Title list of updates

RECENT DEVELOPMENTS IN THE RUSSIAN BANKING SECTOR -- OCTOBER 1998

Summary

This report provides information on recent developments in the banking sector in Russia. While the financial crisis unfolds, and more banks are facing bankruptcy, the Russian government is deciding upon steps to save the banking system from a total collapse. Government and expert agencies have provided updated ratings of banks, according to which the prospects for banks' future activity and effectiveness can be judged. Certain information has been provided from local publications and Interfax International News Agency.

Background on the Russian Banking Crisis

Prior to the August 17 Russian Government default on debt obligations, conventional wisdom for businesses operating in Russia was to rely on larger Russian banks, because they could offer more flexibility and a greater range of services, and were usually active on a broader level throughout Russia's regions, beyond Moscow. However, as it has turned out, many of these large banks owned their size to large profits made on heavy investment in Russian Government bonds, or GKOs. When the default was announced, these very banks saw their assets frozen in non-performing loans to the Russian Government, at the same time as previously reliable income from the GKOs ceased altogether. The result has been a nightmare not only for financial speculators, but for any company which (or any company whose suppliers or customers) maintained accounts in the affected banks.

The Central Bank of Russia has offered deposit holders in six large commercial banks which were severely affected by the crisis (Inkombank, Most-bank, Menatep, Mosbusinesbank, Promstroybank and SBS-Agro) the opportunity to transfer their money to Sberbank of Russia (Russian Savings Bank) which guarantees the deposits' safety. As it has turned out, only 10 percent of hard currency accounts and 50 percent of ruble accounts were actually transferred to Sberbank by the deadline in the first half of October. The low percentage of hard currency account transfers can be partially explained by the fact that for this transaction the exchange rate was an artificially high 9.3 rubles per dollar. At the same time, the fact also shows a lack of trust by depositors in the number one state savings bank, and perhaps some depositors' hope that their commercial banks will bounce back, with government backing.

The Central Bank of Russia is considering implementing a similar program of deposit transfers for a number of other large commercial banks (with deposits over R300 million), among them Rossiysky Kredit Bank, Onexim-bank, Avtobank, Vozrozhdeniye (Revival), MFK, Petrovsky, and others. Smaller banks will be left to themselves, either to survive or go bankrupt. About half of Russia's smaller banks are expected to go bankrupt by mid-year 1999.

Increasing foreign banks' share in the Russian banking system and facilitating their partnership with Russian banks is increasingly seen as one way to overcome the crisis and establish a steadier banking system in Russia. In accordance with current Russian regulations, the share of foreign banks in Russia cannot exceed 12 percent of total capital in the Russian banking system. Victor Gerashenko, President of the Central Bank of Russia, stated that this percentage might not be increased any time soon, because the 12 percent threshold has not been met by foreign banks yet (foreign banks' share is estimated by some experts at only 4 percent).

During the week of October 11, Russian Prime Minister Primakov met with the management of 19 of the largest Russian banks, to discuss the current situation in the banking system and the draft program for its restructuring which has been prepared by the Central Bank. In the program, all banks in Russia were divided into four groups of banks according to their current financial situation. The first category includes banks with steady financial situation; the second category includes banks with enough assets but inadequate liquidity; the third group includes insolvent banks with no prospects for continuing banking activity independently. These banks' assets will be offered to foreign banks as a means of paying debts. An Interfax report of October 13, 1998, quoted Mr. Gerashenko as saying that "nobody in the government of Central Bank will oppose exchanging part of the debt (on Treasury bills and other securities) for shares in Russian banks." The fourth group of banks will include the largest insolvent banks deemed "to big to fail", these banks might well receive support from the Central Bank of Russia.

Practical Implications -- Which Banks to Choose?

The key for companies in Russia now is to identify banks which retain enough liquidity to process payments quickly. While many small banks did not fall into the GKO trap, not all of these are large enough or competent enough to adequately service large numbers of new business clients. Russian branches of big Western banks (e.g., ABN-AMRO, Citibank, Chase Manhattan and others) continue to operate due to their greater liquidity; but they usually maintain balance or minimum transaction requirements which make use of their services prohibitive for all but very large corporate clients. As a result, Russian businesses and their foreign partners are scrambling to find alternative payment channels through smaller, less well-known banks, which may have been less-ensnared in the GKO trap.

On October 19, 1998, the popular business magazine PROFILE published ratings of Russian banks (the analysis was conducted by the magazine's experts on the basis of a review of the banks' balances and other factors). Following is PROFILE's list of the 11 most reliable large (assets over 500 mln rubles) Russian banks, as of September 1, 1998: Mestbank (Moscow), Nizhegorodpromstroybank (Nizhny Novgorod Industrial and Construction Bank), Chelindbank (Chelyabinsk), Omskiy Promstroybank (Industrial Bank of Omsk), Zalogbank (Moscow), Devon-Kredit (Al'yemetiyevsk), Slavyansky Bank (Moscow), Promyshlenno-Stroitelny Bank (Industrial and Construction Bank, St. Petersburg), Transkredit (Moscow), Nefteprombank (Moscow), Sobinbank (Moscow).

The following medium-sized and small banks (200-500 mln rubles in assets) were placed among the most reliable banks in the PROFILE rating: Alef-bank (Moscow), Novyi Simvol (Moscow), YUSIBI (Moscow), Sakhadiamondbank (Moscow), Russobank (Moscow), Petroenergobank (St. Petersburg), Mak-bank (Moscow), Transportnyi Investitsionnyi (Moscow), Pyatigorsk (Pyatigorsk), Tandem (Moscow), and Novosibirskvnrshtorgbank.

Another rating was published in the Moscow Times' Business Journal No 6, October 1998. This is the Rating Information Center's Classification of Russian Bank reported by Interfax News Agency. Again, the banks are classified according to their reliability (as of October 1) in the following categories: A3 - Highest Reliability (no records); A2 - Very High Reliability: Sberbank and Vneshtorgbank; A1 - High Reliability: Alfa-Bank, Avtobank, Gazprombank, International Moscow Bank, International Industrial bank, Konversbank and Orgbank. In Category B the banks were classified in the following way: B3 - Adequately High Reliability: Bank of Moscow, Evrofinans, Guta-Bank, Moscow Industrial Bank, Moskomprivatbank, NRB, Probiznesbank and Zhildorbank; B2 - Medium Reliability: Bin, Briko, Etalonbank, Federal Bank for Innovation and Investment, Gagarinsky Kombank, Irs, Khovansky, Kristalbank, MDM-Bank. Mezhkombank, Metallinvestbank, Moscow Credit bank, MPI-Bank, Novaya Moskva, Novkombank, Platina, Promradtekhbank, Promstroibank Russia, Rossiysky Kredit, Russlavbank, SDM-Bank, Transkapitalbank, Vozrozhdeniye, Vostok-Zapad and Vtoroi Bank; B1 - Satisfactory Stable Reliability lists another 88 banks.

On the practical side, an analysis in Moscow Times Business Journal No 6, 1998, equally recommends avoiding either very large or very small banks. According to the Journal, some 350 mid-sized banks are now considered to be among the most stable in Russia in terms of liquidity, and most likely to withstand the consolidation which we anticipate in the Russian banking sector. The Journal quotes Alexei Zabotkin, financial analyst with United Financial Group, as singling out Probiznesbank, Sobinbank and Svyaz-bank (for telecommunications companies) as examples of good mid-sized Russian banks.

Large, small or medium-sized, one thing is true about any bank a company may consider working with: it should be screened by a professional due-diligence company (such as Dun & Bradstreet, Ernst & Young, Coudert Brothers, or others. While these companies have offices in Russia, they prefer that the U.S. offices be contacted with requests initiated from the USA). Now, over two months after the announced default, many banks have resumed their regular services, but still have a freeze on 50 percent of the money deposited with them before August 31. (One analyst who came to inquire about her money in a frozen VISA debit card account in a U.S.-managed Russian bank, was informed that the bank would soon decide how its frozen accounts would be handled, while at the same time the bank "is operating in its normal manner and has even increased the number of serviced credit cards. You may open a new account and this one would be a fully operational one".)

At present, Western banks look more attractive (and more reliable) than Russian banks (for corporate clients only, because foreign banks are not permitted to service individual clients). However, as previously noted, size constraints may apply. Hopefully, the new program of the banking system restructuring will create conditions for a broader foreign banks participation in the market. First Deputy of the Central Bank Chairman, Mr. Kozlov has been quoted by the Journal as saying that he "sees the major difference of the new banking market in the substantially bigger number of foreign banks operating on it". He was quoted as saying that there exists a possibility for amending the current regulation and increasing the 12 percent share of foreign banks' capital in the Russian banking system, if the number of foreign banks grows drastically.