Three years after the last
banking collapse, Russians continue to shy away from
placing their money in banks for fear that a fresh bout
of hyperinflation will wipe out their savings.
Three years on, bank loans
remain largely out of reach for medium- and small-sized
businesses and individuals.
And the banks that weathered
the 1998 crisis are no more accountable to the
authorities or transparent to the public than
The government intends to
change all that.
After tackling tax and other
legislative issues affecting the investment climate for
the past year, Prime Minister Mikhail Kasyanov and his
team are finally setting their sights on banking reform.
Official Cabinet talks on the issue are set to start
Ten days before the
government convenes, two teams -- the Central Bank and
the Union of Industrialists and Entrepreneurs, or the
RSPP, the country's influential business elite -- are
shrewdly fine-tuning their reform plans to present at
Kasyanov is promising that
the government and the Central Bank will develop a
unified approach -- but it remains to be seen whether
the reform plans in themselves will be able to create a
well-greased and healthy banking sector.
"[There is no] clear system
of transferring capital to sectors that need it,"
Kasyanov said last week.
The three main problems that
have hindered growth in the banking sector are lack of
trust, lack of secure places to invest and lack of free
competition, banking experts say. Thus, the existing
system is small, lopsided and fails to perform one of a
banking sector's most important functions: financial
intermediation, that is drawing in savings and putting
them to work by lending to and investing in the real
Total banking assets are only
about 5 percent of gross domestic product. Out of 1,322
licensed banks in the sector, the two largest --
Sberbank and Vneshtorgbank, both majority owned by the
Central Bank -- together hold about 26 percent of total
bank assets. The next 200 largest banks by capital hold
about 72 percent.
"Every dollar that is kept
under a mattress or in a bank account abroad is not
working for the economy," said Christof Ruehl, chief
economist of the World Bank in Moscow. The World Bank is
advising the Central Bank on banking reform.
"Large financial industrial
groups are awash in cash, but the intermediation
mechanism is not working," Ruehl said.
He said the ultimate goal of
banking reform is to support small- and medium-sized
companies, which can be taken as a proxy for new
"The banking sector is not
linking the need for capital in small- and medium-sized
companies, which drive growth in other transition
economies, to the large amount of existing capital
generated by the large [natural resource] exporters,"
Small- and medium-sized
businesses account for roughly 60 percent of the economy
in Central and East European countries, but for only 30
percent in Russia.
Bank loans are one of three
main sources of investment for companies. The other two
are capital markets and retained earnings. However,
domestic capital markets are small and relatively
illiquid. Domestic companies tend to have lower profits
than comparable companies in more developed countries
and, thus, have less to invest. New or small companies
in particular need alternative sources of
The Economic Development and
Trade Ministry estimates that only 3 percent to 5
percent of investment financing in the country is from
banks, compared to 15 percent to 30 percent in developed
countries and 25 percent to 30 percent in developing
Forced Reform or Laissez Faire?
Against this backdrop comes a
proposed set of swift changes known as the Mamut plan.
The plan, named after MDM-Bank's supervisory board head
Alexander Mamut, who leads the union with Alfa Bank CEO
Pyotr Aven, was hammered out by the RSPP, which has won
major victories in influencing government policy in
legislation such as the reduced profit rate and currency
The Mamut plan focuses on
consolidating banks through minimum capital
requirements, reviewing the Central Bank's ownership of
commercial banks and the role of state-owned banks in
general, and speeding up a transition to international
"After the RSPP's first plan
came out, the Central Bank spoke in favor of maintaining
a two-tier system and deposit insurance," Ruehl said.
"We support both of these -- but if one wants a two-tier
system, one has to destroy the monobank system, which
means the Central Bank has to leave Sberbank and
The Central Bank's approach
over the past three years had been to maintain stability
and "not to force reforms on the banking sector," as
Central Bank chairman Viktor Gerashchenko said last
month, until other reforms -- legal, judicial and
economic -- have been carried out.
The Central Bank has also
decried the low concentration of capital and assets in
the sector and vowed to work on corporate governance.
The most controversial point
in banking reform is not doubt one that both sides agree
upon in principle: the need to consolidate, that is
increase banks' capital and reduce the number of
institutions calling themselves banks.
The Mamut plan proposes
splitting the sector into three tiers: the Central Bank,
federal banks and regional banks. Banks with capital
above $100 million would be eligible for federal
licenses granting the right to perform countrywide and
international transactions. Banks with $6 million to
$100 million would get regional licenses.
The plan has drawn harsh
criticism because it would leave about 20 powerful
federal banks, selected purely on capital requirements,
Size does matter because a
bank's capital -- shareholders' equity and retained
earnings -- determines how much a bank can lend and is
the basis for its operations. Below a certain level,
banks cannot be profitable.
However, size is not
equivalent to stability, as the 1998 crisis proved when
the country's largest banks collapsed.
"An increase in capital does
not mean an increase in stability or security. It allows
banks to lend more money, but if they lend more money to
one client, they may increase their risk," said Mikhail
Matovnikov, deputy director of Interfax Rating Agency,
which rates banks.
"The risk-level of small and
large banks in Russia is almost equal," he
The Central Bank has
expressed dissatisfaction with the lack of
consolidation. But Gerashchenko has also said that
wiping out a large number of small banks could
destabilize the system. The Central Bank raised the
minimum capital requirement from 1 million euros to 5
million euros (now about $910,000 to $4.55 million) in
June, but the limit applies only to newly registered
Economic Development and
Trade Minister German Gref waded into the discussion
Thursday, telling journalists that demands for minimum
capital requirements must be tightened.
And Alexander Shokhin, head
of the State Duma banking committee, said at a banking
conference early this month that the Central Bank should
revoke smaller banks' licenses, converting them into
deposit-lending institutions rather than liquidating
"If [small banks] didn't
serve an economic function and if the economy didn't
need them, they wouldn't exist," said Richard
Hainsworth, head of RusRating, a bank rating agency.
But, he said, if they are not
performing banking functions, they should not have
general banking licenses
Last week, the RSPP softened
its stance, backing away from the two-tiered structure.
Nonetheless, the group lowered its minimum requirement
to at least $10 million for banks to receive a general
banking license to take retail deposits, participate in
the deposit guarantee system and open accounts with
Still, say defenders, small-
and mid-sized banks play a vital role.
"Major Russian banks are
basically wholesalers. They are banks that specialize on
wholesale clients, oil and gas, large loans. These banks
neither specialize in or work with medium-sized and
small businesses," said Sergei Suchkov, head of KMB
Bank, whose acronym stands for Credit for Small
"In the regions there are
already small- and medium-sized banks that are starting
to work with medium-sized and small businesses," he
Banks are currently operating
on a lopsided playing field, in particular where retail
deposits are concerned. Only Sberbank, which monopolizes
the retail banking market with about 75 percent of all
deposits and a network more than 300 percent larger than
its nearest competitor, has a government guarantee for
For the average middle-class
Westerner, holding a bank account is a fact of life,
like learning how to drive or getting a job. In Russia,
the majority of the population has more reason to
distrust than trust banks, especially those who lost
much of their savings to hyperinflation.
"When people trust banks,
banks will have more capital available and [lending
rates] should come down," Ruehl said. "The high cost of
capital for small companies is one of the biggest
barriers to growth."
stranglehold on the market is a key factor, but one that
is unlikely to be resolved in the short-term and one the
Central Bank has resisted.
Both the Central Bank and the
RSPP have suggested deposit insurance for other banks as
a way to start rectifying the situation in the meantime.
The Central Bank has drafted
a deposit insurance bill for the government under which
banks would pay a premium of 0.6 percent of its retail
deposits into a proposed state deposit guarantee
corporation. Sberbank would also be subject to such a
premium but would pay it into a special account at the
"Deposit insurance could be
used to kill two birds with one stone, that is, meet the
need for consolidation and for competition on equal
grounds," Ruehl said. "But it will only be effective if
there are stringent conditions, such as proper
accounting standards, disclosure, capital adequacy
ratios and prudential reforms. The quality of reform can
be judged by the quality of the set of requirements that
Capital adequacy is a measure
of a bank's capital as percent of its assets, such as
the loans it has provided and the securities it holds.
The riskier the assets and the environment, the higher
the ratio should be set. In developed countries, minimum
capital adequecy ratios are usually set at about 8
percent to 10 percent. The Central Bank has set it at 8
If improperly structured,
however, such a guarantee, could backfire horribly.
"Without proper structuring and careful oversight, which
has not been the Central Bank's strong suit, deposit
insurance could give depositors a false sense of
security and lower banks' incentives to manage risk
carefully," said Kim Iskyan, a banking analyst at
The Central Bank willingness
and ability to offer adequate oversight has raised some
"It is not that the Central
Bank doesn't regulate at all, but it regulates in a
Soviet way by demanding reams and reams of paperwork,"
Iskyan said. "The Central Bank should try to assess the
validity of financial results, what banks are doing, who
owns them and their transparency."
The Central Bank has also
been lax about implementing existing laws, Iskyan said.
For example, Russian law sets loan exposure limits, that
is, the amount of capital that a bank can lend to one
customer or one group of related parties, at 20 percent.
Renaissance Capital estimates that seven of the 20
largest banks generate more than half of their business
from one client or small group of related companies.
The Central Bank has also
failed to instill a healthy fear of reprisal in banks,
Iskyan said. Relatively few banks have lost their
licenses since the crisis. Reports of asset stripping
have remained for the most part reports. Bank managers
who oversaw the collapse of their banks in 1998 have
moved, with bank assets, to new banks.
"Bank regulation in less
developed countries is generally extremely difficult and
doesn't work all that well," said Peter Boone, head of
research at Brunswick Warburg. "The most important thing
that drives banks to behave and be careful is the value
of a reputation they have built up. The problem here is
all these banks are new ... and so they really don't
have much of a reputation and it's not very valuable for
them and that is why they are willing to take
Introduction of international
accounting standards, or IAS, is a major plank in the
plans for banking reform. IAS demands greater disclosure
and provides more transparency than Russian accounting
The Central Bank has proposed
implementing IAS as of Jan. 1, 2004. The Mamut plan
calls for its implementation as a matter of urgency,
although Mamut himself last week said the matter was
open to discussion.
The Central Bank has
supported a gradual implementation, stressing the time
and effort involved in retraining its staff, banks'
accountants and auditors and the possibility that more
banks will be insolvent under IAS. Others see this as a
benefit and say the faster IAS is introduced, the
"IAS reveals [banks']
weakness. If we put off IAS, we will need to forbid
X-rays because they show that patients are very sick,"
said Vneshtorgbank CEO Yury Ponomaryov. "We will be
ready by 2004 only if we start quickly now. Under no
conditions should we delay."
IAS, however, does not
guarantee transparency. Russian accountants can fiddle
with IAS statements as easily as RAS financial
statements if the sector watchdog -- the Central Bank --
is not vigilant. This means moving from requiring data
to analyzing the information.
"Control means reporting
requirements, the reams of paper, whereas regulation is
analysis, talking to banks, fine-tuning the mechanisms,"
IAS could also benefit the
sector because it is more geared toward the economics of
running a business than Russian accounting standards.
For example, it allows banks to form reserves -- a
cushion against unpaid loans -- from pre-tax earnings,
which is more reasonable economically. Russian
accounting rules discourage reserves because they
involve additional tax exposure, but low reserves
increase a banks' level of risk.
Lending has surpassed
pre-crisis levels, but less needy export companies have
greater access to credit than small- and medium-sized
businesses and individuals.
"Foreign and large domestic
banks, have the money to loan, but the problem is the
tax and legal environment and the lack of good
borrowers," said Hainsworth.
Banks need the tools and
incentives to perform thorough risk analysis and the
assurance that a strong legal system will protect their
loans, he said.
Duma deputies, together with
the Central Bank, have taken a step to boost lending
activities by drafting a law to create a credit-history
The Mamut plan demands that
the Central Bank's commercial activities be reviewed.
Its role as regulator is in conflict with its role as
majority owner of the two largest banks in the sector,
Sberbank and Vneshtorgbank.
State-controlled banks tend
to loan to government-owned companies, as industrial
pocket banks do to their related companies at nonmarket
rates, distorting the market and frustrating
competition, bank watchers said.
The RSPP proposes limiting
the function of state-owned banks. For example,
Rosselkhozbank, set up to serve the agricultural sector,
would be limited to that sector.
The Central Bank, however,
has insisted banks that met quantitative requirements be
allowed to operate without regard to their
The proposed reform plans
begin to address important issues within the sector, but
without broader reforms -- and improved sector
regulation -- they may not lead to true growth.
"It is like changing the oil
in a car that has no wheels," Iskyan said. "It needs to
be done, but the sector also needs active regulation, a
reliable judicial system and enforceable legislation, in
particular, bankruptcy law, contract enforceability,
recoverability of collateral."
"Gerashchenko is right that
the effectiveness of any banking reforms, which may look
nice on paper, depends on the effectiveness of legal,
judicial and other reforms. Banking reform cannot take
place in a vacuum," Ruehl said.