Russian Banking System: Crisis and Prospects for Development
(summary)*
Intensive development of the Russian banking system, which have been observed in last decade, was defined by the transition from centrally planed to a market economy. Within the comparatively short time the two-level banking system have been constructed. During the first stage 1988-1993 banking sector rapid development was due to banking services' deficit, redistribution of the centralized loans, high inflation and low costs of liabilities. 2 500 commercial banks were created during that period.
Russian financial markets development, mainly government bonds market, provided some changes in banking sector. Liabilities became more important so it was a great competition for clients between Russian banks. Tariffs for banking services were near zero, interest rate policy was very aggressive. Significant growth of accumulated capital was provided by high real yield of return on state bonds and real exchange rate appreciation.
As a result of Russia's financial crisis, commercial banks incurred significant losses. As for the assets, commercial banks' losses were as follows:
- russian banks' GKO/OFZ investments, which amounted to 110 to 120 billion rubles, were frozen for indefinite time. Than means that 17% of banks' liquid assets immediately turned into overdue debts. As of August 17, for instance, Sberbank's government securities investments amounted to between 78 and 85 billion rubles, while other commercial banks' investments in government securities amounted to 33-34.5 billion rubles;
- only a few local governments could fulfill their obligations after August 17, banks' investments in municipal bonds, which amounted to 6.2 - 6.3 billion rubles, also turned into illiquid assets;
- banks' overdue loans to the companies, other banks' and local governments increased in August - September by 23.2 billion rubles.
Fund withdrawal from the banking system (or a decrease in banks' liabilities) was as follows:
- enterprises' ruble deposits in the Russian banks decreased by 5 billion rubles in August 1998;
- enterprises' foreign-currency deposits in the Russian banks decreased by 7.8 billion rubles ($1.3 billion) in August 1998;
- households' ruble deposits in Russian banks decreased by 17.5 billion rubles in June through December 1998, with ruble deposits in the Russian Federation Savings Bank (Sberbank) decreasing by 1.1 billion rubles and ruble deposits in other commercial banks decreasing by 16.4 billion rubles;
- households' foreign-currency deposits in Russian banks decreased by 23.4 billion rubles ($3 billion), with foreign-currency deposits in the Russian Federation Savings Bank (Sberbank) decreasing by a billion dollars and foreign-currency deposits in other commercial banks decreasing by $2 billion.
As a result, banks' total assets, which amounted to 1.1 trillion rubles at the beginning of August, decreased by 140 to 150 billion rubles (or 12.5% to 13.5%) during one day on August 17. Banks' net assets, which amounted to about 700 billion rubles on August 1, decreased by 20% to 21.5% to between 550 and 560 billion rubles.
The amounts of funds needed to restore Russian banking system in view of its losses may be different, depending on the goals pursued. The required sums on January 1, 1999 may amount to:
- $70 billion (or 1.45 trillion rubles at the exchange rate 20.65 RUB/USD on January 1, 1999) will be needed for the restoration of the banking system's assets in dollar terms;
- $15 billion (or 310 billion rubles at the exchange rate 20.65 RUB/USD) will be needed for the restoration of the banking system's assets in dollar terms;
- 76.6 billion rubles will be needed to compensate banks for losses incurred as a result of the freezing of government securities (funds invested in GKOs and OFZs as of January 1, 1999);
- 135 billion rubles will be needed to compensate banks for illiquid assets (overdue loans, GKO/OFZ and municipal bond investments);
- 40 billion rubles will be needed to repay bank deposits that are not matched by assets (illiquid assets excluded);
- 33.3 billion rubles will be needed to compensate Russian banks (Sberbank excluded) for losses as of January 1, 1999. With Sberbank taken into account, 18.5 billion rubles will be needed for this purpose.
Reform of the Russian banking system can be carried out in accordance with three basic approaches (scenarios). However, it is obvious that the future development will actually be taken can contain elements of the three basis approaches. The shape of the Russian new banking system will very much depend on a balance between the approaches, described below, that the monetary authorities will choose.
First - banks overcome the crisis independently. It is obvious that the restoration of Russia's banking system will take much time. However, some banks realize an aggressive strategy to attract new clients, provide cash flows and improve liquidity. Others, mainly large commercial banks simply open new banks. All the "bad" assets and liabilities are left in the old bank, while a new bank is opened to provide cash and settlement services to large corporate clients. Non-performing assets (government and municipal bonds that will be restructured) and frozen liabilities (legal entities' and private individuals' deposits) will be kept at the old bank until restructuring of government securities is completed, while some of households' deposits will be transferred to the Russian Federation Savings Bank (Sberbank).
These strategies can be applied more or less successfully only if the bank has a zero- or insignificant foreign-currency position and large corporate clients. The ruble's collapse (it should be remembered, that the exchange rate grew by 250% in Russia in 1998, while Russia's 1998 inflation amounted to 84.4%) devalued bank assets and created problems impeding the repayment of syndicated loans. Large banks with significant deposit liabilities to individual account holders and significant investments in government securities have practically no chances to resolve their problems independently.
Second - the government support of the banking system. Since the beginning of the banking crisis, the monetary authorities have unveiled several stabilization plans for the Russian banking system, but have taken no actions. This is due to the following reasons:
- lack of the government's macroeconomic-stabilization plan and medium-term economic program;
- under the present conditions, stabilization of the banking system will only increase the financial instability in Russia.
The last statement requires some explanations. Normalization of the bank transfers required the issue of a significant amount of money. The settlement of mutual debts was carried out and the obligatory reserve fund was used for the purpose. Also, a number of the banks received large stabilization loans from the Central Bank.
The transfer of individual clients' deposit accounts from failing banks to the Russian Federation Savings Bank (Sberbank) means that the monetary authorities have assumed an obligation to repay deposits even if depositors lose part of their funds. No wonder, that ordinary Russians, who mistrust both the government and the banking system, will immediately try to withdraw their deposits. The cash received will be immediately transferred to the consumer and foreign-exchange markets. This will cause an increase in Russia's prices and the ruble's rate.
Russian commercial banks also have significant foreign liabilities. When providing stabilization loans to such banks, the Central Bank must understand that some parts of the ruble funds provided will be converted into foreign currency. This will increase pressure on the exchange rate. If the government increases its stakes in some banks, it will also assume liabilities to foreign creditors.
It should be pointed out that the type of collateral and the interest rates will be of much importance when the Central Bank provides loans to commercial banks. If the Central Bank provides loans against GKOs and OFZs used as collateral, it will actually mean the pre-schedule redemption of government securities. The Central Bank's loan provided at the interest rate equal to the refinancing rate (60%) means that, under current market conditions, a particular bank is attracting resources at any cost. So, its chances for the revival are small.
The monetary authorities' participation in the restoration of the banking system will have some positive consequences, including the following:
- control over cash flows. The government's and the Central Bank's acquisition of larger stakes in the large commercial banks will make it possible to increase lending to the real sector;
- more stable behavior of the financial markets as a result of a decreasing presence of speculative capital;
- reduction of capital outflow from Russia as a result of the tightening government control;
- attraction of funds to finance budget deficit through the sale of low-yield government securities.
Third - growing foreign presence in the Russian banking sector. Foreign bank's experience in Russia is painful. First, foreign investment banks incurred huge losses as a result of the restructuring of GKOs and OFZs, while the problem of the repatriation of funds they still have is not yet resolved. Russian foreign-currency denominated bonds (MinFins, Eurobonds and etc.) are high-risk investments because Russia may still default on them. Foreign banks' lending to companies, which increased in the mid-1990s, declined again.
In view of this, Russia is hardly an attractive place for most foreign banks. However, in two cases foreign banks may be interested in staying in Russia. First, banks that incurred significant losses and are not yet able to repatriate what they still have will have to stay in Russia if the government and the municipal bonds are exchanged for other government securities or company shares or if profit repatriation is impossible. Second, banks with strategic interests in Russia may open not only their representative offices in Russia, but also small branches involved in a limited number of operations.
By and large, it can be stated that reform of Russia's banking system has not yet begun. Some banks implement pursue strategies aimed at surviving and winning a larger share of the market for banking services. Others enjoy stabilization loans received from the Central Bank of Russia. Last, some banks are already closed or are on the verge of bankruptcy. The State Agency for the Restructuring of Lending Institutions (ARKO) is not yet functioning. Foreign banks' arrival to Russia is welcomed by the Russian monetary authorities. However, no steps have been made in order to attract them.
Thus, the most probable scenario for 1999 is that no banking reform will begin in Russia. Nationalization of the commercial banks is unlikely due to their significant deposit and foreign liabilities. In view of Russia's continued financial instability, the monetary authorities will be unable to restructure government debt in a way that will inflict minimum losses on investors. They will also be unable to reform Russia's banking system efficiently.
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