With President Vladimir Putin demanding the government spur economic growth, banking reform has taken on new momentum.
Although Russia has enjoyed three years of economic growth since the collapse of the financial system in 1998, the underdeveloped banking sector may already be slowing growth, Central Bank head Sergei Ignatyev said at the 11th annual International Banking Congress in St. Petersburg earlier this month.
Further economic growth depends on investment -- and that depends on a system that can move accumulated cash to areas that need it, as Putin said in his state of the nation address in April.
"A very important factor in economic development is an effective banking system," Putin told the parliament. "We must overcome the lag in bank reform, strengthen supervision, ensure transparency in banking activities, take steps to increase capitalization."
Putin has called for growth of 8 percent to 10 percent per year to close the gap between Russia and even the least of the developed countries. Economic growth rates, however, have slowed from 9 percent in 2000 to 5 percent in 2001 and are expected to hit a respectable but insufficient 4 percent in 2002.
Banking reform began moving up the government's list of priorities last summer, although the government and the Central Bank -- under previous head Viktor Gerashchenko -- agreed on a strategy outline only in December. Since then, however, a new, more cooperative team has been installed at the Central Bank, and the newcomers have shifted the focus from stabilizing the sector, which had been Gerashchenko's goal, to giving it a shot in the arm.
The new team has come out of the gate strongly. At the recent St. Petersburg banking congress, two months after his appointment, Andrei Kozlov, first deputy chairman of the bank, set a three-year deadline to modernize the sector. His program, which focused on improving the Central Bank's supervision and boosting bank quality and profitability, fleshed out and supplemented the government and the Central Bank's joint banking strategy.
Economic growth is strongly dependent on capital investment, and one of the largest sources is the roughly $20 billion per year that flees abroad, according to the World Bank's recent economic report on Russia.
Capital flight has slowed and money has been returning. At last week's meetings in Halifax, Canada, between the finance ministers of the Group of Seven leading industrialized nations and Russia, Finance Minister Alexei Kudrin, who is also Deputy Prime Minister, stressed the importance of reduced capital flight for the development of the economy and its integration into the world economy.
Cyprus, a tax haven for both domestic and foreign companies operating here, is now the country's third-largest foreign investor after Germany and the United States. As of April 1, Cyprus had invested a total of $4.55 billion, most of it over the past four years, according to the Economic Development and Trade Ministry.
"The precondition to growth is to get that capital back here, and a much better system is needed to handle inflows," said Christof R?hl, chief economist of the World Bank's Russia office. "Without capital returning and staying at home, growth rates like Putin wants won't happen."
A healthy banking system is necessary not only to absorb returning capital but also to move it efficiently to areas that need it. In particular, funds need to be made available to new small and medium-sized businesses, which spur growth through the creation of new production and new jobs, R?hl said.
Kozlov has blamed so-called pocket banks affiliated with major natural resources companies for moving resources offshore and for slowing the flow of capital into other areas of the economy.
"Looked at from the micro point of view, resource banks are defending the interests of their owners," said Richard Hainsworth, CEO of bank rating agency RusRating and banking analyst at Renaissance Capital. "Looked at from the macro point of view, the behavior of the resource banks is not conducive to growth of the national economy. The real issue for the Central Bank is to create conditions so that interests of resource bank owners and the growth of the economy are aligned. And that is also something Kozlov has recognized. He has stated that banking should be profitable."
With the banking sector on everyone's lips, the World Bank recently weighed in with a hefty 300-page tome, presented to the Central Bank and top executives of major banks, including retail monopolist Sberbank, on June 4.
The book focuses on how to build trust: both banks' trust in borrowers and clients' trust in banks.
For banks, a crucial issue is improving and enforcing property rights and bankruptcy procedures, which depend on judicial reforms. For clients, banks must become more transparent and reliable, which in the short-term depends largely on Central Bank supervision.
The Central Bank has targeted supervision as a top priority for the short-term.
The bank's new team has agreed to take one step that Gerashchenko had resisted: divesting its stakes in the commercial banks it is supposed to regulate. The Central Bank's stakes in the country's two largest banks -- 99 percent of Vneshtorgbank and 64 percent of Sberbank -- have raised conflict-of-interests issues given its role as watchdog.
The government is planning to offer to the Central Bank government bonds worth more than 42 billion rubles ($1.34 billion) with annual yield of 6 percent for a 99 percent share in Vneshtorgbank, Interfax reported a government source as saying earlier this month. No deadline has yet been set for the Central Bank to divest its majority stake in Sberbank.
"Privatizing Sberbank would only replace a public monopoly with a private monopoly. But the Central Bank has to be moved out," R?hl said.
Kozlov said the Central Bank will try to streamline the technical aspects of supervision, to reduce the burden on banks. At the same time, he wants to move the Central Bank toward more subjective assessment of banks, including their capital structure, risk profile, quality of management and financial viability. The Central Bank may now look only at current and past financial statements, and can take action only when capital adequacy falls below 2 percent -- at a stage that usually signals a bank is failing.
"Central Bank authorities are now looking at the float, which only hints what the fish is doing, but to find out more they have to look into the deep water," said Mikhail Matovnikov, deputy director general with Interfax Rating Agency. "The Central Bank should intervene not only when a bank is collapsing but when it begins to increase its risk. Regulatory ratios are easily manipulated and often start to show problems only when the bank is bust, so intervention is late."
One of the most fundamental issues is to properly assess the quality of banks' assets and to make the necessary reserves, Matovnikov said. Nearly 75 percent of banks have increased their assets in the past year. Total banking assests exceed pre-crisis levels by almost 7 percent but are still only 35 percent of gross domestic product, according to the Central Bank.
Improved supervision -- and analysis of risk -- is essential for another of the Central Bank's priorities: deposit insurance. Deposit insurance is seen as a partial solution to Sberbank's monopoly on deposits. But it could be fraught with the moral hazards of banks taking unreasonable risks, knowing deposits are insured.
The Central Bank plans to implement strict criteria for banks that wish to participate. The criteria, which are to be written into the deposit insurance law, will have to be approved by the State Duma.
The levels of insurance have already been decided, according to Deputy Economic Development and Trade Minister Arkady Dvorkovich. Deposits up to 20,000 rubles ($637) will be covered 100 percent and deposits from 20,000 rubles to 120,000 rubles -- 75 percent. The highest possible payout would be 95,000 rubles ($3,025).
The Central Bank is expected to have the legal framework ready for the autumn Duma session and to announce the criteria for banks to join the system by the end of 2002. Deposit insurance is to be voluntary until 2004, during which time the Central Bank intends to grant new retail licenses while scrutinizing banks' compliance with the established criteria. In 2005, the Central Bank plans to revoke retail licenses of any banks not participating in the system.
"Kozlov's scheme appears to be a reasonable compromise between severity and getting the scheme in place as soon as possible," Hainsworth said.
Deposit insurance will only go part of the way toward smoothing out the distortions in the sector where Sberbank holds more than 70 percent of all retail deposits and provides almost 32 percent of all corporate loans.
Sberbank distorts the market because it offers higher interest rates on deposits and lower interest rates on loans than other commercial banks, Hainsworth said.
"Distortions have to be eliminated if the government is serious about a functioning banking system and increased financial intermediation, which is needed for economic growth," R?hl said. "But the monopoly can't be broken only by deposit insurance."
One solution may be the introduction of narrow banking for Sberbank, said R?hl. This would mean restricting Sberbank's lending to "safe" instruments -- such as government bonds or the interbank market, if restricted to banks that qualify for deposit insurance.
"This would give other banks a chance to participate in Sberbank's huge deposit base, it would diminish the interest rate differential between Sberbank loans and other banks' commercial loans and it could introduce a measure of caution to Sberbank lending," R?hl said. In addition, he said, the boost given to qualified banks could encourage consolidation.
Not all analysts agreed that Sberbank needs to be changed.
"All banks complain that Sberbank is strangling them," Matovnikov said. "But what does a normal commericial bank do in such a case? It looks for possible mergers, to create a comparable bank. Why don't our banks merge? Because they were not created to perform commercial activities, they were formed to provide loans to their owners. Practice has shown that until the conditions are right, no outside measures will help."
Overall, banking reform has picked up pace in the right direction, analysts said.
"Kozlov's reforms are fulfilling the desires and recommendations of many banking specialists, both Russian and foreign," said Hainsworth. "The problem is that vested interests in the economy have made it difficult for reforms to take place. The question is whether they'll prevent Kozlov from carrying out his reforms. On the other side of the coin ... it is likely he accepted his post on the condition that he would be able to put through a series of reforms."
With Putin voicing support for banking reform, it seems unlikely he would remove a strongly reformist vice chairman before the reforms are in place, Hainsworth said.
Although Russia has enjoyed three years of economic growth since the collapse of the financial system in 1998, the underdeveloped banking sector may already be slowing growth, Central Bank head Sergei Ignatyev said at the 11th annual International Banking Congress in St. Petersburg earlier this month.
Further economic growth depends on investment -- and that depends on a system that can move accumulated cash to areas that need it, as Putin said in his state of the nation address in April.
"A very important factor in economic development is an effective banking system," Putin told the parliament. "We must overcome the lag in bank reform, strengthen supervision, ensure transparency in banking activities, take steps to increase capitalization."
Putin has called for growth of 8 percent to 10 percent per year to close the gap between Russia and even the least of the developed countries. Economic growth rates, however, have slowed from 9 percent in 2000 to 5 percent in 2001 and are expected to hit a respectable but insufficient 4 percent in 2002.
Banking reform began moving up the government's list of priorities last summer, although the government and the Central Bank -- under previous head Viktor Gerashchenko -- agreed on a strategy outline only in December. Since then, however, a new, more cooperative team has been installed at the Central Bank, and the newcomers have shifted the focus from stabilizing the sector, which had been Gerashchenko's goal, to giving it a shot in the arm.
The new team has come out of the gate strongly. At the recent St. Petersburg banking congress, two months after his appointment, Andrei Kozlov, first deputy chairman of the bank, set a three-year deadline to modernize the sector. His program, which focused on improving the Central Bank's supervision and boosting bank quality and profitability, fleshed out and supplemented the government and the Central Bank's joint banking strategy.
Economic growth is strongly dependent on capital investment, and one of the largest sources is the roughly $20 billion per year that flees abroad, according to the World Bank's recent economic report on Russia.
Capital flight has slowed and money has been returning. At last week's meetings in Halifax, Canada, between the finance ministers of the Group of Seven leading industrialized nations and Russia, Finance Minister Alexei Kudrin, who is also Deputy Prime Minister, stressed the importance of reduced capital flight for the development of the economy and its integration into the world economy.
Cyprus, a tax haven for both domestic and foreign companies operating here, is now the country's third-largest foreign investor after Germany and the United States. As of April 1, Cyprus had invested a total of $4.55 billion, most of it over the past four years, according to the Economic Development and Trade Ministry.
"The precondition to growth is to get that capital back here, and a much better system is needed to handle inflows," said Christof R?hl, chief economist of the World Bank's Russia office. "Without capital returning and staying at home, growth rates like Putin wants won't happen."
A healthy banking system is necessary not only to absorb returning capital but also to move it efficiently to areas that need it. In particular, funds need to be made available to new small and medium-sized businesses, which spur growth through the creation of new production and new jobs, R?hl said.
Kozlov has blamed so-called pocket banks affiliated with major natural resources companies for moving resources offshore and for slowing the flow of capital into other areas of the economy.
"Looked at from the micro point of view, resource banks are defending the interests of their owners," said Richard Hainsworth, CEO of bank rating agency RusRating and banking analyst at Renaissance Capital. "Looked at from the macro point of view, the behavior of the resource banks is not conducive to growth of the national economy. The real issue for the Central Bank is to create conditions so that interests of resource bank owners and the growth of the economy are aligned. And that is also something Kozlov has recognized. He has stated that banking should be profitable."
With the banking sector on everyone's lips, the World Bank recently weighed in with a hefty 300-page tome, presented to the Central Bank and top executives of major banks, including retail monopolist Sberbank, on June 4.
The book focuses on how to build trust: both banks' trust in borrowers and clients' trust in banks.
For banks, a crucial issue is improving and enforcing property rights and bankruptcy procedures, which depend on judicial reforms. For clients, banks must become more transparent and reliable, which in the short-term depends largely on Central Bank supervision.
The Central Bank has targeted supervision as a top priority for the short-term.
The bank's new team has agreed to take one step that Gerashchenko had resisted: divesting its stakes in the commercial banks it is supposed to regulate. The Central Bank's stakes in the country's two largest banks -- 99 percent of Vneshtorgbank and 64 percent of Sberbank -- have raised conflict-of-interests issues given its role as watchdog.
The government is planning to offer to the Central Bank government bonds worth more than 42 billion rubles ($1.34 billion) with annual yield of 6 percent for a 99 percent share in Vneshtorgbank, Interfax reported a government source as saying earlier this month. No deadline has yet been set for the Central Bank to divest its majority stake in Sberbank.
Bank Sector Indicators Compared to July 1, 1998 | |||
| July 1, 1998 | April 1, 1999 | April 1, 2002 | |
| Total bank assets | 100% | 58.3% | 106.8% |
| Assets as % of GDP | 30.1% | 41.1% | 35.3% |
| Total bank capital | 100% | 26.8% | 114.7% |
| Capital as % of GDP | 4.6% | 2.1% | 5.1% |
| Loans to the real sector, including past due loans | 100% | 57.1% | 147.1% |
| Loans as % of GDP | 8.5% | 12.2% | 13.5% |
| Retail deposits | 100% | 47.7% | 96.5% |
| Retail deposits as % of GDP | 25.2% | 17.9% | 14.5% |
| Corporate deposits | 100% | 84.3% | 148.3% |
| Corporate deposits as % of GDP | 5.8% | 11.3% | 9.4% |
| Source: Central Bank | |||
"Privatizing Sberbank would only replace a public monopoly with a private monopoly. But the Central Bank has to be moved out," R?hl said.
Kozlov said the Central Bank will try to streamline the technical aspects of supervision, to reduce the burden on banks. At the same time, he wants to move the Central Bank toward more subjective assessment of banks, including their capital structure, risk profile, quality of management and financial viability. The Central Bank may now look only at current and past financial statements, and can take action only when capital adequacy falls below 2 percent -- at a stage that usually signals a bank is failing.
"Central Bank authorities are now looking at the float, which only hints what the fish is doing, but to find out more they have to look into the deep water," said Mikhail Matovnikov, deputy director general with Interfax Rating Agency. "The Central Bank should intervene not only when a bank is collapsing but when it begins to increase its risk. Regulatory ratios are easily manipulated and often start to show problems only when the bank is bust, so intervention is late."
One of the most fundamental issues is to properly assess the quality of banks' assets and to make the necessary reserves, Matovnikov said. Nearly 75 percent of banks have increased their assets in the past year. Total banking assests exceed pre-crisis levels by almost 7 percent but are still only 35 percent of gross domestic product, according to the Central Bank.
Improved supervision -- and analysis of risk -- is essential for another of the Central Bank's priorities: deposit insurance. Deposit insurance is seen as a partial solution to Sberbank's monopoly on deposits. But it could be fraught with the moral hazards of banks taking unreasonable risks, knowing deposits are insured.
The Central Bank plans to implement strict criteria for banks that wish to participate. The criteria, which are to be written into the deposit insurance law, will have to be approved by the State Duma.
The levels of insurance have already been decided, according to Deputy Economic Development and Trade Minister Arkady Dvorkovich. Deposits up to 20,000 rubles ($637) will be covered 100 percent and deposits from 20,000 rubles to 120,000 rubles -- 75 percent. The highest possible payout would be 95,000 rubles ($3,025).
The Central Bank is expected to have the legal framework ready for the autumn Duma session and to announce the criteria for banks to join the system by the end of 2002. Deposit insurance is to be voluntary until 2004, during which time the Central Bank intends to grant new retail licenses while scrutinizing banks' compliance with the established criteria. In 2005, the Central Bank plans to revoke retail licenses of any banks not participating in the system.
"Kozlov's scheme appears to be a reasonable compromise between severity and getting the scheme in place as soon as possible," Hainsworth said.
Deposit insurance will only go part of the way toward smoothing out the distortions in the sector where Sberbank holds more than 70 percent of all retail deposits and provides almost 32 percent of all corporate loans.
 |  |
Sberbank distorts the market because it offers higher interest rates on deposits and lower interest rates on loans than other commercial banks, Hainsworth said.
"Distortions have to be eliminated if the government is serious about a functioning banking system and increased financial intermediation, which is needed for economic growth," R?hl said. "But the monopoly can't be broken only by deposit insurance."
One solution may be the introduction of narrow banking for Sberbank, said R?hl. This would mean restricting Sberbank's lending to "safe" instruments -- such as government bonds or the interbank market, if restricted to banks that qualify for deposit insurance.
"This would give other banks a chance to participate in Sberbank's huge deposit base, it would diminish the interest rate differential between Sberbank loans and other banks' commercial loans and it could introduce a measure of caution to Sberbank lending," R?hl said. In addition, he said, the boost given to qualified banks could encourage consolidation.
Not all analysts agreed that Sberbank needs to be changed.
"All banks complain that Sberbank is strangling them," Matovnikov said. "But what does a normal commericial bank do in such a case? It looks for possible mergers, to create a comparable bank. Why don't our banks merge? Because they were not created to perform commercial activities, they were formed to provide loans to their owners. Practice has shown that until the conditions are right, no outside measures will help."
Overall, banking reform has picked up pace in the right direction, analysts said.
"Kozlov's reforms are fulfilling the desires and recommendations of many banking specialists, both Russian and foreign," said Hainsworth. "The problem is that vested interests in the economy have made it difficult for reforms to take place. The question is whether they'll prevent Kozlov from carrying out his reforms. On the other side of the coin ... it is likely he accepted his post on the condition that he would be able to put through a series of reforms."
With Putin voicing support for banking reform, it seems unlikely he would remove a strongly reformist vice chairman before the reforms are in place, Hainsworth said.
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