Over the past year Russia became one of the last major emerging economies to take tentative steps out of recession following the oil price collapse in 2015, showing some signs of growth and a decline in inflation on the back of the Central Bank of Russia’s sensible monetary policy and commitment to easing despite FX rate pressures.
According to analysts polled by Reuters, the country is expected to show GDP growth of 1.4% this year, up from 1.3% predicted a month ago, but still short of the 2% growth rate promised by the economy ministry this year.
The rouble has been one of the better performing EM currencies this year, having made significant strides from RUB65 per US dollar in August last year to a peak of RUB55 per US dollar in April, before depreciating over the following months to settle near the RUB60 mark this month.
The Central Bank’s commitment to its easing cycle saw inflation drop steadily through the year, from 6.9% in August 2016 to hover near the target of 4% year-on-year. Still, interest rates remain high relative to some other CEE and emerging economies, at 9% - a significant improvement on 17.5% in 2015, when the CBR hiked interest rates to stem the rouble’s depreciation.
But While Central Bank chief Elvira Nabiullina’s strict monetary policy has aided the economic recovery, it has taken a toll on credit, which is already strained by the banking sector consolidation programme she launched back in 2013. The growing number of defaults, as well as technical glitches that brought about cash withdrawal problems for clients of some of the major banks in the country, have raised concerns about health of the sector.
“When the Russian economy was doing well, new lenders popped up everywhere, far more than was required, not least when you see how top-heavy the sector is. That was widely seen as a source of vulnerability, including the potential for corruption when such a large sector is unregulated,” said Capital Economics Senior Emerging Market economist William Jackson, adding that the move to consolidate and clean the sector was sensible and ought to pay off in the medium to long-term.
But recent troubles at Otkritie – the shining star among Russia’s private banks in recent years – in some ways exemplifies the challenges facing the sector at the moment. In July, the bank saw its rating downgraded to BBB- by ACRA, Russia’s own rating agency, whose role has grown following the recent exit from Russia’s domestic market of The Big Three – S&P, Fitch and Moody’s.
This placed Russia’s biggest private lender (and a top-10 bank) in a tight spot, as it found itself below the A- grade required by the regulator to allow access to state funds. The downgrade also meant that Otkritie’s bonds could no longer be used as collateral on the interbank borrowing market, adding further pressure on the bank’s finances.
Shortly after the downgrade the bank saw capital outflows of nearly RUB106bn, according to BKF Bank analyst Maxim Osadchiy, cited on state-run media agency RIA, with government-linked entities withdrawing RUB76bn worth of deposits from the bank due to regulatory pressures, leaving the Central Bank as the only remaining source of funding for the ailing bank.
The outflows were aggravated by mass private account withdrawals, with some observers seeing signs of a run on the bank, indicating a deterioration of trust in the system. In the first half of 2017 four major banks (from the Top-100) saw their licences revoked, including, most recently, Yugra Bank, as well as multiple smaller and regional lenders, many of which ended up cut off from state funding due to tighter restrictions.
According to the CBR, it added 33 Russian corporate and FI bonds (worth around RUB160bn) currently on the market to the blacklist that prevents them from being used as collateral, thus cutting holders of those notes from CBR’s fixed-rate overnight lending instruments. Among those were bonds of certain banks, including the ailing BinBank, Renaissance Credit, Novikom bank, and a number of others.
Curiously, these developments come despite a growing liquidity surplus in the sector on the back of continued cash injections by the CBR via its repo operations; according to an official statement, the regulator injected RUB575bn into the system in August, compared to just RUB42.7bn previous month.
“The banks’ rouble liquidity is ample,” Uralsib analyst Irina Lebedeva told RBC. “So the surge in demand for local currency suggests that some of the banks are losing access to the interbank lending market and are forced to borrow from the CBR at higher rates. This is indicative of a deterioration of trust among the banks.” Lack of growth in the interbank lending rates, despite a surge in demand, is a further sign of this deterioration.
According to Denis Poryvai, a Raiffeisen Bank analyst, the sector is still quite stable and the extent of current troubles will become apparent when the CBR publishes its quarterly statements, which would indicate which of the banks have been especially active on the REPO exchange, and reveal the extent to which any of the concerns over liquidity are justified.
“Corporate clients are currently not protected by any agency in the banking sector, unlike retail, which is covered by the Deposit Insurance Agency (DIA). When corporates fear losing money, they tend to transfer funds to more stable, safer lenders, which typically include Sberbank, VTB and, to an extent, Alfa and Reiffeisen. Otkritie recently saw a downgrade from ACRA, which provoked some withdrawals by state entities, which accelerated the run. But the exact extent of the damage will become apparent when the statements are published later this month,” Poryvai told Bonds&Loans.
With this in mind, Otkritie’s figures and its fate in the longer-term appears to carry added significance to the sector as a whole. Whispers on social-media and among the bank’s clients, alongside the recent withdrawals, appear to have alerted the highest tiers of the bank’s management to the issue. Otkritie’s founder Vadim Belyaev, chairman of the board and its largest shareholder, announced last week he is stepping back into the role of chief executive after a two-year hiatus, signalling the bank’s commitment avoid a crisis.
Recent reports in Reuters suggest that the bank, which is part owned to Otkritie Holding and which lists executives from Lukoil, VTB Bank and other prominent businessmen among its shareholders, is talking to a number of potential investors as it seeks to boost its capital. Rising yields on its April 2019 Eurobonds, which jumped 255bp to 8.8% since the downgrade, should be attractive enough. In early August, Russian newspaper Kommersant reported that the ailing bank has put forward a tender offer on RUB35bn worth of its bad loans, although the report has not been confirmed by the bank.
The bond sell-off is likely to put a dent in the bank’s short-term liquidity – some suspect that the recent breakdown in Otkritie’s ATMs services was an early sign of this shortage, contrary to the official statement citing a technical glitch due to damaged communications cables. Russia’s TASS agency claimed that one of the options put on the table by the bank’s board was to open an irrevocable credit line from the CBR, although it appears that for now, less radical measures are sufficient.
Whether or not that will happen, this latest development once again brings to the fore debate, recently raised in the Peresvet Bank case, about what the “systemically important bank” status really entails and how far the CBR should go in rescuing those entities or helping them to a “soft landing”.
Poryvai suspects that even if Otkritie ends up in hot water, it is too important to be allowed to fail.
“I think the same steps as with Peresvet will be taken again with Otkritie and I don’t expect any licence withdrawals within the top-10 banks, because they are systemically important, meaning that the cost of saving them is much lower than the damage their bankruptcy could incur. I don’t expect Otkritie to be treated in the same way as Yugra, BinBank or Moscow Credit Bank,” he concluded. But others are less confident.
“It appears that the line that the CBR would draw when dealing with some of the larger lenders is rather blurred,” William Jackson noted.” There is concern in this situation, because when you are not sure when a bank is large enough to require a bailout, that it could cause a run on the bank and lead to liquidity issues, perhaps even broader concerns about the financial sector.”
This continued uncertainty is already costing the sector, with bond yields for some of the smaller and medium-sized lenders rising faster than expected, even with the Fed’s hawkish outlook priced in. According to RBC media agency, Promsvyazbank’s yields on notes maturing 2021 rose from 6.89% to 7.36% in the past week, while Moscow Credit Bank’s perpetual bond yield was up to 9.5% from 9.33%, with spreads on Alfa Bank’s perpetual notes widening from 1.5% to 2% month-on-month from July. Over-the-counter trading of Russian bank Eurobonds has seen the sell-off intensify over the past two weeks, the agencies’ sources added.
While for now this appears to be more of a knee-jerk reaction of the market to Yugra’s collapse and the CBR demonstrating that it is willing to let underperforming lenders go under, the situation could escalate with external factors coming into play. With oil remaining around the $50 mark and additional sanctions recently signed off by president Trump, pressure on the rouble is growing and its depreciation could push yields even higher.
For now, though the CBR should focus on its job of cleansing the sector, says Jackson.
“The immediate challenge for the CBR is winding out smaller banks and further consolidation of the sector; there is a broader challenge of reducing the NPL ratio, which has grown during the recession. Past examples from CEE suggest that could be quite a significant constraint on credit for several years, even as the economy recovers,” the economist concluded.
With the quarterly banking sector report results due in two weeks, investors will be on their toes to see which Russian banks have skeletons in the closet – and, more importantly, how regulators will deal with them.
