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Russian Banking FRBSF WEEKLY LETTER Number 95-35, Odober 20, 1995 Russian Banking On the last day of 1991 the Soviet Union van­ (notably Sberbank) the government retained ished, and the various countries of the former some degree of control. What remained of the USSR accelerated their ongoing political and old Gosbank within Russia became the new economic transformation. One result is that Central Bank of the Russian Federation (or CBR). the title of this Weekly Letter is no longer an oxymoron. Indeed, the Russian banking system Industry structure stands out among sectors of the Russian econ­ Establishment of new banks has been rapid; there omy for its high degree of privatization, its are now more than 2500 commercial banks in market orientation, and its rapid adoption of Russia. Sberbank is in a category by itself; its Western technology and management methods. branch network is immense (roughly 30,000 of­ fices, compared to about 5500 for the rest of But partly because of its rapid development, the the banking system), and it is by far the largest Russian banking sector is fragile. This point was holder of personal deposits. The rest of the Rus­ emphasized during August 1995 when the Rus­ sian commercial banking industry divides into sian interbank credit and payments system froze, three segments. One segment arose early in the precipitating calls for central bank intervention transition process: Large industrial enterprises, and government action. This Letter describes the needing a mechanism to make and receive pay­ emergence of a private banking system in Russia, ments and needing access to credit, established provides insight into banking's current state, and their own banks. Since these banks are owned discusses the critical issues Russian banking still and controlled by their one major customer, they faces. are like treasury departments of the associated industrial firms. A second segment of the indus­ A brief history try sprang up when the specialized arms of the During the Soviet era the Russian banking sys­ former Gosbank were privatized. Many regional tem, such as it was, consisted of branches of the branches of the specialized banks have them­ central bank (the Gosbank), and functioned pri­ selves become independent commercial banks, marily as an accounting network for the annual about 750 in all. The third segment of the indus­ central viano Credits were transferred on the try consists of a large number of completely new books of the Gosbank to account for flows of commercial banks, some quite small, including physical production and inputs between state­ many of the most progressive. It is hard to get owned enterprises. Firms paid wages in cash precise figures on the various types of banks, but provided by the Gosbank; workers paid cash for this third segment probably accounts for about purchases and deposited the excess "under the two-thirds of the total number. mattress" or in the Gosbank's savings bank sec­ tion, called Sberbank. In 1987, under perestroika, A small number of U.S. and other foreign banks the Gosbank was split into several specialized now operate in Russia, although primarily to banks for different sectors of the economy, with service their existing international clients. In the each bank still centrally controlled. Beginning in other direction, Russian banks are just starting 1988, a few commercial banks began operating, to apply for entry into U.S. banking markets. although their legal foundation remained vague. Supervision and regulation Formal banking legislation was passed in late A new central banking law, signed by President 1990, and a licensing and regulatory process Yeltsin in April 1995, specifies the duties of the was put in place. After the breakup of the Soviet CBR as Russia's bank supervisor. The CBR li­ Union, the former specialized banks were par­ censes new banks, supervises existing banks, tially or totally privatized through the issuance and can impose penalties or revoke banking of shares to the public, although in some cases licenses when appropriate. FRBSF The CBR has been criticized as lax in its efforts the U.S., and (outside of Sberbank) most are busi­ to close troubled banks; many poorly capitalized ness deposits; in fact, the new Central Bank Law and even insolvent banks remain open. Follow­ requires that total personal deposits not exceed a ing some clarification of the CBR's powers, the bank's own capital. pace of closures has increased: 65 banks were dosed in 1994, and an additional 71 during the Banks are heavily involved in foreign currency first six months of 1995. However, some observ­ dealings, both as brokers to earn fees, and as ers believe that many more Russian banks are traders to attempt to earn speculative profits insolvent. Part of the problem is simply know- from exchange rate movements. They also pro­ ing which banks are the bad ones. The CBR has vide payments services for business enterprises, been hiring and training examiners, or inspectors although there are no checking accounts in Rus­ as they are called in Russia, but real competency sia. Russian enterprises use third party transfers, will come only with time. carried out by commercial banks, to make inter­ firm payments. It takes an inordinate amount of Russian banks must meet various regulatory time to clear these transfers, although new pri­ standards: liquid liabilities cannot exceed liquid vate and central bank electronic clearing systems assets, large credit exposures cannot exceed 25 now are being introduced. percent of a bank's capital, and loans to share­ holders of the bank cannot exceed 20 percent of Beyond these activities, banks are active in­ capital. Currently, banks must have capital of at vestors in real estate and nonbank securities, least 1 million ECU (roughly $800,000 at current including common shares. Thus, Russian banks exchange rates); recent increases in this mini­ are j'universal banks," with powers more like mum should help weed out some of the worst those of European banks than those of u.s. banks, and the requirement is due to rise further, banks. Until recently a certain amount of cen­ to 5 million ECU by 1999. In addition, the CBR trally directed credit also flowed through the measures capital adequacy using standards simi­ banking system, primarily to former state-owned lar to those developed by the Bank for Interna­ enterprises, and banks earned a fixed spread for tional Settlements; a bank's equity must equal at acting as the conduit. However, such credit pro­ least 4 percent of its risk-weighted assets, rising grams appear to have ceased. to 8 percent by 1999. Crisis and aftermath Russia has no formal deposit insurance system. The August 1995 paralysis of the banking system The Russian Federation explicitly guarantees de­ was caused largely by the practices of Russian posits in the Sberbank. Deposits in other com­ bankers, likely aggravated by a change in mone­ mercial banks have been uninsured since the tary policy in early 1995. Previously, monetary discontinuation of a guarantee fund maintained policy had a "stop-go" character, with slow by the CBR, although several versions of a de­ monetary growth and low inflation during the posit insurance act have drifted through parts of first half of each year, followed by rapid mone­ the Russian legislative system. tary growth and high inflation in the second half. Annual inflation rates in excess of 1000 percent The business of banking in Russia had two effects on banking. One was that credit The activities of an institution call a "bank" in analysis was not emphasized: the real value of Russia differ from those of a typical U.S. bank. loans became so small so fast that principal re­ Intermediation, or the transformation of deposits payment was irrelevant, as long as borrowers into loans, is much less important. A sizable part continued to pay interest. The second effect of of the lending Russian banks do is to each other: rapid inflation was that banks with foreign ex­ ~over 25 percent of aggregate bank assets are change licenses profited by positioning against plowed into the interbank market. Loans to non­ the ruble, betting correctly that the currency bank customers have increased recently, to about would depreciate against foreign currencies. 45 percent of total bank assets, but are still far less than the 60 percent figure typical for the u.s. But significant monetary tightening was intro­ These loans predominantlyfinance inventories duced in early 1995. Banks' reserve requirements and receivables, and are very short term; loans went up and money growth slowed; annualized for capital investment or housing are virtually inflation fell from 700 percent in January to 70 nonexistent. Deposits amount to only 35 percent percent in August, and the ruble began to ap­ of assets on average, compared to 60 percent in preciate on exchange markets. As welcome as these developments were to the Russian econ­ nancial infrastructure" that would let its banks omy, many banks suffered. Previously profitable provide credit effectively. One problem is infor­ foreign currency positions became losers, higher mation: unreliable or false financial information required reserves meant forgone interest, and raises the risks facing lenders and obstructs the default by marginal borrowers became likely as flow of capital through the banking system. A loan principal no longer was trivialized by infla­ second, perhaps more significant problem is con­ tion. With no sign of the usual monetary policy tract enforcement. Property rights are ill-defined, reversal, suspicions grew that the condition of the legal status of collateral is unclear, and Russia some banks was tenuous. A lack of truthful, pub­ still does not have laws governing such things as licly available financial information made it the order of claims in bankruptcies.
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