Russia once played roulette with its currency and balance sheets, but its banks are now gambling on a less risky approach, says Mikhail Fridman
The Russian banking sector is now much healthier compared with before the 1998 financial crisis, but major problems remain that need to be resolved to restore the sector's reputation with the international financial community.
The recent increase in domestic output and considerably higher export revenues have helped restore banking liquidity. Banking assets now amount to $78bn, having risen 40% in dollar terms since 1999.
Russian banks have also improved the structure of their balance sheets and are now less exposed to foreign currency risks. While in mid-1998 the hard currency liabilities of Russia's 100 largest banks exceeded their foreign currency assets by some $9,000m, the current situation is exactly the opposite: foreign currency assets now exceed foreign-currency liabilities by $7.5bn.
Also, mortgage schemes have recently been developed, which points to the possible expansion of banking activity aimed at financing final demand. While mortgages represent an extremely small portion of total banking assets, in light of forthcoming tax reform, this type of lending may enjoy a boom. It should be noted that in developed countries, mortgage lending is a very important area of banking activity.
Finally, Russia's macroeconomic recovery has had a positive impact on bank lending to the real sector. Liquidity, which spread from export sectors throughout the rest of the economy, has improved the solvency of local companies. Combined with a decline in financial market yields in 1999/2000, this has pushed banks to expand their loan portfolios. Since the beginning of 1999, total banking sector loans to Russian enterprises grew, while financial portfolios stagnated.
At the same time, the exchange rate's stability based on a larger trade surplus has reduced exchange rate risks and made rouble loans both more attractive for banks and available for enterprises. The increase in banking loan portfolios since the end of 1999 was mainly driven by rouble-denominated lending. In fact, this represents a reallocation of exchange rate risks from the real to the banking sectors.
The increase in lending to the real sector occurred mainly in the form of short-term loans. While banking credits helped finance the turnover gap, financial resources were not channelled into investment. Indeed, Russian banks as never before provided massive corporate financing, but the lack of information regarding a stable client base represented an obstacle. Yet another problem involves the lingering consequences of the 1998 financial crisis, in particular the need to improve banking regulation.
Two years after the financial crisis, the Russian banking sector remains non-transparent. Only a few banks that defaulted on their foreign obligations in 1998 (such as Uneximbank and Rossiisky Kredit) managed to reach agreement with their creditors. Currently, around 900 Russian banks have had their licences withdrawn, but they have yet to be liquidated in anticipation of court decisions at various levels. Another problem has been the creation of numerous bridge banks during and after the crisis, aimed at facilitating asset stripping and which have now begun to expand their businesses.
In a nutshell, Russia lacks stable banks with established reputations. This complicates interbank transactions and places excessive strain on risk management.
The restoration of Russian banks' international reputation must be addressed. Following the financial crisis, several banks were saddled with unregulated forward contracts, which represent the primary obstacle to restoring foreign counterparty transactions. Whereas, prior to the crisis, foreign loans constituted a significant portion of banks' long-term liabilities, such resources are virtually inaccessible at present. An effort from Russia's banks themselves is therefore required: foreign capita] will not become available for Russian financial institutions at least until they rid themselves of huge amounts of unregulated forward contracts.
Another problem that needs to be addressed involves the restoration of confidence on the part of individual, depositors. Currently, Russia's market for private deposits is virtually monopolised by Sberbank (which holds around 80% of total private deposits) since it provides state guarantees. A priori, this deprives commercial banks of the ability to influence the reallocation of household deposits. The attraction of household cash holdings (estimated at $20-$50 bn) represents an opportunity to build up long-term liabilities. Unfortunately, this requires a stable macro-economic environment over a sufficiently long period of time.
The problem of how to restore public confidence will be crucial in ensuring the future development of Russia's banking sector. Following the 1998 crisis, Russian banks have a pervasive liabilities structure, with most operating in a situation wherein balance sheets are dominated by short-term liabilities, mainly corporate short-term deposits. Whereas before the crisis liabilities with a maturity of less than one year represented around 80%-85% of total liabilities, this portion now amounts to about 90%-95%. This has placed severe restrictions on banks' lending capacity and has forced them to operate in an environment of high liquidity risks.
The issue of confidence cannot be resolved without contributions from the Central Bank of Russia (CBR). Monitoring of the banking sector was previously conducted too formally, and was focused mainly on the timing of the presentation of financials. This function must be enlarged in order to assess banks' true financial health and the risks to which they are subject. The monitoring function should also be combined with a strong willingness to act rapidly to prevent the failure of troubled banks.
A second goal involves changing the Law on Bankruptcy of Banking Organisations, particularly by including a more transparent means of dealing with insolvent banks. An acceleration of bankruptcy cases would reduce the risk of asset stripping and maintain value for a bank's creditors. This in turn might allow Russian financial organisations to attract foreign capital not as loans, but rather in form of equity participation.
A third aim should be to manage the transition of Russian banks to international accounting standards. While the CBR has already begun a pilot project involving six banks, IAS standards will not be fully adopted before 2002. '
All these changes will be crucial in ensuring the banking sector's ability to drive a sustainable economic recovery in Russia.