If the Central Bank does not actively refinance a growing economy, crisis in the banking sector is merely a matter of time. And time is up for Russia.

Yana Galukhina and Maxim Rubchenko

On July 1, the Russian government approved in its entirety the “Strategy for Banking Sector Development 2004-2008” developed by the Central Bank and the Finance Ministry. As the meeting began, Prime Minister Mikhail Fradkov stated that he believes maintaining the public’s faith in the banking system is crucial. “The Strategy needs to focus on achieving stability in the banking system and preventing crisis situations among particular market participants,” the prime minister stated.
To ensure stability in the Russian banking system, the Central Bank and Finance Ministry proposed in part to require that banks opening after January 1, 2007 have at least 5 million euros in equity. In addition, the agencies recommended raising the level of capital adequacy (the ratio between capital and assets) from the current level of 2% to 10%.
Stricter bank regulation and a variety of measures aimed at increasing banking transparency are also part of the plan to ensure stability and avert crisis. Mikhail Fradkov said that the banking system needs to address the issue of how to turn savings into real sector investment. The prime minister also turned his attention to the need to improve Russian banks’ competitiveness as they integrate into the global financial system. According to the Strategy’s authors, putting these measures into effect will allow banking sector assets to increase from today’s 42% to 56-60% of the GDP by 2008. Loans to the real sector will grow from 18% to 26-28% of the GDP.
“Recently, deposits in credit institutions on the part of private individuals have increased, and we must encourage this trend,” Fradkov recommended as part of his proposals.
The next day, the bank crisis hit Russia.

The way down

The first sign, as many have already noted, came when Sodbiznesbank lost its license on May 13 for reasons previously unheard of on the Russian market, namely for not abiding by “federal laws regulating banking activities and the regulatory acts of the Bank of Russia, as well as the frequent violation of the requirements of the law On Counteracting Income Legalization (Money Laundering).” Possibly, this event would not have had much of an effect on the market, if the head of the Federal Service for Financial Monitoring (FSFM), Viktor Zubkov, when commenting on the Central Bank’s decision, hadn’t carelessly stated that the Service had similar problems with at least a dozen other banks. That was more than enough to send the sector into a panic. Several versions of the so-called “bank black list” circulated around the market. Banks that appeared on the list instantly lost their access to credit and depositors began withdraw their money.
Kredittrast was the first to collapse in late May, as it either had a large stake in Sodbiznes shares or was owned by Sodbiznes. No one knew for sure. Nonetheless, by early June Kredittrast was forced to stop payment. June 21, the National Association of Stock Market Participants (NAUFOR) recalled its reliability rating of Kredittrast and suspended its ratings of Dialog-Optim and Paveletsky Banks.
In the heat of the moment, as events evolved around Sobiznesbank and Kredittrast, a brief mention was made in the media that Guta Bank’s documents were also in the process of being seized. This remained an unconfirmed rumor and was quickly forgotten by the public. However, as it turned out, other banks did not forget and by late May, no one would lend Guta any money. For about a month, the bank used its own funds and financial support from the other companies belonging to the Guta Group to deal with its obligations. By early July, however, the money ran out and on Friday July 2nd, news got out that Guta was having trouble servicing its accounts.
The weekend dispelled some of the tension by the evening of July 5, Guta Bank closed its doors to clients. The next day, information appeared in the media that “there were problems” at Alfa Bank as well. On July 7, long lines of credit cardholders wanting to take out cash appeared at Moscow ATMs. At commercial banks clients were signing up to withdraw cash three days in advance.
At that time, Sergei Ignatiev, head of the Central Bank, Pavel Medvedev, Deputy Chair of the Duma Banking Committee, and other state officials kept trying to assure the public that nothing was wrong with the banking system and that there was not and could not be any crisis as there were no macroeconomic suggestions of a major problem. Indeed, there had been no suggestions at all: income to the federal budget is increasing, gold reserves are growing, oil prices—the foundation of Russian prosperity—are still high. Nonetheless, there were more than enough reasons for a crisis.

A lesson in psychology

The first of these reasons is purely psychological. The problem is not that, as many officials have announced recently, that the Russian populace reacted “inappropriately” to the Central Bank’s decision regarding Sodbiznesbank. Quite the contrary: people reacted with a high degree of appropriateness. The image of all bankers as thieves has solidified in the minds of the majority of average Russians since back in 1998. After the authorities waxed eloquent about “bringing order to the banking system,” the public came to a very logical conclusion and started their withdrawals.
Specialists recall all too well how the overwhelming majority of banks earned their capital in the 1990s. Law enforcement officials could make very serious claims against almost any Russian bank except those appearing after the 1998 crisis if they wanted. The fact that law enforcement and security authorities do want this, without a second thought as to how long ago irregularities happened, is perfectly demonstrated by the YUKOS Affair, which began with claims against the company’s owners that involved privatization deals made a decade ago. Thus, everyone easily and instantly believed the announcement that officials had a bone to pick with several banks.
By the way, as a consequence of the YUKOS Affair, a massive amount of capital flowed out of Russia. Naturally, the outflow of large amounts of cash abroad substantially weakened the Russian banking and financial system.

Liquidity breeds confidence

The second reason for the current crisis on the banking market is purely economic. It stands out in sharp contrast to 1998, when a budget crisis spread to the rest of the economy as the federal budget could not honor the country’s debt obligations. Today’s events point to a bank liquidity crisis in its purest form.
To maintain the necessary liquidity, banks can refinance and borrow money either from the Central Bank or from other banks on the inter-bank credit market. This is all in theory. In practice, the situation has become far more complicated and depressing.
After the Sodbiznesbank collapse and the release of the first “black lists,” only banks whose stability and solvency did not provoke any doubts could borrow funds on the inter-bank market. No one under any condition has been willing to give money to second- and third-tier banks, especially those appearing on one of the “black lists,” for the past two months.
The situation with refinancing via the Central Bank is even more complicated. “If we are talking about refinancing, then we have to say that it basically does not exist and that in Russia there are practically no means to refinance,” says Mikhail Matovnikov. “There are only one-day accounting loans that do not solve banks’ problems. There is, in theory, refinancing in the form of guaranteed loans with securities as collateral, but that in essence is merely an exchange of one liquid asset for another. The main goal of this kind of refinancing is predominantly to prop up the state bond market and not to refinance banks. Now, almost all of the Central Bank’s refinancing is aimed at ensuring deposits can be returned. In other words, the Central Bank is only making guaranteed loans. The Central Bank is not carrying out its refinancing function.”
As a result the Russian bank refused loans by its inter-bank market colleagues can only rely on its own resources. If this bank does not have any more cash resources but has plenty of panicked clients, the bank is doomed to go bust. As a result of the specifics of the Russian banking system dozens of banks today are facing a liquidity deficit and consequently the possibility of bankruptcy. The most offensive part of it all is that the Bank of Russian has more than enough resources to help them out. The problem lies elsewhere.

I can’t and I won’t

The first problem lies in the weakness of Russian regulation. “The Central Bank cannot lend to banks because they don’t have established credit limits and it is impossible to establish these limits because there isn’t the appropriate regulatory basis,” argues Matovnikov. “Central Bank officials simply cannot take the risk.” And they don’t want to, as last year one high-ranking Bank of Russia official was convicted of “exceeding authority” when he authorized a stabilization loan to one problem-ridden bank. He was the last hero of his kind at the Central Bank.
The second problem with the Russian banking system lies in the goals and functions of today’s Bank of Russia. “The Central Bank has two tasks: to combat inflation and to regulate,” explains Sergei Leontiev. “The crux of the matter is that these tasks contradict each other. Refinancing obviously affects inflation, which is why the Central Bank does not make loans to banks. It is afraid inflation will rise.”
At the same time, the Central Bank’s established practices have begun to create problems not only for the banking system, but for the entire Russian economy. In the near future, these problems will continue to grow. “We have modeled the monetary and lending situation in the coming years and made global projections to 2007. This revealed that in the coming years we can expect decreased growth of gold and currency reserves,” states Oleg Solntsev, a leading expert at the Center for Macroeconomic Growth and Short-Term Forecasting. “We should expect the Central Bank to reduce its currency purchases in the next several years, which up to this point have been the main source of rubles flowing into the economy. Consequently, it will need other ways to pump money into the economy, in part through bank refinancing. The dramatic part is not that additional money supply could stimulate inflation but that there could be insufficient money in the monetary supply to cover the economy’s demand for money.”
The main routes for getting out of the crisis in the banking sector are obvious. The first and most important way is to organize a refinancing system. “One of the main banking problems is maintaining liquidity, which is directly connected to refinancing,” says Solntsev. “Refinancing on one hand is a means of solving the liquidity problem and on the other a way to encourage lending. For this reason, the possibility of Central Bank refinancing would expand banks’ ability to make loans.”

The technology of crisis

This is all well and good. However, there are doubts that the Central Bank would take up the practical realization of these ideas enthusiastically. These doubts are based on a single, simple principle: who benefited most from this crisis? First of all, Sberbank did, which, much like after the 1998 crisis, saw a huge increase in customers. The majority of clients withdrawing their money from commercial banks went right to Sberbank. While Sberbank’s share of individual depositors has fallen for the last three years, one can say with confidence that for 2004 their number will increase substantially.
The second bank that benefited from the expanding crisis even more than Sberbank was Vneshtorgbank, which picked up the decent retail chain that once belonged to Guta Bank for a song. It also got a whole assortment of interesting manufacturing and commercial assets, including a large stake in the construction of an elite housing complex, Zolotoi Ostrov (Golden Island). All this, thanks to a loan made by the Central Bank. Two points are of particular note here. Firstly, the Central Bank refused to give financial assistance to Guta itself. Just as it previously refused to help Sodbiznesbank, Kredittrast, Dialog-Optim, and all the other troubled banks. Secondly, only after it became clear that Guta was willing to sell to Vneshtorgbank, the Central Bank began to take measures to localize the crisis by cutting the mandatory deposit rate in half.
Objectively, within the context of the current crisis the monetary authorities worked in favor of strengthening the state bank system. If the authorities liked this idea (and this is highly plausible), it means two things. First, the crisis is functioning more or less effectively but will stop soon. On one hand, authorities have the money to make this happen. On the other hand, Vneshtorgbank has already acquired a retail chain and needs some time to digest its victory. However, there is also a “second of all.” If a strategy to reinforce the state bank system has crystallized, this will mean that until this system is in place, crises like the current one could happen at any moment when the next victim is ready to be taken over. The technology of crisis is simple and effective. All you have to do is start some rumors that the bank in question is having problems with law enforcement.

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