A year of important changes for a key sector

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By MICHEL PERHIRIN / Chairman of the European Business Club’s banking committee

Michel Perhirin, chairman of the European Business Club’s banking committee, contributed this report for the Russian Banking Roundtable organized by The Russia Journal and Vremya Novostei.

Apart from the year 2000 having been the first full year of genuine economic upturn in Russia, it was also a year of important changes in Russia's banking system.

Two years after the financial crisis, the Russian banking system is showing good signs of recovery. Along with the Central Bank's efforts on banking-sector reform, the situation in the sector, animated by the growth of the economy as a whole, has stabilized. In fact, we have seen healthy improvement in banks' financial status, capital and assets.


Progress in the development of Russian banking was clearly felt in 2000. If one looks at the last couple of years, the indicators reflected rather speedy change. Two years after the 1998 financial crisis, nine out of 10 banks reported profits; total banking capital grew very fast during the year. Growth in assets was equally impressive. What is remarkable is that, in 2000, ruble assets – in real terms – grew almost twice as fast as assets in foreign currency, which reflects increased trust in the domestic currency and is a direct result of its stability in 2000.

I would also like to highlight the following two processes that are under way, both of which are essential to the development of Russia's banking sector and the economy as a whole.

First, the share of loans in the assets of the banking system is increasing – banks are becoming less exposed to the risk associated with capital-markets activity, and are turning toward more traditional banking services, so desperately needed for economic growth. Still, I have to note that the share of corporate loans as a proportion of banking assets remains much lower than in the countries of Central and Eastern Europe.

Loans by banks to real sector, percent of GDP, First half of 2000: Slovakia 38.2; Czech Republic 35.1; Hungary 25; Romania 24.6; Poland 21.9; Russia 11.

At the same time, approximately 14 percent of total bank assets is simply free liquidity held in correspondent accounts with the Central Bank. This liquidity, aside from being totally unproductive, creates inflationary pressures and poses a threat to domestic currency stability. Lacking other attractive investment instruments, banks tend to use this liquidity overhang for speculative activities on the foreign exchange market.

Second, the value of deposits is increasing. Popular mistrust of the banking system was one of the worst consequences of the 1998 crisis. Now confidence is being restored. But it is still very fragile – most deposits are short-term deposits (and still, funds remaining "under mattresses" are estimated as $30 billion).

It is essential for banks to give all possible support for these two tendencies to continue to develop, so that as a result, "long money" emerges in the economy, cementing the basis for continued economic growth.


Although "new" leading banks have replaced the largest failed banks after the crisis, the overall landscape within the banking sector has, in general, been preserved.

Active client migration after the crisis strengthened three major groups of banks:

1. State-owned banks: Clients moved to the safer banks offering state guarantees (Sberbank, Vnesheconombank, Vneshtorgbank).

The role of the large state-owned banks remains strong, even invigorated, after the crisis: Their market share is impressive: Sberbank holds 76.3 percent of household deposits and 26.2 percent of total banking assets in the sector. Out of the total number of Russian banks operating bank branches (over 3,800), 41 percent belong to Sberbank.

State-owned banks continue to increase their market share.

Sberbank and Vneshtorgbank are not likely to be seriously harmed by the growing competition in the sector, and other state and quasi-state banks are entering the market:

Rosselkhozbank, specializing in agricultural loans;
Rossiisky Bank Razvitia, focusing on state investment programs;
Vnesheconombank is continuing to aggressively attract clients.

2. Expanding banks: attracted clients by acquiring new infrastructure from old banks (i.e. Alfa Bank and Guta Bank acquired parts of the Inkombank and Unicombank network).

After the collapse of the main private pre-crisis retail market leaders, smaller rivals that survived the crisis moved to the fore, attracted the majority of ruined banks' clients, and managed to obtain state support in one way or another. These are Alfa Bank, Guta Bank and several others, which have significantly enlarged their capital and now occupy leading positions in bank ratings.

3. Foreign banks provide a relatively reliable and consistent standard of professional service.

Foreign banks were able to significantly increase their market share after the crisis. Their main advantages are their reliability and the variety of their retail banking products. The major contributing countries are Austria, the United States, Germany and Japan. The market share of foreign banks is relatively stable, approximately 6 percent of the total Russian market.


If we could roughly divide the whole range of reforms that the banking system vitally needed after the crisis into "categories," the two major ones would be:

1. Cleaning-up work – examining banks and segregating the insolvent ones, which were to be restructured or liquidated, and their ensuing restructuring or liquidation.

2. Improving efficiency of remaining banks – the reforms primarily directed at banking capitalization and consolidation (mergers), so that the newly emerged and stronger financial institutions could effectively perform their functions. This would require effective banking supervision, as well as much work on improving the legislative basis, increasing bank transparency, improving management and enforcing contracts.

The first stage appears to be nearly complete now. The Central Bank has put considerable effort into examining existing banks, and was very firm about withdrawing licenses – the number of banks in Russia declined substantially – and also about restructuring insolvent banks.

Certain work toward the restructuring of insolvent banks is done by the Agency for Restructuring of Credit Organizations (ARCO), created in January 1999. Still, ARCO's problems include its desperate lack of financing and inability to operate independently.

As a result, Russia now has a banking system that is, in general, much healthier than the one that existed before. And now it is essential to make the new, improved sector develop further and work more efficiently. And this relates to the second "category" of reforms, defined above.

Clearly, the second is more complicated, and obviously more time-consuming. Despite certain improvements, major problems in the banking sector remain. However, the starting conditions for reforms are at present very favorable. The exchange rate policy of the Central Bank has kept the ruble from appreciating too fast in real terms, and has enabled Russia to preserve strong external accounts and protect domestic producers, leading to higher growth, much improved financial status of domestic enterprises, and growth in personal incomes – all of which has contributed to measures aimed at improving Russia's banking system.

First of all, this attracts capital to the sector. This is a fundamental goal which, broadly speaking, depends on the successful implementation of the following items (some of which have already begun):

• Maintaining the overall solvency of the banking system. Substantial efforts have been made here already. Improvements in banking supervision have been noticed: for example, evaluation of the true financial status of operating banks and estimation of associated risk.

• Closely related to effective banking supervision is the issue of balance sheet transparency. The planned transition to international accounting standards (IAS) is essential for this goal to be achieved, and preliminary activity toward adopting IAS has already begun. The transition, however, will inevitably lead to solvency and capitalization problems, so a very delicate issue will become regulation of capital adequacy standards – i.e. rates for obligatory deposits, capital structure and other norms.

• Improvement in bank management, appropriate risk exposure evaluation, and introduction of personal responsibility for losses – currently all topics widely discussed and very important for the successful development of the sector.

• And last but not least, creating the appropriate legal basis for the reforms. Amending existing banking laws and legislation on restructuring and bankruptcy of financial institutions. The sector also needs legal support for everyday banking activity (i.e. legislation regulating syndicated loans and contract enforcement). Though some work has been attempted here, unfortunately the process is not going as fast as it could.

Second, progress on restoring (popular trust – that of households) – to the banking system. A system of governmental guarantees for the individual deposits is now being discussed. In fact, introducing a guarantee system in Russia could help increase savings held in banks. Besides, governmental guarantees on demand deposits, for example, could also become an effective tool to prevent banking crises in the event of emergency situations.

Finally, we would like to emphasize that the substantial improvement in the settlement system (Inter-regional electronic settlement system), set up by the Central Bank, and the planned transition to settlement-in-real-time represent important progress for Russia's banking sector. This is true not only from the point of view of efficiency and convenience, but also with respect to improvements in account management and banking supervision.

To conclude, we would like to say that the banking reform strategy is rather comprehensive, and its successful implementation depends not only on the Central Bank. Macroeconomic stability remains a vital factor. Though we hope that the economy will continue to grow, no one can predict with 100 percent certainty how long the growth will continue. Still, it is important not to postpone or delay. What we have today, as a result of the achievements of 2000, is a good start, and the current opportunity must not be missed.