Ben Aris in St Petersburg -

How many bankrupt banks does it take to make a crisis? There has been a lot of talk recently about a possible "second wave" to the financial crisis hitting Russia sometime this autumn. The good news is that with autumn only a few months away, a second round is beginning to look less likely. The bad news is that the banking sector's problems are probably still a lot worse than anyone anticipated.

Currently, the Russian Deposit Insurance Agency (DIA), which is responsible for bailing out banks if they go bust, is doing pretty well. A total of 45 banks out of a total of just over 1,000 have had their licenses withdrawn this year and the agency has 18 banks in its rehabilitation programme. But in the middle of July, the DIA's general director, Alexander Turbanov, told delegates at the Northwest Banking Conference that up to 60 banks could be closed by the end of this year. "This year, 50-60 banks could have their licenses revoked, and we might have to implement rescue packages at 15-20 others," Turbanov said to the assembled leading bankers in St Petersburg.

And that would only be the beginning. Thanks to the Central Bank of Russia's (CBR) decision to hike the minimum capital requirement from January 1, 2010 to €2.5m, experts at the rating agency Standard & Poor's estimate that another 170 banks will have to be closed at the start of next year. The danger is that if too many banks are closed too quickly, then punters will start to panic and withdraw their money, leading to a meltdown of the whole financial system.

Problem loans

Most of the discussion of the problem has focused on the rising number of non-performing loans (NPLs): the official line is that NPLs will reach some 10% of total loans by the end of the year, but most commentators believe the actual level will be double or more. Clearly, if too many credits go bad, banks will start to collapse, but no one is sure exactly what level NPLs have to reach before this happens.

And some commentators are beginning to point out that NPLs are only the tip of the iceberg; regulators would be better off thinking about problem loans rather than NPLs. "NPLs are not a good guide to the problems of the bank sector, as they don't include restructured loans, which are nominally performing, but actually not serviced properly at all," says Ekaterina Turbanov, head of financial institutions at Standard & Poor's. "If you look at the wider definition of problem loans, then this could grow to 40% of the total loan portfolio next year. Banks are not taking a wait-and-see approach but a wait-and-hide approach; we are expecting credit losses of up to a third of the entire loan portfolio, but you will never see this result on paper. Banks are hoping that the CBR can provide support to the sector faster than they can die."

The good news is that a new consensus is emerging that there will be no crisis this autumn, or if it comes, it will be mild and the state will be able to cope. The bad news is that the damage done to the banks is starting to look a lot worse than first feared and the peak of the bank sector's problems won't arrive this autumn, but some time next year.

Turbanov is cautiously optimistic, but at the same time remains aware that things could still go horribly wrong. Is the closure of 60 banks this year enough to spark a crisis? Turbanov thinks not, thanks to the resources the state has already committed to helping out banks. But in a recent report S&P said the sector will probably need between $20bn and $40bn of recapitalisation over the next three years. Even if the nightmare scenario requiring up to $80bn of recapitalisation comes to pass, the state still has over $400bn in cash reserves to call on and should be able to cope; Russia is confident enough of the resources it has to be one of the few emerging markets in the world not to cut a deal with the International Monetary Fund (IMF) for help. "We believe that a second wave [of the crisis] is possible in the fourth quarter of this year, but it is not inevitable," Turbanov said. "We are hoping for the best, but preparing for the worst."

And this is the bit that really worries some analysts. S&P's Trofimova says the Russian government probably does have enough money to bail out struggling banks. What it doesn't have is the manpower to cope with a rapid decay in the health of the sector that can ensure these resources get to needy banks fast enough to prevent a full blown meltdown.

No Plan B

The DIA was beefed up earlier this year to head off bank sector problems before they got out of control. It has received a total of RUB300bn ($9.3bn), of which RUB180bn comes from the CBR and another RUB115bn from the budget.

The agency has three approaches to rescuing troubled banks. Those with good assets but suffering from short-term liquidity problems can be sold off to investors. With banks that have a mix of good and bad assets, the bad assets are separated out and the rest of the bank is sold to investors. So far 12 of 18 banks in rehab have been rescued in this way. In the remaining cases, the banks were considered to be unsellable but of social significance, eg. in regions were there are no other banks, so the DIA took them over directly with a view to selling them again when the economy recovers. However, in 45 cases the banks were simply closed.

The slightly more than 2:1 ratio of closure versus rescue is pretty good and the 5:1 ratio of sale to investors versus de facto nationalisation is even better. However, analysts worry that we are still only in the early stages of restructuring the bank sector and that the DIA will be unable to cope when the number of banks getting into trouble starts to rise. Even the DIA can see a second wave would be very tough and Turbanov is calling on the state to do the groundwork now. "If a second wave comes, we will need a massive buyout of assets and we need to prepare the legal foundations now before it happens," he says.

Trofimova worries that the Kremlin doesn't have a Plan B if things get very bad. The DIA's plan is to try and sell off struggling banks that have some decent assets to investors, but in a second wave the only plan on the board at the moment is to borrow more money from the state and nationalise banks. "We have no limit on the loans we can take from the CBR. We don't think we will need the extra funding even if the situation worsens, and we don't think that there will be any bankruptcies amongst the major banks," says Turbanov. "Even in the worst-case scenario, we will be able to find investors and the DIA is not afraid of becoming a shareholder in troubled banks."

There are two problems with this approach. First is that finding investors to buy another 15-20 banks at a time when the financial sector's health is deteriorating would have been hard enough, but doing this just as 170 presumably healthy but small banks come on the market will very hard indeed. The second problem is that "unlimited" lending by the CBR is not unlimited at all. While the DIA has the resources to take over almost all of the country's smallest 950 banks - which collectively account for only about 5% of the entire sector's assets - it doesn't have enough money to cope with even one big bank collapsing.

Turbanov admits that the DIA is already having problems cleaning up KIT Finance's accounts, which was the first bank to get into trouble last September. "[KIT Finance] is a mess that will take a long time to sort out and I suspect that other people were behind [its main shareholder Alexander] Vinokurov," says Turbanov. "They risked the bank for their business agenda."

However, KIT Finance was one of Russia's fastest growing banks, run by a bunch of Russian Wall Street-returnees and relatively transparent, as it was hoping to become Russia's first commercial bank to IPO this year. If the DIA is having so much trouble restructuring such a western-oriented bank as KIT, then what sort of problems will it have restructuring big banks that have never pretended to be anything other than glorified treasury operations for their big business owners? "We see fairly efficient micro-management of the crisis in Russia, but what is missing is the macro strategy for what happens next," says Trofimova. "There has been no change in the business model and after the situation stabilises, the government expects the bank sector to go back to its high growth rates. Regulation is strict now, but we fear that it will be relaxed again once growth returns... the structural weaknesses of the sector was why Russia was so unexpectedly hurt by the crisis and the vulnerabilities that come with fast growth are not being addressed."

erratum: In the original version of this article Turbanov was misquoted as referring to Sergey Grechishkin as the main shareholder of KIT. He actually referred to Alexander Vinokurov, who was the main shareholder. bne apologises for any inconvenience or embarrassment this mistake caused.

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