David Nangle -

Russian banks are bigger and more sophisticated, but the arrival of foreign investors is pushing Ukraine's banking sector harder.

The banking sector of the CIS, and in particular that of its two core markets of Russia and Ukraine, is currently enjoying its moment in the spotlight.

Buoyed by strong economic growth, the banking systems of Russia and Ukraine are enjoying some of the fastest growth in global banking as they start to realize some of their massive potential. For both, it is a clear case of being examples of under-penetrated fast growth markets. And the trends being played out are carbon-copies of what the markets of "New Europe" experienced in the not-too-distant past.

Clear, positive growth trends are mixed in with some classic issues that are characteristic to many emerging markets at this stage of development. Transparency in both markets is improving from a low base, and growing interaction and integration with the financial capital markets is becoming a key driver.

International reporting is carried out across the board on an annual basis. However, timely reporting, intermediate reporting and full disclosure still need to be improved upon. Further reform of the banking sector in both countries is necessary, with areas such as long-term funding, property rights and credit bureaus all very much still a work in progress.

Snapshot of the two systems – differences defined

The Russian banking system includes over 1,000 banks – a legacy of the 1990s when licensees were freely distributed to all who demanded them. In reality, it is widely accepted that only the top 100-200 banks are serious functioning banks.

The other defining feature of the market is the dominance of one player in the sector, Sberbank, with circa 30% of the total assets of the Russian banking system and more importantly circa 50% of the retail banking market. All other banks are a distant second in terms of competition to this state-owned behemoth.

Beyond Sberbank, state banks or quasi-state banks occupy four of the top five positions; local private banks are quickly getting their houses in order, while strong growth is increasingly attracting foreign players to the market. However, we doubt that foreign banks will dominate the Russian bank sector for the foreseeable future.

The banking system of Ukraine is characterized by fewer banks than in Russia, while still having way too many banks in our view – 100 plus. The market place is a lot more fragmented than that of Russia with no one dominant banking franchise and is more akin to that of the Polish market with many mid-sized players.

The top two players – Raiffeisen Bank Aval and Privat Bank – hold circa 10% of the market. There are two state banks of importance, Oschadbank (Ukraine's Sberbank) and Ukreximbank (Ukraine's trade finance bank). Oschadbank, while having a distribution franchise similar to that of Russia's Sberbank, is a transformation story and is being cleaned up after years of mismanagement by the Ukrainian state. Unlike Russia, Ukraine has been a happy hunting-ground for foreign banks and already three of the top five banks are in foreign hands, with the doors clearly wide open for foreign banks to dominate this system as they do in many markets of Central and Eastern Europe.

Similarly risky, but Ukraine more so

Both sectors are seeing an increase in the competitive landscape, especially since the arrival of international players who bring the expertise, experience and products from their home markets. Competition puts pressure on margins and drives up costs, in particular wage inflation and real estate prices. This all affects the profitability of the respective systems and the players operating within it. Competition is more pronounced in the Ukrainian market, with many banks of a similar size fighting for a smaller market share and the presence of foreign players more apparent.

Asset quality is a clear concern in markets like Russia and Ukraine, which have experienced credit booms as many individuals and companies take up credit for the first time. While asset quality seems to be in good shape in both markets at the moment, we would have to favour Russia's economic situation over that of Ukraine.

Furthermore, with circa 50% of the Ukrainian banking system dependant on foreign currency, this is a clear additional risk for asset quality as well the overall stability of the system if there were to be any serious shifts in the local currency versus the dollar.

David Nangle is the bank analyst with Renaissance Capital in Moscow