Is Russia on the verge of another banking crisis?

Is Russia on the verge of another banking crisis?
By Ben Aris in Berlin September 8, 2017

ED: this is the third in a series of three pieces looking at the collapse of Russian commercial bank Financial Corporation Otkritie and the implications for Russia's banking sector.

The near collapse of leading commercial bank Financial Corporate Otkritie has raised a wider question: is Russia is facing another banking crisis?

Tensions are high and the soaring repo deal volumes in August, when banks were trading bonds for short-term cash loans from the Central Bank of Russia (CBR), clearly shows that banks are building up war-chests to deal with potential runs on accounts — just in case. But just how sound is the Russian banking sector?

The short answer is: a lot better than it was a year or two ago. Russia’s banking sector has gone through two of the worst years since the end of the 1990s – worse even than the 2008 crisis year.

In 2015 and 2016 the only profitable bank was state-owned retail giant Sberbank, which always does well in times of crisis thanks to the explicit state guarantee on all its deposits. It is the only bank in Russia to enjoy this privilege.

In 2015, the entire sector made only RUB191bn (€2.8bn) in profits, all of which was earned by Sberbank. In 2016 things improved, with the sector earning RUB944bn, and this year banks will easily beat last year’s result. Sberbank still earns the lion’s share, but that share has fallen to about 65% of the total as other banks begin to recover.

The worst of the banking crisis seems to be past. In the first half of this year banks posted record pre-tax profit of RUB770bn. And the pace is picking up: in July, banks posted pre-tax profit of RUB157bn — the second-highest profit during the year after the RUB215bn posted in April.

The recovery is being lead by the powerful state-owned giants, which after the takeover of Otkritie by the CBR now account for some 64% of total bank assets, according to expert assessments.

VTB Group significantly outperformed the sector, earning RUB60bn in July, of which the parent bank accounted for RUB49bn (ROAE of 44%). This was followed by Sberbank with RUB56bn (22%), but Sberbank had a stellar second quarter and significantly beat expectations with RUB185bn of net income, up 27.6% y/y. That implies an annualised ROAE of a whopping 24.8%, as well as record high returns on equity.

But, “the temperature is not the same in all the rooms in the hospital,” as Russian bankers like to say. If there is a problem then it will come from the commercial banks, as Otkritie has already demonstrated.

Rescued earlier this year, Peresvet Bank reported the biggest loss in July of RUB8bn. Meanwhile, among specialised retail banks, Tinkoff, Rencredit, OTP and Home Credit had healthy profits equal to 2%-4% of equity, while consumer lending pioneer Russian Standard achieved breakeven, according to Fitch.

All 10 systemically important banks complied with capital requirements in July including buffers (core Tier 1 6.1%, Tier 1 7.6% and total ratio 9.6%), Fitch reports. Commercial bank Promsvyazbank was in the worst shape, with a too small cash cushion of Tier 1 capital ratio at 8%. But the bank has already dealt with this problem by issuing a $500mn perpetual bond in August that was added to its Tier 1 capital. Non-systemically important banks' requirements including buffers for core Tier 1, Tier 1 and total ratios were slightly lower at 5.75%, 7.25% and 9.25% respectively, but still good enough.

In general, as the chart shows, the capital adequacy ratio (CAR) of banks – the cash they keep to meet withdrawal requests – has been improving in the last year. However, the sector’s CAR remains in the low teens, above the mandatory minimum of 10% but well off the 15%-20% banks maintained before the 2008 crunch.

All of which is encouraging, but clearly there are some time bombs ticking in the sector. Since taking over as CBR governor, Elvira Nabiullina has closed over 300 banks, but most had a hole of around $1bn hole in their balance sheets. With Otkritie, the CBR clean-up campaign is moving into the really big bank territory. It is not clear how big the hole in Otkritie’s balance sheet is, but according to some experts it could be north of $14bn, which puts it beyond the CBR’s ability to bail it out.

It is already clear that the sector’s liquidity is very unevenly distributed. Sberbank and most large private and foreign banks have liquidity surpluses, as they have repaid most or all of the money the CBR lent them starting in 2008. As of August 1, these big banks kept RUB0.7 trillion in interest-bearing deposits with the CBR, which is considering issuing bonds to absorb excess liquidity from them. However, some state-owned banks, especially VTB, are still reliant on state funding.

Among private banks, few used expensive ruble CBR funding, with Otkritie being the stand out exception in July (RUB338bn), as well as B&N which borrowed RUB51bn to cover funding outflows in June-July. At August 1, both banks had liquidity buffers covering about 20% of customer accounts, which for Otkritie is only moderate, given the magnitude of previous outflows. Promsvyazbank is another name that comes up in connection with Otkritie’s problems.

If the CBR can calm nerves then in theory the banking sector profits that can be used to improve Tier 1 ratios will continue to reduce pressure. The problem is while the very profitable retail lending segment has finally started to rise again after several years of contraction, corporate lending is falling as Russia’s leading companies prefer to borrow longer and cheaper on international markets. As bne reported in its last monthly bond market wrap the volume of international bond issues by Russian companies roughly mirrors the fall in corporate loans at home.

The high cost of borrowing is the culprit and despite the string of rate cuts in the last year, the CBR’s base rate remains 9%. With slow growth of under 2% expected this year, the cost of borrowing is still too high to make many investment projects in Russia viable. After inflation started to fall again in July, the CBR is widely expected to resume its rate cuts at its next meeting in the middle of September, but it will be another year at least until the rates are low enough to spur domestic borrowing.

 

This article is part of the cover section in bne’s monthly free magazine. You can read the whole issue here and sign up to receive the magazine by email each month by filling in the form here

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