Georgy Luntovsky, deputy chairman of the Russian Central Bank, devoted most of his banking career to Promstroybank, a division of the Soviet-era State Bank, where he worked from 1974-91. He was appointed chairman of the board of the Voronezhkreditprombank private bank in 1991, and a year later took up the post of general director of the Voronezh private bank.

In 1995, Luntovsky was elected to the Russian State Duma lower house of parliament where he served as chairman of a banking subcommittee, before being appointed to his present position at the Central Bank last year. The Central Bank is successor to the State Bank, which controlled all banking in the country. During Perestroika, the State Bank was stripped of some of its functions, including customer operations. Under a law adopted in 1990, it was renamed as the Central Bank and started focusing on monetary issues.

Luntovsky talked to The Russia Journal about progress in the banking sector, the Central Bank’s role in reform and amendments to the law governing the Central Bank.

RJ: How would you characterize the banking system in Russia right now?

GL: The banking system is on the road to recovery after the 1998 financial crisis. The number of banks has shrunk [1,318 banks today], but banks are healthier today, at least as compared with 1998. Nine banks in 10 finished the year with a profit.

RJ: That means 10 percent of banks are still loss-making.

GL: Yes, but if you look at industry, only six companies in 10 ended the year with a profit. The situation in the banking sector is better than in the economy as a whole. This is thanks to improvement in lending organizations’ asset quality and to restructuring measures that have been carried out. The task of clearing the banking system of banks in serious financial trouble is almost complete. But there are still problems. We haven’t yet reached pre-crisis levels of capital [85 percent], asset volume [90.4 percent] and household deposits [70 percent].

RJ: Were there too many banks before the crisis?

GL: Yes, but no one’s ever said how many lending organizations we actually need. In developed countries, along with banks you also have savings-and-loans organizations, credit unions and mutual-lending societies. There should be different types of lending organizations. You could say that we got too carried away with setting up commercial banks in the 1990s, and because the capital base was obviously insufficient, small banks were being set up with minimum charter capital and couldn’t develop.

RJ: So, it seems banks acted mostly as cashiers – carrying out monetary settlements and servicing accounts.

GL: I don’t agree. Commercial banks made loans, but they had limited scope for lending. The banking sector’s assets now represent 34 percent of GDP, which is clearly not enough. Loans to the financial sector account for 11.5 percent and the share of money the population puts in the bank comes to 12.2 percent. One of the Central Bank’s and the government’s main tasks is to increase commercial banks’ capitalization and have them merge to form larger banks.

RJ: How can the state and the Central Bank influence this process?

GL: We have stated that mergers, takeovers and consolidation should take place in market conditions. Our job is to simplify the procedures. We can also have an impact through economic rather than administrative means. Limited assets, after all, mean limited opportunities for attracting credit resources, and many banks have hit the point where they need more capital to develop their business.

RJ: So why don’t they just increase their capital?

GL: One problem is that shares in many banks are held either directly or through affiliated individuals by the bank’s management, and it’s not in their interests to increase capital, because they would then either have to buy up part of the shares themselves or see their own stake become watered down.

RJ: Is this a general trend?

GL: It doesn’t happen on a mass scale. Another problem is that interest in banking has cooled off since the crisis. And then there’s the general lack of free investment resources. In this respect, there’s an obvious need to attract foreign capital. At the moment, foreign investment accounts for around 7.5 percent of Russian commercial banks’ charter capital. But this figure is as high as 80 percent for some Central and Eastern European countries. We think it would be a mistake to put restrictions on foreign capital, but at the same time there has to be suitable registration procedure. We have to have information on the origins of capital and be able to check the reputation of this or that investor. We want to keep this procedure but without setting any limits on foreign participation.

RJ: So, at the moment, there are no legal limits on foreign banking capital?

GL: No, the only restrictions are related to high degree of risk, for example, but there are no restrictions from the state.

RJ: Another image of the pre-crisis bank sector was that it was a criminal business. Has it become cleaner?

GL: Talk of the criminal element in banking is exaggerated. I’ve been in banking since 1971 and know what it’s like. I think this was just a campaign to discredit our banking sector. As for capital flight, we didn’t invent anything there. We need at least a few years of political and economic stability and a lot of legislative decisions, including on land and tax issues, before the situation will begin to change.

RJ: Do you really think there was a planned campaign to discredit our banks?

GL: I’m not going to name names, but it was in someone’s interest to discredit the Russian banking system. But interest in banking has waned above all because the banking sector is still re-covering from the crisis. Deposits and investments depend above all on trust and we lost that trust. It’s a long and slow process to win it back.

It will take years for people, clients and depositors to have confidence and come back to the commercial banks. But this process has already begun. Deposits are growing – mostly in Sberbank – and, though not so fast, people are coming back to the commercial banks.

RJ: A law on guarantees for deposits could help here.

GL: Yes, we’re actively working on this, and the president has directly assigned the government to work on it. If we pass the law this year, it would begin working in 2003. This is because there has to be a transition period so that we can work out what to do about banks that already work with household deposits. The proposal, after all, is that there will be specific criteria that banks will have to meet, and some banks will require time to bring themselves into line with the law’s provisions. We have more than 1,200 banks that work with deposits, and to suddenly tell some of them that they don’t meet the new system’s requirements would cause them serious problems. The banks have to have time to prepare.

RJ: So all banks wanting to work with deposits will have to meet these criteria. But what exactly are they?

GL: For us at the Central Bank, what’s important is to fulfill economic regulations. I think there could be higher demands on the size of a bank’s capital for banks working with private deposits. This would increase the shareholders’ responsibility to make the bank work effectively.

RJ: How will the guarantee fund be formed?

GL: We think the state should help set up a minimal reserve. The fund’s initial capital should be 2 billion to 2.5 billion rubles. We hope that the measures we’re taking now will enable us to create a banking sector strong enough to weather any future crises, so that we won’t have to go through all this again. Depositors have been burned more than once, and each time, it takes more effort to win back their trust. The current reforms aren’t just about deposits but also about better banking supervision and more shareholder responsibility, increased transparency of commercial banks and introduction of international accounting and reporting standards. But we must remember that banking reform will be useless unless it goes hand in hand with economic reform. No matter what the state of the banking sector, no bank is going to want to lend to a bankrupt company.

RJ: What’s the current situation with amendments to the law on the Central Bank?

GL: It’s an absurd situation. In essence, it’s a whole new law. In the first reading, the Duma passed amendments that keep within the framework of the current law. But then more than 500 amendments were proposed that change both the spirit of the current law and the amendments passed in the first reading. The current law was passed in 1995 and has proved its worth. It corresponds to the current legal and economic situation in Russia. Any changes to the law must be made carefully and should draw on selective experience abroad. The general trend throughout the world today is to give central banks greater independence.