One of the most remarkable results of 2002 was that Russian banks managed to increase the profitability of their operations despite noticeably worsening conditions for banking activity. Last year, Russian banks’ total profit (minus losses) increased by 38%, with profitable banks enjoying a 49-percent rise. A year ago, the profit balance increased fourfold, and the amount of profit gained by profitable banks rose by 45.6%.
Of course, part of the absolute increase in profits was created by an increase in the scale of banking operations. In 2002, the banking system’s average annual assets exceeded the 2001 level by 21.2%. However, during the same period, there also was a rise in the sector’s profitability – the profit-to-average annual assets ratio increased from 2.4 to 2.8%.
This positive trend is also noteworthy because, objectively, conditions for banks worsened. The lower pace of ruble depreciation meant fewer revenues from the currency position, so favored by Russian banks. Profit from securities re-valuation, which helped the Russian banks to return to profitability in 1999 and 2000, also distinctly declined.
The spread in loan-deposit transactions decreased, too. In the fourth quarter of 2002, the spread of granting ruble loans to enterprises using citizens’ ruble deposits narrowed by two percentage points versus the same period of 2001. When making loans in hard currency and attracting funds in US dollars, the spread remained practically unchanged, dropping in the middle of 2002. When making loans in rubles using currency deposits, the spread contracted by about two points.

Balance maneuvers

Other things being equal, a decline in bank profitability would be imminent. However, Russian banks have demonstrated a very good ability to adapt. Over the last two years, radical changes have occurred in banks’ balance structure, with most changes coming at the end of 2001. In 2002, the banks, to a great extent, already reaped the fruits of their efforts. Over two years, the amount of funds in banks dropped 6.7 percentage points, and investments in securities and other non-working assets declined by 1-2 percentage points. On the other hand, the share of loans to the non-banking sector increased nearly 10 percentage points and increased to half of the assets. Many major banks have increased the share of loans in their assets to 60-70% and reached a level they seem unlikely to exceed in the medium term.
By restructuring their balances, banks conspicuously enhanced their business and increased their profitability. The rapid growth also meant some reduction in transaction costs. Among the major banks, Sberbank has achieved the greatest success in this area: its non-percent expenses/assets ratio dropped from 6.4% in 2001 to 5.9% in 2002. This drop accounts for half of the bank’s increase in profitability (from 3.3% to 4.2% of average annual assets). However, the major changes in structure are no novelty for our banks: the same thing took place in 1995-1997, when the banking system was switching from operating under high inflation to functioning under the currency corridor. But credit expansion defines the difference between bank transactions in 1995-1997 and in 2000-2003.

In search of a new borrower

After the crisis of 1998, the largest financial-industrial groups re-oriented their borrowing and sought loans from foreign banks, leaving Russian banks, including those incorporated in financial-industrial groups, to work with medium-sized and retail borrowers. As the economy grew, a large number of enterprises, which had never obtained bank loans before, started borrowing. Medium- and small-sized companies also conspicuously expanded their presence on the credit market. Borrowing became easier for individual consumers as well, both in terms of consumer credit and mortgages.
This kind of expansion in loans invariably gives rise to doubts about their quality, since any macro-economic deterioration in a country leads to an increase in defaults.
However, as long as potential problems with credit portfolios are far away, the banks are reaping the fruits of the borrowing boom. The changes are especially visible at the largest banks, which traditionally have lent a considerable part of their funds to their own financial-industrial groups on preferential terms. Many such banks have managed not only to keep up credit portfolio yield, the interest revenue from loans versus the average annual value of the credit portfolio, but also to increase it substantially. Within the banking system as a whole, portfolio yield has remained at the same level despite a decline in interest rates.
The second factor that contributed to the increased return on loans– the change in the currency structure of newly granted credits –didn’t manifested itself in 2002. Over 1999-2001, the percentage of loans in rubles has grown noticeably, totally 69% of loans to enterprises by the beginning of 200. In 2002, this trend not only slowed but even reversed. As of January 1^st, 2003, the percentage of loans in rubles dropped to 65.5%, less than at the beginning of 2001.

Unstable equilibrium

Over the last two years, the Russian banks have started look more like normal financial intermediaries and resemble normal commercial businesses than ever before.
However, they still face the task of embarking on the path of sustained development. The paramount problem is to ensure that banks are independent from additional injections of resources on the part of shareholders. The authorized capital of all currently operating Russian banks (excluding Sberbank) has increased by more than 250 billion rubles over the last four years. This sum includes capitalization of past years’ earnings, but the real cash contributions have been very large, too, and amounted to at least 200 billion rubles.
Nevertheless, except for at a number of model banks, shareholders have received no income, but they had to contribute additional funds to their capital for development purposes. Russian banks’ assets have grown very rapidly for several years. After the large-scale re-capitalization of the banks in 1999, when capital growth rates were nearly twice as much as asset growth rates (150.4% versus 82.9% for 1999), the growth rates of assets have noticeably outstripped those of capital in subsequent years. As a result, the percentage of capital in Russian banks’ liabilities has gradually lowered.
When profits provide for the same high growth rates for capital and for assets, the situation is optimum for banks. Banks then have the opportunity to pay dividends to shareholders without jeopardizing their long-term development. When banks turn into commercially active endeavors, preconditions arise for making qualitative changes in the relationship between banks and shareholders, for forming the banks’ equity market and for reducing banks’ dependence on shareholders.
For the present, banks’ profits don’t provide even half the increase in capital. However, the share of profits in the increase in capital is rapidly rising, and the growth rates of assets and those of capital are closing in on each other. In principle, such a trend signifies the possibility for banks to enter the curve of balanced growth as early as 2003. By maintaining the current profitability of assets, this goal can be reached via reduction of the capital share in liabilities, provided that the trend of assets growth slowdown continues. Regional banks, in general, due to lower asset growth rates, a relatively low share of capital in liabilities, and high profitability have come close to the stage of equilibrium growth, whereas Moscow-based banks will likely continue to rely on shareholder resources in the next few years.
However, many factors may undermine these favorable trends. Along with the achievements in the banking system, risks are increasing as well. The rise in the loans share in assets inevitably leads a rise in the share of speculative assets and to the increase in demand for reserves to cover potential losses on loans. The possibilities of further increase in profitability owing to changes in the asset structure are very limited; the decline in interest rates reduces the yield of loan portfolio and its quality is very unstable. Under such circumstances, the quality of bank management, designed to ensure the balance of risk and efficiency, is gaining importance.

Source: Bank of Russia

Table 2

Profit and shareholder contributions are the main source of increase in Russian banks’ capitalization

Note: all figures are in billion rubles.
* includes capitalization of retained profit; excludes share premium.
**May significantly differ from taxable profit.

Source: RA Interfax