COMMENT: A look at the Russian banking system in October

By bne IntelliNews November 28, 2008

Nikolay Podguzov of Renaissance Capital -

All the largest Russian banks have issued local accounts as of November 1, allowing us to draw preliminary conclusions on the sector's key trends over October.

Certainly, October was much tougher than September, having marked the most difficult period for the banks since summer 2004. Among the key problems - which, we note, would have been very difficult to predict - were a significant acceleration of capital outflow and even more aggressive pressure on the rouble, combined with the euro's very significant underperformance against the dollar. However, our key contention remains intact, specifically: the sustainability of Russia's major banks was strongly supported by the authorities, and the risk of large-scale bankruptcies in this area remains low and entirely manageable.

1. Retail deposit outflow. Although figures for the system as a whole are unlikely to be disastrous, given the dominance of the state-owned banks (month-on-month outflow of deposits was likely around 5-6% in October), the privately owned banks have been in a much tougher situation, losing 10-12% of retail deposits, on average, in October. Reportedly, even Sberbank faced a RUB95bn deposit outflow in October (3.2%). The key drivers here were: speculation about defaults in the banking system; and the perceived devaluation of the rouble against the dollar given the poor performance of the euro. The two effects of this were: a flight to quality (to the state-controlled banks); and a flight from the rouble, with massive withdrawals of dollars in the form of cash and the conversion of deposits into currency (over just one month, we saw the share of foreign exchange in retail deposits increase from 21.2% to 26.5%).

2. Corporate deposits: Mixed flows. In terms of corporate deposits (which represent the largest proportion of the banking system's liabilities, about 40%), we saw no unifying trends. Some of the banks faced significant corporate deposit outflows (up to 20%), while others saw inflows. For example, Sberbank faced almost no significant withdrawals on the corporate deposit side, and even saw some inflows on settlement accounts. In line with our expectations, corporates have been moving their funds towards institutions with greater capacity to provide lending resources.

3. Central bank funding. As we had expected, the Central Bank of Russia (CBR) played a pivotal role in supporting banking system liquidity in times of severe deposit outflows. The RUB638bn of funds injected into the system in October has more than covered deposit withdrawals by the individuals, and (unsurprisingly) a very significant proportion of cheap, excessive liquidity supplied by the regulator was absorbed in the forex market.

We also highlight that the list of banks that received CBR funding is broader than implied by the formal rating criteria initially defined by the regulator: a significant number of unrated institutions received RUB0.3bn-2bn in October. In most cases, we think this likely indicates significant financial stress on these institutions, but, in some cases, it may reflect a high degree of political involvement by certain banks' management. In any case, this clearly demonstrates that, despite the tough rhetoric of the CBR and government officials, the regulator is supporting a much broader range of institutions than just the largest 20 or 50 banks. On November 20, the CBR amended the regulations to open its liquidity window not only to banks rated by S&P, Fitch and Moody's, but also to those rated by national agencies (approved by the CBR). Essentially, this leaves the CBR much greater discretion in choosing the institutions that are to be granted access to the liquidity window.

4. Lending activities. Although the individual institutions have demonstrated different trends, we would describe the general market situation thus: 1) most of the privately owned banks have significantly cut their lending activities and their loan portfolios declined by an average of 5-7% over October; 2) the two largest state-controlled banks significantly accelerated loan originations and reported loan book increases (VTB: +RUB120bn; Sberbank: +RUB124bn). Overall, the aggregate effect on the system's loan portfolio will be neutral to slightly negative, in our view. However, most of the new loans granted by the majors were relatively large-ticket deals with big corporate borrowers, while smaller businesses clearly had significant problems in raising debt in October. Another result of very tight lending market conditions in October is the first signs of asset quality issues. The volume of one-day delinquency has increased 15-20% in the system.

This is only a very early sign, as most of the loans will be restructured, but going forward we expect more collateral repossessions.

5. FX market: Capital flight and liquidity absorption. One of the major disappointments of the past two months has been the CBR's failure to implement successful measures to ease speculative pressure on the rouble. Preliminary figures indicate that banks increased their interbank foreign assets by $15bn-20bn in October. Together with the population withdrawing cash (in dollars and euros) from banks, this proved the major channel of capital outflow in October.

So far, the CBR has taken no efficient steps to stop or soften this speculation - on the contrary, the mini-devaluation of 1% against the basket has even made the speculation more aggressive. Interestingly, while in September the most active players against the rouble were foreign banks, in October, Russian banks joined in, and have accumulated significant amounts of excess foreign currency on correspondent accounts and deposits. There have been widespread rumours that over the coming weeks, the CBR will implement tougher controls on the usage of liquidity, and implement sanctions against banks that have used state funding to buy dollars. However, so far we have seen no meaningful moves in this direction. It is also doubtful that any such measures would be fully efficient given that some of the largest state-controlled banks were involved into these operations.

Our outlook for the coming months:

• Deposit stability will largely be determined by policy on the rouble exchange rate. Deposit flight has, at least temporarily, stabilised, but the balance is very fragile and could be disturbed by even minor events.

• Until we see some stabilisation in the forex market, it is difficult to expect banking system lending activity to recover. We expect further loan restructurings and collateral repossessions.

• Liquidity provided by the state will become increasingly crucial to the banking system. Accordingly, there is at least a vague chance that the CBR will broker a deal with the banks along the lines of, "you don't withdraw too much capital and we won't cut off your lending facilities." Banks that fail to cooperate face significant regulatory risks.

Overall, in terms of the sustainability of the banking system, the risks still remain comfortably manageable, in our view. Russia's 20-30 largest banks are well positioned to survive, as are its strongest regional institutions. In addition, PM Vladimir Putin has reiterated that banking sector consolidation will be strongly supported on the political level.

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