As the Russian economy has declined over the past few years, a great deal of the coverage in the business press has been highly targeted and specific. Which company had to go begging for state aid? Which bank had to be recapitalized by the deposit insurance agency? How many licenses did the central bank of revoke this week?

This is, to a certain extent, quite understandable: the economic damage from the downturn in energy prices has been so widespread that there is essentially never a shortage of interesting stories about whom or what was impacted. But while the travails of particular companies are interesting, far more revealing is the fate of entire sectors. Given the critical importance of credit for the functioning of a modern economy, the health of the Russian banking sector is of paramount importance. Healthy banks, of course, don’t guarantee a prosperous economy, but it’s extremely hard, if not if impossible, to see how any kind of sustainable economic development can take place in an environment in which Russia’s banks are hobbled by non-performing loans and bad debts.

To investigate the health of Russia’s banks writ large, I aggregated the financial statements of four of the largest state-owned institutions: Sberbank, VTB, Rosselkhozbank and Gazprombank. Through aggregation, the intent was to remove the distortive impact of business-specific factors and instead focus on the trends influencing the sector as a whole. 

Several trends jump out. The first is that the size of Russian banks’ loan portfolio has grown substantially, even over the past difficult year. When energy prices first started to nose-drive at the end of 2014, the widespread fear among economic commentators was that, in combination with Western financial sanctions, lending in the Russian economy would come screeching to a halt. It is true that, thanks to a series of central bank interest rate hikes, borrowing money is much more expensive now than in the past. Based on the size of their loan portfolios, though, it certainly does not appear that Russian banks suddenly put a freeze on new lending.

Secondly, even though their loan portfolios have grown, the lending environment for Russian banks has steadily deteriorated: their net interest margin has grown steadily smaller from about 6.5% in 2011 to 4.5% in 2015. The deterioration was particularly sharp over the past two years. This development is partially related to the aforementioned Western sanctions: afraid of suddenly finding themselves on a sanctions list and having their overseas assets frozen, a significant number of Russian corporates repatriated significant sums of cash. For a bank, of course, these customer deposits are liabilities, and in many cases the sudden influx of customer cash was larger than the growth in loans. Liabilities that are growing faster than assets is a recipe for compressed margins, which is exactly what you see across the sector. 

The third, and perhaps most disconcerting trend visible across the Russian banking sector is that the quality of the loans held by Russian banks has been deteriorating. The relative size of provision charges increased every year from 2011-14, roughly doubling from 2012-13 and then doubling again from 2013-2014. There was a very modest improvement from 2014-15, but the 2015 level was still more than five-times higher than 2011’s level. This has had a crushing impact on the banks’ post-impairment margins, which, by 2015, were less than 2%. 

Assessing the true level of delinquent loans across the sector is complicated by the banks’ differing disclosure policies. Sberbank, Rosselkhozbank and Gazprombank provide reasonably detailed guidance on which loans are 30, 90, 180 and 365 days past due. Some of the numbers appear a bit odd (Gazprombank’s loan portfolio, in particular, appears to be in shockingly good health considering the bank’s poor performance), but the level of disclosure suggests a good faith effort on the banks’ part to inform users of the financial statements. It certainly doesn’t suggest any kind of attempt to deceive.

VTB is another story entirely – the bank’s disclosure on its delinquent loans consists of a single sentence: “As of December 31, 2015, the gross amount of non-performing loans which the Group defines as impaired loans with repayments overdue by over 90 days, was RUR 635.4 billion or 6.3% of the aggregate loan portfolio.” While better than no disclosure at all, VTB doesn’t provide any insight into how delinquent these loans are, or whether the structure of the delinquent loans has meaningfully changed over time. What is clear is that the current level of delinquency is meaningfully higher than in 2011 and 2012, when non-performing loans were stable at 5.4%. Despite aggressive growth, the quality of VTB’s underlying assets has been gradually eroding. That, as ought to be clear, is not a sustainable trajectory.

Amber alert

The condition of Russia’s banks does not present an immediate problem for the authorities. There were a series of equity injections by the state into several banks in 2015 to maintain liquidity ratios, but despite inflated rhetoric to the contrary there is no danger of a “bank run”. The banking sector’s fundamental problem is not that Russian consumers mistrust it with their deposits, but that, given the sclerotic condition of the economy, there are not enough profitable opportunities to extend loans. That is a very real problem, but it is a very different problem than large-scale customer panic or widespread doubts about the solvency of the banks.  

Where do things go from here? It’s hard to see how the story has a very pleasant conclusion. The state-owned banks, almost by definition, are not simply vehicles for profit-maximization, they have other political and social roles to play. One of the more important, since the onset of Western sanctions, has been to safeguard the formerly-overseas deposits of Russian corporates. In a purely market-oriented context, it seems likely that many of these deposits would have been refused: the banks had no way to offset the liability that they would incur by bringing them onto their books. But, of course, the political reality is that turning down deposits was a non-starter – the Kremlin had to demonstrate that it would do what it could to help shield large corporations from the impact of sanctions. While politically astute, that decision has very real economic costs – costs that the government, sooner or later, is going to have to pay.

It seems likely that, over the next few years, the banks’ health will continue to gradually deteriorate, kept solvent by continued modest infusions of state aid. At some point pressure within the system will build to breaking point, but there seems to be little danger of this happening within the next year or two. So expect continued stability, albeit with a greater chance of serious disturbances further down the line.