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Russia & CIS

Russian Bank Purge Deemed a Success, But the Sector Remains Overcrowded

Over the last three years Russia’s Central Bank went on a delicensing spree, shutting down hundreds of small and medium-sized banks. Although the sector is now looking healthier, it remains overcrowded, according to experts.

Nov 7, 2016 // 5:53PM

Elvira Nabiullina, the head of Russia’s Central Bank, has been seen as the architect behind the country’s economic recovery despite international sanctions following the annexation of Crimea and the simultaneous collapse in oil prices.

In the last three years the Central Bank of Russia (CBR) has been trying to cleanse the banking sector of ‘rotten apples’, bringing the number of lenders operating in the country from over a thousand to around 600 at present.

The CBR delicensed 46 banks in 2012 and 2013 respectively, then 87 in 2014 and 93 in 2015. This year so far the purge has brought down another 70 banks, including a number of lenders listed in the Top-100 Russian banks. The reasons in most cases are all too familiar; falsification of data, poor transparency, money laundering, insufficient reserves and high-risk credit policy.

"The cleansing process has been completely justified and very effective, and is a flagship policy of the new CBR leadership,” said Oleg Kouzmin, Russia & CIS economist at Renaissance Capital in Moscow. “According to the Ministry of Finance, it has helped reduce the amount of suspicious activity and capital outflows in Russia, which dropped from around US$200bn in the last two years to just under US$10bn.”

This sentiment is also echoed by Capital Economics’ emerging markets economist Liza Ermolenko. “The CBR has done a very good job given the long standing problem with overcrowding in Russia’s banking sector. The process has been relatively quick and painless.”

“Most of the delicensed entities had been running unofficial operations and did not have strong governance, so the industry is now looking a lot healthier – even though the process is still ongoing,” she added.

Strict inflation targets

In addition to the aforementioned factors, which have weakened the Russian banking space, the sector was placed under further pressure from currency volatility.

The performance of the Russian rouble in recent years has been highly volatile amid plummeting oil prices, dropping to an historic low of RUB81 against the US dollar in January 2016.

Currency volatility forced the CBR to hike interest rates to 17% in 2015, causing inflation to shoot up, which peaked at 15.6% in October that year.

Since then, the CBR has been gradually easing its monetary policy, reducing benchmark rates to 10% over the last 12 months in bid to reach an ambitious 4% inflation target for the end of the year. October inflation stood at 6.1%.

But the cuts have not been enough to ease pressure on Russia’s banking sector, which was already suffering the effects of the clean-up operation.

“They have continued with the tricky balancing act of cleaning up the sector while trying to maintain financial stability,” said a senior Moscow-based banker.

“It is still a relatively tight monetary policy, which does make life difficult for local banks, and the sector continues to have problems; the economy is not growing and they have strict inflation targets, making it difficult for even those banks that are in good shape,” they added.

The currency’s recent rebound to around the low 60s to the US dollar, in part due to oil’s recovery, has brought some relief. Indeed, Moody’s upgraded the Russian banking sector’s outlook from negative to stable in October.

Top-heavy banking sector

However, although the situation is relatively stable, and liquidity is sufficient for now, it remains unevenly distributed in a top-heavy banking sector. The largest Russian banks, Sberbank and VTB have more net assets than the next 20 banks combined.

After these two giants, four other banks hold total assets in excess of US$40bn: Gazprombank, VTB24, Bank Otkritie Financial Corporation and Bank of Moscow. Overall, large state banks in Russia hold around 80% of all deposits.

“Overall, liquidity in the market is quite strong, but not equally distributed,” explained the banker. “It is dependent on access to certain markets like the interbank market. Some banks have had difficulties due to lack of access to the bond market, for example.”

“There are also examples of the knock-on effect, where problems in one bank have led to other banks cutting off loans, leading to an increasing concern amongst clients about overexposure,” they added.

Ermolenko agrees that the sector is still overly reliant on the biggest players, which could cause future problems. However in the short-term the outlook remains positive.

“For now, at least, we do not expect to see any major problems with the top-ranked lenders,” she said. “The CBR’s robust reaction to the Russian rouble’s collapse two years ago instilled confidence in its abilities to manage the industry. Looking at medium-tier banks, which have come under increasing pressure, the CBR has the tools and capital to cover potential damages there.”

RUB90bn budget hole

While hundreds of smaller banks have disappeared in the purge, the biggest newsmakers are the medium-tier and Top-100 lenders. The circumstances of these banks’ closure are raising questions not just about internal management, but also about the credibility of auditors and regulators.

The Russian Orthodox Church (ROC)-affiliated bank Peresvet, which allegedly holds deposits of some of the top-managers of Russia’s commodities and construction companies, was placed in temporary administration late last month amid concerns about suspicious cash outflows.

The disappearance of the banks CEO a week prior to CBR’s intervention, and ensuing downgrade by Fitch to D, lead to the discovery that the lender had given out loans totalling RUB12bn (half of its capital) to entities with no real assets.

According to latest estimates by Russia’s Deposit Insurance Agency (DIA), pay-outs to customers of the ailing bank could reach RUB6.3bn, and its future is now in doubt.

Among other major entities that ended up in hot water during this crackdown are Finanscapitalbank, Czech-based European-Russian Bank, Military-Industrial Bank and Rosinterbank. The latter case is of particular concern.

The lender, ranked 68 in Russia’s top 100 banks, had its licence revoked in September. Since then the DIA’s investigators have encountered ‘unprecedented levels’ of resistance from the bank’s management in terms of opening up their books.

According to the report by local newspaper Kommersant, the previous management destroyed all documentation and burnt servers holding data for the bank’s last two months of operations. The size of Rosinterbank’s ‘budget hole’ thus rose from initial estimates of RUB39.9bn to RUB90.9bn.

Similar difficulties have arisen as temporary administrators took charge at dozens of other struggling entities such as Mostransbank, Credit-Moscow and Promregionbank amongst others.

“Most of the banks that have gone down so far were in some way or another involved in capital outflow schemes. They were not necessarily those that had bad loans – but questions arose about the transparency of their operations,” Ermolenko explained, adding that the political significance of some of the biggest players kept them protected from the CBR’s investigations.

Central Bank reshuffle

However, ‘political immunity’ is only likely to stretch so far, particularly if the top 5 banks are forced to cover the losses of dozens of smaller lenders.

“A big question mark now hangs over the Peresvet bank – it is a fairly large lender, and if it wobbles, will other banks in the Top-50 category be threatened?” said the source. “While the sector has so far been pretty stable, I have doubts about whether all of the biggest lenders are in great shape. Peresvet up until recently appeared to be totally fine so naturally one would ask, what else have the regulators missed?”

The Central Bank’s former management team had recently been criticised personally by Vladimir Putin, and shortly afterwards the institution underwent a management reshuffle. Nabiullina, one of Putin’s closest and most trusted allies, saw her powers extended to cover the Bank’s monetary policy, with Deputy Chairman Alexei Simanovsky appointed as her advisor.

But long-time Central Bank Deputy Governor Mikhail Sukhov was demoted to VTB, with first deputy chairman Dmitry Tulin promoted in his place. Furthermore, recent reports suggest that the CBR will take over regulatory and audit assessment duties from the Finance Ministry, with the economic department’s head, Nadezhda Ivanova, moving into the Bank’s regulatory arm.

Experts see these developments as part of the CBR’s plan to tighten the regulatory and audit sectors in order to address the roots of the sector’s problems, in so far as regulators, whether through incompetence or collusion, have been failing to anticipate and prevent bad lending practices.

“If the CBR does end up assuming the Finance Ministry’s role of regulating the audit sector, it may actually be a positive development, as the CBR has shown itself to be a more organised and independent institution than the Ministry, which is constrained by political obligations,” said Ermolenko.

“The management reshuffle in the CBR indicates that the clean-up is coming to a close, with new leadership set to take charge of the next step - namely establishing new operational and regulatory guidelines and improving the licensing culture,” stated Kouzmin.

He added that while the sector, still with over 600 banks, continued to look overcrowded, much of it was down to the country’s regional and territorial specifics, and also due to the fact that the Central Bank did not set itself any concrete numerical targets. “Its job was to rid the sector of unscrupulous and ‘shady’ entities.”

Top banks to the rescue

Most experts also do not anticipate any local currency or FX liquidity problems in the near future, as Russia’s ample reserves and the relatively solid positions of the major banks – rather than the international debt markets – will continue to provide solid financial bedrock for the sector.

One unorthodox financial instrument that major Russian banks have employed recently are overnight local bonds, traded on the Moscow Stock exchange.

“These overnight bonds are a new and unique high-tech product on the stock market. They will allow overnight investment of unclaimed rouble balances and are targeted at a wide range of investors interested in reliable and short-term financial instruments and services,” said VTB’s official statement as it announced plans to float RUB5tn of short-term exchange-traded bonds.

As many Russian state lenders are still under sanctions, they struggle to increase exposure on the international bond markets. The overnight bonds are seen as a way of dispersing liquidity across the sector to benefit the smaller lenders.

“In terms of liquidity, international bond markets are still an effective instrument, but only for larger banks, and for those that are not under Western sanctions and who are prepared to pay a premium to investors – such as Alfa Bank or Tatfondbank,” noted Sergey Dergachev, EM senior portfolio manager at Union Investment Privatfonds GmbH.

“But, for most Russian banks, Eurobonds are still a relatively expensive instrument. I suspect they will continue to rely on the CBR for liquidity support. Since the CBR and Russian government are very alert to any signs of a possible banking crisis in the country, I think liquidity support for sector should remain very strong over the coming months,” he concluded.

Clearly, as Russia’s economy gradually gets back on track (the IMF recently improved growth forecast to 1.1%), and consolidation continues, the health of Russia’s banking sector is expected to improve further.

But global factors, like a renewed fall in oil prices or a sudden deterioration in the geopolitical situation around Russia could threaten that status quo, with potentially worrying ramifications for the banking sector.

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