Banks face long haul to regain lost confidence

Foreign investors and local customers remain cautious at piecemeal attempts to restructure What little confidence Russians had in their banks, which they have instinctively regarded with deep suspicion, was dealt a devastating blow by the financial crash of August 1998.

Most of the country's private financial institutions were forced to close and there is little sign of enthusiasm from customers for those that survived or have been created in the past two years. Having seen their savings wiped out because the banks could not pay their depositors, many Russians believe their mattresses still provide greater security for their money. Stephen O'Sullivan, head of research at UFG, the Moscow investment bank, says: 'One of the worst things about the crisis was that the group of middle-class Russians who had learned to trust the banks lost a lot of money.' Two years down the road, however, there are some positive signs. Some surviving banks have now earned the respect of bank analysts. These include state-owned institutions like Sberbank, which recently announced a five-year growth strategy and has been lending money very aggressively as it tries to transform itself from a savings bank into a lending institution. Also among the survivors with a future are banks with strong shareholders such as Gazprombank and International Bank of Moscow, medium and small Moscow banks with few external liabilities, and large private ones such as Alfa-Bank and National Reserve Bank. Alfa has been rapidly expanding its retail operation to take advantage of the competitive edge gained from surviving the crisis reasonably intact. There is also a very large and informal micro-credit sector in Russia which can almost be termed 'neighbourhood banking'. In it, small family-owned business develop strong links and extend credit to each other, nullifying to some degree the absence of a normal banking sector. On the investment banking side, most of the international banks, except for Morgan Stanley, have retreated from Moscow. But there are a number of local institutions, such as Nikoil and Troika, whose primary focus is local business, and others like Brunswick Warburg and UFG which are increasingly active. Most business is in equity sales and trading and there is a growing corporate finance business. However, foreign investors and local customers remain extremely cautious. They are probably sensible to take this attitude to a sector where the pace of reform depends on the economic climate and political whim and even the viable banks are powerless to determine their future. There is no doubt that wide-ranging restructuring is needed. The non-state banks are too small to satisfy the requirements of the country's largest industries. Some analysts predict another banking crash in two years unless steps are taken to toughen regulatory and reporting standards, improve lending quality, increase capitalisation and reduce links between banks and parent industrial groups. Natasha Page of Fitch IBCA, Duff & Phelps, the international bank analysts, says: 'The absence of an even quasi-reliable banking system before the crisis and its ineffective restructuring have slowed down the recovery of the Russian economy. As the European Bank for Reconstruction and Development (EBRD) notes: 'developments in Russia underline the risks to macroeconomic stability of inadequate banking reform'.' Some progress has been made. Uneximbank and Rossiyskiy Kredit Bank, the two large private sector banks that failed in August 1998, reached an agreement earlier this year with their mostly foreign creditors and restructured their obligations. However, some other large banks, including SBS-Agro, have still not been shut down. There is little evidence that the government has addressed the issue of banking restructuring since the 1998 crisis. This was caused by the devaluation of the rouble when most banks had a big exposure to state treasury bills (GKOs) and dollar forward contracts that allowed these rouble-denominated bills to be converted into hard currency. The devaluation to 25 roubles to the dollar left most Russian banks owing billions on their forward contracts, which had locked in at seven roubles to the dollar. Banks were also left with substantial loan loss provisions and losses on securities portfolios. Kim Iskyan, bank analyst with Moscow brokers Renaissance Capital, says: 'With no meaningful changes in regulation or oversight of the sector since 1998, the same actors are simply in the process of playing the same games that resulted in the August 1998 crisis.' He adds that, with President Putin concentrating on consolidating his power base, any banking reform 'is likely to be put on the back burner until the autumn. It remains to be seen whether any changes will begin to be implemented at that time or whether they will have a positive impact on the banking sector.' Bankers put much of the blame on Viktor Gerashschenko, governor of the Central Bank of Russia (CBR). He has a good reputation for his monetary policy, but his record in restructuring the banking system and establishing proper reporting standards is regarded as abysmal. Says one analyst: 'He does not enforce the existing laws. Banks' statements are shabby and fraudulent. He must introduce proper accounting standards and some element of moral hazard.' Some say that it is difficult for the CBR to impose its will in the regions. 'Central Bank reforms have been minimal, but its regional institutions have considerable autonomy and that, in itself, creates difficulties for supervision,' says Richard Hainsworth, Moscow representative of rating agency, Thomson Bankwatch. But analysts say Gerashschenko should have done much more. 'If you set the right attitude and show a lead from the centre, the impact will feed through the whole country. Now that President Putin has put such pressure challenging corruption, we may see some action.' Bankers are contemptuous of what some see as Gerashschenko's total lack of political integrity. This, they say, affects his decisions about whether to act against banks. For example, temporary administration was imposed on Most Bank earlier this year. Bankers say this decision had more to do with the link between the bank and the Media-Most media empire, which had been critical of the government, than with any banking issue. According to Iskyan: 'It was unclear what banking-related reasons the CBR had for imposing the measure on Most Bank when it acted — and not, for example, in 1998, or on any other of the several hundred bank-like institutions.' A further structural problem is that there are too many small banks. Mergers are unlikely because of the tax advantages to industrial groups from having their own banks — if they transfer money from part of the group to another using an outside bank they have to pay tax on the transactions but they do not have to do so if this is done through their own bank. The capitalisation of the banking system remains weak although it has improved since the end of 1998. Fitch IBCA's Page says: 'There is a small group of relatively strong private banks that came out of the crisis well, having built on the weaknesses of the failed banks and consolidated their clients. Such banks are adequately capitalised or better. However, the largest state-owned bank, Sberbank which dominates the banking sector and is the only truly nationwide bank in Russia, is currently in need of real capital, given its rapid loan growth and low tier-one capital.' The financial sector is not fulfilling one of the key roles of a banking system, which is to lend to small and medium-sized companies. There is plenty of liquidity in the system as a result of booming oil and metal prices, which has created a massive trade surplus, and this is reflected in increased payments in cash and less barter. The strengthening of the rouble should also boost confidence in the economy. Banks are either placing their deposits in government bonds or in foreign currency deposits. They are not lending to companies, in part, says O'Sullivan, because 'there is a problem finding institutions that are fit to lend to. In addition, structural issues such as the weak bankruptcy laws discourage lending because of the difficulty of pursuing delinquent borrowers while the absence of commercial land ownership means that there is little collateral available as security for lending. Nor is there much decent analysis of businesses. There is some lending to the big companies like Lukoil, but there are not enough growing businesses with a track record and collateral.' A further problem is that there is a potential mismatch between borrowing and lending profiles. According to Hainsworth of Thomson Bankwatch: 'Corporate entrepreneurs want to borrow money for a minimum of four to six months, but nervous depositors are placing their money in short-term deposits. Where banks are lending, they are taking security mismatches, which is all right when the economy is growing but could lead to another banking crisis if the economy eases.'