Russia's slow-motion banking crisis

By bne IntelliNews June 29, 2009

Bne Aris in Berlin -

At first the Russian government believed the banking sector would breeze through the crisis if they simply threw enough money at it. By the start of this year and some $23bn later, officials at the Central Bank of Russia started to get worried, fearing there wasn't enough money in the state's coffers to deal with mounting bad debt that could lead to a systemic meltdown. Now, as summer approaches, the attitudes have shifted again. Russia's banking sector is facing a climb to the 13th floor because the lift is broken: it will be a real slog and not everyone will make it, but it is doable if the effort is put in.

Russian banks are going through a slow-motion crisis that doesn't necessarily have a dramatic ending. The drama of September when the likes of KIT Finance teetered on the edge of collapse has passed. Now comes the boring, but potentially much more damaging, part of the crisis. Bankers are in a frustrating position, as even those who have been prudent and implemented good risk management are seeing their loans go bad, simply because the real economy is slowing and killing off companies that were making healthy profits only nine months ago.

Exactly how many floors banks will have to climb is still not entirely clear - it could be the 7th floor or maybe the 56th floor. A lot will depend on just how bad the problem with non-performing loans (NPLs) gets.

On the one hand, the economy's 9.8% contraction in GDP over the first quarter has caused a lot of damage, driving up NPLs uncomfortably fast. On the other hand, oil prices over $70 in May have taken some of the pressure off and the CBR actually increased its reserves by $10bn in June. An increasing number of analysts are predicting a faster-than-expected recovery in the second half of this year, but with the year-end GDP predictions ranging from minus 6.8% to zero, clearly the situation is as clear as mud. Let's say everyone's mood has brightened since March and leave it at that.

Bad loans

What happens to NPLs is key to what happens next and even the more cheerful observers admit the problem of bad debt will get worse before it gets better. Still, the issue will take about six months to hits levels where it threatens the stability of the system, giving the banks and state plenty of time to prepare.

Banks have been hording cash and ploughing profits back into their capital in an effort to create cushions to soften the bad-debt blow. April was one of the worst months for rising NPLs, but it was also one of the best for an increase in banks' capital adequacy ratio (CAR) - the cash that a bank keeps on hand to pay out to customers expressed as a ratio of total liabilities.

The sector's average CAR increased to a robust 18.1% in April, which is well above the 8% minimum that the Bank for International Settlements, the central bankers' central bank, recommends and also above the 14-15% of cash emerging market banks tend to keep in the till. This is good news, as it buys more leeway for banks in that they have more cash use for covering bad debts before they are forced to tap their capital, which is when the problems start.

Speculation over where NPLs will end the year has been continuous and the range extends from the CBR's official estimate of 10% of the total loan book by the end of this year (clearly too low) to the emerging market crisis norm of 35% (clearly too high). However, as banks start reporting their first-quarter results, some clarity is beginning to emerge and the good news is that the level of NPLs will be higher than the CBR was expecting at the start of the year, but still within the realms of what the state can cope with - some banks will have to be recapitalised, but a full-blown bank crisis will be avoided.

By the end of April the sector average of NPLs was 4.2%, according to the CBR, up from 1.6% last October when the crisis first struck, and are continuing to rise. The worst affected banks in the sector include leading commercial lender Alfa Bank, which already has NPLs of over 10%, but says that it has been provisioning and will cope.

Likewise, Alfa Bank's main rival MDM Bank reported results in June and has NPLs of 7.2%, up from 4.8% at the start of the year. However, the bank is expecting bad debt to reach 12% for the full year and, as it has already built up loss provisions of 7.5% of total loan book, the bank says it is confident it will be able to cover all its bad debt through to the end of the year. After that things will start to get better, as most observers are expecting the Russian economy to start growing and NPL levels to recede; MDM says next year it is confident it can recover half of its bad debt.

MDM and Alfa's experience compares with Bank St Petersburg, which expects to see a slowdown in the pace of asset-quality deterioration in second quarter and Bank Vozrohdenie is expecting levels of bad debt to start falling as soon as the second half of this year.

Bank recapitalisation

The big banks that account for the bulk of Russia's banking assets are a bit more confident about surviving to the end of the year, but not everyone is going to make it. The government was clearly hoping that the $23bn it has already pumped into the banking sector would be enough, but by June it became clear more money would be needed.

Moody's Investors Service said in a report at the start of June that Russian banks would require an additional $40bn in recapitalisation over the rest of the year and estimates the true average level of NPLs is already more than double the official estimate, or about 11%, as of the end of the first quarter. NPLs could reach 20% by the end of the year, the rating agency predicts, but if oil prices hold up, then the situation will be easier.

If it does come to recapitalisation, then a lot of small banks will go bust. So far, almost all the fresh capital that has been injected into the sector has gone to state-owned banks while small and medium-sized banks have received almost nothing; the number of banks in Russia has already fallen from over 1,200 at the start of last year to 1,087 as of the end of June. Thus Moody's believes that, "the Russian banking sector might experience further consolidation in the form of mergers and acquisitions as a result of weakening credit fundamentals of banks not directly benefiting from government support."

So who will get the money? At June's St Petersburg Economic Forum Russian President Dmitry Medvedev announced the Kremlin was planning a voluntary recapitalisation of troubled banks by buying their preferred shares.

During his opening speech at the biggest gabfest on the Russian calendar, Medvedev told delegates the Russian authorities had rejected the idea of a so-called bad bank to clean up bank balance sheets. Chief presidential economics advisor Akardy Dvorkovich elaborated, saying that banks are expected to do the workouts themselves. However, for banks that can't cope with their NPLs, the government is offering to buy their preferred shares on a need-only basis. And the deputy chairman of the CBR, Alexei Ulyukaev, went on to say that the government will buy commercial banks' preferred share issues on a voluntary basis using the OFZ government bonds as payment (which can be sold to the CBR in repo deals for cash). However, the recapitalisation will come next year and Ulyukaev said the money already budgeted for recapitalizations - some RUB435bn ($14.5bn) - will be enough to deal with the immediate needs of the sector.

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