and legal advice. «The problem with Russian law is that it can be very grey,» says Mr Vysokov. «We help to translate the grey and make it clear.»
The attractions of Russian regional banks in general are the focus of a new investment fund set up by Russian investment bank Renaissance Capital. «Value [for investors] will come in two ways. We buy cheaply by paying no more than five times book value on average. We pay for a minority stake and we sell alongside the controlling shareholder,» says Sergey Nazarov, director of the RenFin Fund. «Then there is the high growth rates of the banks. They are growing at 40% to 50% a year with ROEs of 25% and more.»
Fellow director Marina Chekurova says: «By western standards the banks are undercapitalised. Our aim is help the banks to add capital and increase the leverage.»
Better balance sheet management is another tool for increasing the value of Russian banks and securitisation is starting to gain traction. Rosbank is planning to securitise car loans later this year while Promsvyazbank is currently studying the feasibility of securitising mortgages. HSBC is advising the bank.
Another hot product in Russia is mortgages. Johann Jonach, chairman of Raiffeisens Russian operation, says: «Mortgages are the flavour of the year. Everyone is going into the sector.»
Raiffeisen, which was among the early movers in the Russian market, has consolidated its position in the market by buying 100% of Impexbank for $500m. The integration process of the two banks is proving slow, however.
«One of the peculiarities of the Russian situation is that you can only do one procedure at a time,» says Mr Jonach. «We wanted to increase the capital base, which takes three months, and only after that can we do the legal merger process, which will be completed before the years end.»
These kinds of legal complexities undermine the argument that Russian banking is becoming normal.
A market with growth rates of 50%, salary rises of 30% and massive untapped demand is clearly unlike that of western Europe, even during a growth period. Russias bankers are installing the latest technology in their banks and applying state-of-the-art techniques to risk and balance-sheet management but still the biggest challenge of all is to raise sufficient capital to match asset growth.
TransCreditBank, for example, grew its assets by 50% last year and delivered a 40% return on equity. TCB is due to be privatised with the transfer of a 75% stake from the government to the Russian Railways, which in turn has committed to double shareholders equity with a $200m capital injection. TCB boasts a regional network covering 115 cities and provides payroll and retail services to 1.3 million employees of Russian Railways. It has issued more than 1.25 million credit cards.
TCB president Sergey Pushkin says: «Our tasks in 2007 are to transfer the 75% stake to Russian Railways, to begin consolidation of our subsidiary banks, to double our retail business, to improve technology and to increase our regional presence.»
Vice-president Oleg Panarin adds: «We are finalising a detailed strategy to take us to 2010 and make us one of the top financial institutions in Russia.
The S&P report says: «With asset growth outpacing that of internal capital generation, and new equity injections being scarce, the average total and Tier 1 regulatory capital ratios for Russian banks declined to 15.7% and 10.8% respectively at March 31, 2006, and 15.8% at year-end 2002. Against this backdrop, external capital injections are crucial in enabling banks to continue growing.»
The challenge for the banks is to decide which route to take. Center-Invests Mr Vysokov says: «There are three options: an IPO, a strategic investor or organic growth, which might consist of acquiring other regional banks.»
Rosbank was about to set off on an IPO roadshow last June, when Societe Generale acquired 10% for $312m, giving it two seats on the board. SGs stake was raised to 20% last September with an option to go over 50%. Germanys Commerzbank owns 15.32% of Promsvyazbank.
Alfas Mr Khvesyuk is sceptical about the merits of having a strategic investor. «The question is what do you need a strategic investor for? Is it for capital or to improve technology? Neither is critical for us at the moment. Our shareholders have sufficient funds, we have good technology and we are the most international of Russian banks in terms of our management.»
Other banks are more focused on the IPO route, even though raising equity in Russia can be slow and bureaucratic. Rosbanks Mr Popov says: «Raising equity in Russia can be difficult and time consuming. You have to supply a lot of information, such as details of shareholders and source of funds. The approvals process can take five or six months.»
Sberbank raised $8.8bn in a domestic rights issue in February but as a state- owned bank it would be politically difficult for it to go overseas. Many other Russian companies have done foreign IPOs and the management at the MICEX Stock Exchange are busy improving systems to ensure they remain attractive. Currently, the law requires that Russian companies that launch overseas IPOs must also list in Russia.
«The primary task for us is to continue building up the liquidity and to reform the post-trade infrastructure,» says MICEX Stock Exchange president Alexei Rybnikov, while pointing out that last years currency liberalisation measures removed a lot of technical obstacles for foreign investors. Last year, volumes increased three to four times depending on the instrument and put Moscow among the worlds top exchanges, even though its 200 listed companies is less than the number traded in Warsaw.
To IPO or not to IPO? Nomos Mr Sokolov says the bank plans to IPO before the end of 2008 and will likely pick London. He adds that the bank needs $200m to $300m of additional capital but expects to raise $500m.
«I dont say that we will never use the IPO option,» says Promsvyazbanks Mr Levkovskiy. «Now we are in the process of putting our new strategy together and an IPO is one option for the future but its not an immediate option and is not more effective than other methods.»
Mr Perhirin of MDM says: «We dont have any intention to sell to a strategic investor but we are looking at organising an IPO next year as well as organic growth.»
hange of emphasis
Another challenge for Russian banks is to reduce the percentage of their profits coming from trading. Rosbanks Mr Popov says that currently his bank earns 20% of profits this way but is aiming to reduce it to 15%, especially in light of possible volatility as Russia gears up for a presidential election.
Despite all this activity, some Russian banks are still finding time to invest overseas. Ukraine is the favourite destination but other countries such as Azerbaijan and Belarus are also attracting interest. Russian banks have come a long way in a short space of time.