Richard Hainsworth, CEO of Global Ratings -

Russia's banks have been charging interest rates over 50% on consumer loans. In mature economies, these are the interest rates charged by loan sharks preying on the financially illiterate, poor and desparate. As in times past (consider the medieval history of banks), such high interest rates eventually cause a backlash from the populace. The backlash has begun in Russia.

The high interest rates are primarily due to the massive disconnect between high consumerism motivating demand and supply, primarily from global capital markets. However, some Russian banks have exacerbated the negative reaction to high interest rates by advertising low nominal interest rates (and charging high non-interest commissions with little transparency), writing service contracts that even experts find difficult to untangle, and designing repayment schedules that some clients complain trap them into a never ending cycle of interest payments without ever paying off the principal.

So great is the backlash that court cases have been taken out against several banks, the Duma and the Central Bank of Russia are attempting to regulate interest rates on consumer loans, and now the State Prosecutor has launched a court case against a Russian bank.

There is one bank that is at the focus of most complaints, namely Russian Standard Bank (RSB). Given that RSB was the first to offer consumer loans and remains one of the largest providers of consumer lending products, the level of complaints against it is far beyond complaints about the other large banks. As part of an on-going court case, the Russian State Consumer Protection Commission released figures for complaints it had received and lodged against all Russian banks. RSB was the subject of 734 complaints, Home Credit - 127, and the next bank received 8! Nearly two orders of magnitude separate RSB from the third most complained about bank.

For full disclosure, I should point out that the court case in question comes from RSB, who is claiming $10 million in damages each against my company (RusRating) and against a senior analyst of mine for diminishing RSB's business reputation - we downgraded the bank in December 2006. The case creates at least two precedents - it is the first time a rated company is taking a rating agency to court just following a downgrade in its rating (the connection is just too strong to be coincidental), and the statements of the rating agency's analysts were quoted in an article (a direct attack on freedom of expression). The article itself was not written by any of our analysts!

Aside from the court case and the short-sighted business behaviours of a small number of Russian banks, the Central Bank of Russia (CBR) is in a quandary as to how to regulate the situation. The Russian banks advertise a nominal interest rate (sometimes as 'low' as 10%), whilst effectively charging over 50%. The remaining payments are for a wide variety of "extra costs" such as a charge for opening the account, taking money from the account (to pay for the goods being bought), and insurance cover.

The CBR does not want to regulate or cap the interest rate, for it is a strong adherent of market forces. What it really wants is to force all banks to disclose a single "effective" interest rate. In this way, all banks would need to "come clean" in public and the market would choose the lowest effective interest rate. The problem is finding a single method for including uneven principal repayments, front-end costs and "third-party" costs (eg., an insurance premium paid to a tied insurance company) into a single effective rate that would be the same for all banks and would not be susceptible to playing the numbers. In the end, it has not proven possible to find a single calculation method.

The economically correct way would be to enforce disclosure of the entire loan re-payment schedule, showing the proportion of interest, non-interest, and principal repayments before the loan agreement is signed. Even fairly unsophisticated people can compare a set of repayments and whether they want to make them.

Irrespective of the disclosure requirements that are finally imposed, Russian banks have once again earnt themselves the enmity of a section of the population. This cannot but have a negative impact on the banks most widely seen to have been acting as a bully. However, even in the short-term it is unlikely that there will be any fall in the profitability of consumer lending. The real economic driver for the increasing consumer loan growth is that there is a still a massive pent-up demand for consumer loans combined with a scarcity of funds being allocated to this asset class.

For more information see the Global Ratings website