Russia’s banking pain is forcing long-overdue sector consolidation

(Business New Europe – bne.eu – Ben Aris in Moscow – September 24, 2015)

Russian banks are in a world of pain. Real incomes are falling for the first time since President Vladimir Putin has been on the job, and sanctions have cut banks off from their main source of long-term cheap financing. The upshot is that Russia’s financial sector has embarked on an accelerated consolidation that will radically shake up the industry landscape.

“The model is broken,” one senior Russian banker tells bne IntelliNews. “In the old days we could borrow long-term cheap money from abroad, and lend it domestically with shorter maturities and at higher interest. It was easy.”

The US and EU financial sanctions imposed last year have excluded all of Russia banks – not just the handful of state-owned banks actually named on the lists – from the global capital markets. Compliance and risk offices in international banks will not approve loans to any Russian bank in case it winds up on a sanctions list down the line. Long-term capital is now only available from the Central Bank of Russia (CBR) – and following the emergency interest rate hike in December in the midst of the oil-price induced ruble rout, Russian-sourced money is now impossibly expensive.

Russia has been moving slowly towards having less banks for over a decade, but the pace accelerated recently. Since the days of Russia’s “wild cat banking” when anyone with a pocket full of change could open a bank, the number of banks has fallen steadily from over 4,000 in the early 1990s to 923 at the end of 2013, 834 at the end of 2014 and 797 banks today.

Yet that is still way too many. The top 50 banks account for well over 80% of the system’s assets, while the bottom 700 are largely glorified treasury operations for companies and oligarchs – or what a former Renaissance Capital analyst Kim Iskyan famously dubbed, “bank-like institutions” that are little more than money-making scams.

The Russian authorities are well aware of the problem; having so many small and crooked banks makes the financial sector impossible to regulate, as there are simply too many banks to inspect properly. Last year President Putin weighed in, calling for consolidation in the sector. “We have just under a thousand banks. That is, of course, a large quantity of financial institutions for our economy,” Putin told a meeting with students.

He suggested that Russia should copy Germany and reduce the number to around 300. And if the current pace of bank closures continues, that goal will be reached sometime around 2025 – although as the number of insignificant banks dwindles the danger of destabalising the system by closing them more quickly recedes, so the process can be expected to accelerate from here.

The Central Bank of Russia (CBR) was already turning the screws last year to head off a consumer credit bubble, by increasing prudential reserve requirements and withdrawing the licences of the more egregious outfits.

But closing banks is not easy and can be downright dangerous. The regulator nearly crashed the system in 2004 when it withdrew the licence of the aptly named Sodbizness Bank, as the owners had been stealing depositors’ money. It was the first time the CBR had cancelled a license and it set off a panic, with rumours of a “black list” of small banks that would also be closed. Fears quickly spread to the more established banks. The leading retail specialist Guta Bank actually went bust and Alfa Bank had to fly in $800mn of cash to bolster its position, according to a well-connected bne IntelliNews source who saw the cash piled up on pallets in a warehouse on the edge of Moscow at the time.

However, the quality of the closures has changed this year. Now good banks with formerly strong businesses are being closed, simply because the market won’t support them.

The CBR pulled the licence of Probusinessbank in August, a leading commercial bank specialising for years in financing small and medium-sized enterprises (SMEs) after it failed to meet the minimum capital requirements. Probusinessbank was a decent bank working in a sector that the government is trying to support, but its business simply dried up.

Even more worrying is the fate of Russky Standart (Russian Standard Bank), the pioneer of the express retail loan business that is currently fighting for its life. Set up by vodka tycoon Rustam Tariko a decade ago, the bank was initially dismissed as a flash in the pan, until it grew into a multi-billion-dollar retail lending business and others were forced to copy its business model. However, this year Tariko has had to bail the bank out twice and will probably inject more money in October, as well as applying to the CBR for state support.

Several other well-regarded, high-profile commercial banks are in similar positions. Vostochny Express, a medium-sized bank that competes with the incumbent retail giant Sberbank in Russia’s far-flung regions, is also in trouble. On September 18, Moody’s downgraded the bank’s deposit and debt ratings due to the “continued deterioration of the bank’s asset quality and profitability”.

The list is growing longer and consolidation is accelerating as the stronger banks (usually either owned by an oligarch or are close to the state) increasingly buy up weaker ones. In September, Promsvyazbank, a leading commercial bank, took over the well-respected Vozrozhdenie Bank and one of the very few mid-cap Russian banks to be listed. Likewise, the CEO of Renaissance Credit bank, owned by oligarch Mikhail Prokhorov, told bne IntelliNews in September it is on the look out for acquisitions and is rumoured to have its eye on beleaguered rival Svaznoy Bank, with a possible deal in sight in October. And FC Otkritie, Credit Bank of Moscow and B&N Bank are all reported to be in talks to take over MDM Bank, Bank Absolut and Bank Petrocommerce.

The appeal of merging is that it is the path to more state support: FC Otkritie and Promsvyazbank have already been included on the list of “systemically important banks” introduced by the CBR earlier this year, which guarantees them bailouts if they get into trouble. If the other mergers go through, then the merged banks will probably also be given strategic status.

The upshot of all these deals is that while the biggest state-owned banks will continue to dominate the top of the list, the swathe of second-tier commercial banks will be radically transformed.

Slo-mo crisis

Russia is in effect going through a slow-motion financial crisis, where the state is using its massive resources to engineer a soft landing for the sector to avoid bank collapses and runs.

The CBR has plenty of firepower and is deploying it to keep liquidity on the interbank market sufficiently high so the sector can tick over. “You and I know perfectly well the situation in our economy is fairly complicated but not critical,” President Putin said at a conference on the draft budget for 2016. “We need the economic levers to fully enact Russia’s own economic capabilities. We have absolutely everything for this.”

Russia’s banking industry was profitable in June for the second consecutive month, but the sector as a whole only had a 1.5% return on equity in the first half of this year. By comparison, according to Raiffeisen Bank International’s (RBI) CEE Banking Report in June, the return on equity for the CEE region’s bank sector is at its lowest level since 2000 but still at a much higher 6.9%.

Lending and deposits at Russian banks picked up in August, so the bottom of the downturn may have just passed, but the whole sector is doing little more than treading water, waiting for the political and economic problems to run their course.

In the meantime, the government is pumping cash into the sector to stave off worse problems. The international rating agency Standard & Poor’s (S&P) said in September that the state has already injected RUB2.5 trillion ($37.6bn) into the sector this year to avoid systemic problems – more than double the RUB1 trillion initially put aside to support financial institutions, a third of which went to state owned VTB Bank alone – and will probably have to put in even more funds before the end of the year.

Indeed, on September 23 the CBR announced it would prolong its relaxed requirements for banks through the end of the year. This means that banks will still not have to create provisions for borrowers whose financial standing has deteriorated due to sanctions, and that they may continue using more favourable exchange rates when calculating the capital adequacy ratio (CAR) for another three months. However, the more favourable exchange rates are less so than before: the ruble-dollar rate was raised from RUB45 per dollar to RUB55, and the ruble-euro rate was raised from RUB52 per euro to RUB64, reports Alfa Bank. “The CBR’s deputy chairman Mikhail Sukhov mentioned earlier this month that much less than half of Russian banks were still taking advantage of the relaxed requirements, down from about 75% in May,” Natalia Berezina, an analyst with Alfa Bank, said in a note on September 23.

S&P was full of praise for the Russian authorities, highlighting that the sector remains stable and CBR Governor Elvira Nabiullina was even named as the “best central bank governor in the world” by Euromoney magazine in September. “We believe that the Russian government is ready to provide further support to the banking sector in the form of capital and liquidity,” S&P said in its report.

But that has left Russia’s banks more dependent than ever on the state for capital due to the limited access to external borrowing, the agency’s analysts concluded. And that will only bolster the state-owned banks’ already dominant position.