Contrary to the predictions of pessimists, Russia's banks have pulled through the last year without a liquidity crisis. That was primarily thanks to favorable developments in the sector of foreign trade.
Strong prices for traditional Russian exports including oil boosted the hard-currency supply into Russia and consequently allowed Russia's banks to accumulate substantial liquidity reserves now sufficient to overcome shocks that may occur in the future.
It is the accumulation of these "oxygen bags" that sector insiders consider the main result of the past year as far as Russian banks are concerned. Unfortunately, no qualitative developments have occurred in the system.
The development of Russia's banking system in the past year can be characterized as basically extensive.
Late 2000 compared to mid-1998 (pre-crisis), the combined total assets of Russia's banks increased 260 percent in ruble terms, which means a 25 percent increase in real terms, but a 20.3 percent reduction in dollar terms. As regards capital, pre-crisis level has not been reached and is currently 38.4 percent less than the pre-crisis figure.
The second half of 1999 and the first quarter of 2000 can be called a period of "recapitalization" of Russia's banking system; but beginning from March 2000, the tempo of capital growth ceased to run ahead of the growth of assets. Therefore, by the end of the last year, capital support of the risky assets, let alone assets as a whole, was below the pre-crisis level.
As of late 1999, the situation in Russia's banking sector was quite apprehensive. Lack of confidence forced the banks to maintain high interest rates on deposits, and the slowing of the liability growth rate portended a classical liquidity crisis.
Fortunately, help arrived in the fall of 1999 – and from where it had not been particularly expected. In September 1999, precisely when domestic sources of liquidity had been virtually exhausted, Russia's balance of foreign trade entered a phase of substantial and steady growth, solving the banks’ inevitable problems and allowing liquid assets above the survival limit to be accumulated.
Simultaneously, the cost of liabilities, after peaking in mid-2000, started declining and fell through the "zero line" (in real terms) by the year's end.
INDUSTRY WINS THE WAR OF INTEREST RATES
Another notable result of the past year was the victory for the so-called "real economy" in its decade-long war against the banking sector. Needless to repeat that during the period of high inflation the banks enjoyed an unfair share of GDP, benefiting from rapid depreciation of financial resources and a huge spread between credit and deposit interest rates.
The end of 2000 saw the breaking point in the "war." The cost of money fell precipitously, undermining the banks, but giving the industries access to cheap financing.
The rapid fall of interest rates on credits in the second half of 2000 was stimulated by the slump of interest rates on deposits and state securities and, to a no lesser extent, by the optimistic expectations of economic growth.
The present level of banking interest rates is based on the assumption that the percentage of bad credits among those issued after the crisis of 1998 will not exceed 5 percent of the total. But if the actual figure exceeds this limit, the banks will have to revise their crediting policy, particularly to increase interest rates. Such a negative development may possibly occur by the middle of this year, especially if the country’s foreign trade balance records a noticeable reduction of its surplus.
There are no reasons to expect any substantial growth in the interest rates on personal deposits, which have plummeted to below the rate of inflation. In a situation where financial resources are overabundant, it is financially inefficient to pay more for attracting money from the population. However, in the longer run, personal deposits are poised to become one of the two basic sources of liability on a par with foreign borrowings.
BEING SMALL IS TOO EXPENSIVE
Another serious problem facing Russia’s banks is related to the so-called factor of size. Most of Russia’s banks simply would not survive in a hypothetical situation where interest rates drop to the level of the United States or Western Europe. The reason basically lies in high operating costs, and the only way to push them down lies through mergers and acquisitions, first of all via expansion into the regions. However, last year saw as few as 11 mergers and acquisitions, with 12 the year before that. Most of them represented acquisitions of small regional banks by bigger ones that turned them into affiliates.
The process seems to have been gaining momentum since late 2000, the most notable examples being the merger of International Bank of Moscow with Kreditanstaldt-Russia; St. Petersburg Promstroibank with Cherepovets Metcombank; and Rosbank with Uneximbank. Besides, MDM-Bank and Conversbank have announced merger intentions.
Mergers between large banks operating on related segments of the market allow dramatic cost reductions, however no statistical data is available at this point to estimate the efficiency of such mergers in Russia.
This year, Russia’s banking system has faced a new problem – the need to adapt to the slowing tempo of industrial growth that had come to a stop in the fall of 2000. Throughout the past year, the percentage of bad debts owed by the industries to the banks tended to decrease, but the past several months have seen a reversal of this trend. It can be forecast with a high degree of certainty that the amount of bad debts will grow. So far, the losses stemming from bad debts have been compensated for by the liquidity reserve, but as these reserves are not infinite a new banking crisis, though not imminent, is becoming increasingly possible.
THE LIVING DEAD
In addition to problems stemming from the economic and financial situation, Russia’s banking system is suffering from what can be called a "structural problem," i.e. the existence of several hundred insolvent banks that have long since been deprived of their licenses but have not been liquidated and conduct a limited scope of operations. What is worse, their operations are not transparent and are out of the Central Bank’s control. As of late 2000, there were three "disabled" banks for every five operational banks in Russia. The "disabled" banks represent an "alternative" and uncontrollable banking system.
In terms of assets, the "phantom" banks accounted for 8.5 percent of Russia’s banking system’s total as of December 31, 2000. This is without the fallen giants – SBS-Agro and Rossiiskiy Kredit – which still hold valid licenses. The combined total of assets of these banks (including SBS-Agro and Rossiiskiy Kredit) equaled 210 billion rubles. For comparison, this is nearly 50 percent of Sberbank’s assets.
During the last year, only 36 banks were deprived of licenses on the grounds of "unsatisfactory financial standing," another 11 banking licenses were cancelled due to mergers and acquisitions and nine new licenses were issued. As a result, the year 2000 showed the smallest reduction in the number of operating banks in the last five years – from 1,349 to 1,311. For comparison, during 1996 the number of operating banks fell by 266 (11.6 percent) and the corresponding figures for 1997, 1998 and 1999 were 332 (16.4 percent), 221 (7.7 percent) and 127 (8.6 percent) respectively.
Incidentally, the crisis of 1998 was less damaging for the banking system than the crisis of 1995. The latter pushed 28 percent of the banks out of the business, while the former caused the sector to shrink by only 16.7 percent.
Although the rate of license deprivation tends to decline, the problem of "phantom" banks continues to aggravate. Surprisingly, as of late 2000, there still existed several banks that were deprived of their licenses as far back as 1993. Sixty percent of the "phantom" banks lost their licenses before 1998.
The problem has nothing to do with the complexity of the liquidation process. Not a single bank of the 30 that lost their licenses during 1993 and 1994 had been a large crediting organization. The problem is rooted in intolerably slow decision-making. Making a decision on a bank’s liquidation takes nine to 10 months, and the process of liquidation takes another two to three years on average. And this is despite the fact that precedents of a bank’s license being reinstated are very rare.
The last three years have not seen a single precedent of a bank being liquidated within one year of its license deprivation date, despite the fact that many of them were very small banks with tiny credit portfolios.
This situation graphically illustrates the backwardness of the Russian financial market’s infrastructure. The absence of a secondary credit market, where bad debts could be sold, holds back the process of liquidating insolvent banks. Besides, external managers are often dishonest, and lots of money is spent on the maintenance of a bank under liquidation. As a result, creditors get only a small portion of their due, and over a very long period of time.
The last year saw a noticeable improvement in the situation: 238 banks were liquidated, which is nearly half of the total number of liquidated banks during the existence of Russia’s banking system. To a certain extent, this was a result of the decisions made by the Central Bank in 1997.
Needless to say, the liquidation of a bank does not automatically resolve the problems of its creditors, and the liquidation procedure currently in use is far from perfect.
The need to perfect and develop the mechanism of bank liquidation is currently more important than that of developing a bank-monitoring system.