Russia’s banking sector is being shaken up by new entrants armed with the latest technology, but the process is proving anything but smooth for some of these pioneers.

Tinkoff Bank is a classic example of a disruptive startup taking on established rivals. Founded as Tinkoff Credit Systems in 2006 by serial entrepreneur Oleg Tinkov, who was previously involved in brewing beer, Russia’s first internet-only bank quickly, but with some bumps on the way, became one of the leaders in Russian consumer finance thanks to its branchless model and reliance on the internet to reach into the regions.

With a population of 146mn people spread over nine time zones, the biggest problem that most Russian businesses face is how to cost effectively reach all corners of the market. Russia’s enormous geographic size makes the internet an extremely attractive platform and Tinkoff Bank has epitomised the thinking by adopting a “Moscow last” strategy during the decade it has spent building up its client base. Two-thirds of its customers are in towns of less than 200,000 and another third are in towns of less than 50,000, the bank told bne IntelliNews in an interview.

Tinkoff Bank has no branches and operates exclusively online, handing itself a huge cost advantage by eschewing the expense that comes with bricks and mortar branches, which the Central Bank of Russia (CBR) requires meet stringent security standards for vaults and the like.

The bank took several years to build up the trust of the Russian population, but it has been flying since the economic slump that hit Russia in 2014. Tinkoff Bank is able to offer higher interest rates than its competitors and is grabbing a larger slice of the only cheap source of funding in Russia at the moment: deposits.

“Tinkoff Bank is a leader in credit cards and has developed a successful online retail deposits programme in Russia, serving customers through a high-tech branchless platform,” says Oliver Hughes, the British-born CEO of the bank.

By the end of 2015, the bank was the second largest player in the Russian credit card market, with a market share of 7.7%, having issued over 5.4mn credit cards. It offers customers credit, debit and prepaid cards, deposits, and mortgage products.

At the heart of the startup bank’s success is cutting-edge technology, focusing on mobile services and offering special apps. “Tinkoff is applying competitive pressure for others in the industry to use data to better focus on customers, provide better services, and use data for competitive advantage,” says Roger Nolan, director of solutions at Informatica, a provider of data management solutions that has worked with Tinkoff Bank for some time.

The bank’s strategy was borne out in June when London-listed TCS Group, of which Tinkoff Bank is a part, reported record profits of RUB1.85bn (€25.4mn), just over double the previous year, completing a reputation turnaround from being a dog to a star of Russia’s financial system. Its return on equity had rebounded to 16.7% by the end of 2015, and it expects its net loan portfolio to rise by 15-20% in 2016.

Online in a big world

Mobile phone companies actually pioneered the way for Tinkoff Bank. The first piece of Western technology that nearly ever Russian bought was a mobile phone. More recently, while “dumb phone” sales have slowed, smartphone sales are continuing to expand and these have provided a readymade platform for expanding financial services for punters fed up with standing in slow-moving queues at Sberbank, Russia’s retailing behemoth.

Already a leading seller of handsets, Svyaznoy, modelling itself on the UK's Tesco, decided in 2012 to leverage its store network by becoming a bank too. Russians not only bought their phones at the company’s 3,000 branches, but would go once a month to the stores to top up their accounts. The company hoped to leverage its strong financial relations with its customers. By offering credit cards, it also avoided those onerous CBR branch regulations, while its countrywide retail network in effect gave it one of the largest branch networks in the banking system.

The Svyaznoy Bank expanded into utility, phone bill payments, and started selling non-government investment funds, known as PIFs in Russia, to rapidly become the third biggest player in the nascent mutual fund business by the end of 2012. But it went too fast. The growing pressure on the financial system, slowing economy, rising cost of capital and international financial sanctions combined to kill the bank off at the start of 2015, when its capital ratio fell below the mandatory minimum requirements.

A similar story has played out at MTS Bank, the financial arm of Russia’s biggest mobile phone company Mobile TeleSystems. Svyaznoy had a 92% brand awareness in Russia when it launched its bank, but MTS has 100% and is probably the country’s most valuable brand. Its parent company AFK Sistema already owned the Moscow Bank for Reconstruction and Development (MBRD) and decided to rebrand it with the same logo as the phone service.

MTS, which is listed in New York and Moscow, paid $100mn for a quarter of the bank and intended to expand into the fledging financial services business to provide further products to its 70mn customers in Russia. The logic is that Russia remains one of the largest “unbanked” markets in the world, especially focusing on credit and debit card customers. Like Syvaznoy before it, MTS was also hoping to leverage its 4,200 phone stores to help sell financial services in addition to the handful of fully licensed MBRD branches that the bank operated.

“The problem is that you cannot offer banking services unless you have a bank license. We would love to allow people to simply point their phones at a cash register to pay their bills, but you need to have a bank behind you to do that,” says Joshua Tulgan, director of corporate finance and investor relations at MTS.

However, the company has had to scale back its ambitions. Like others, its bank has got caught up in the recession and now is not a good time to be rolling on out new ambitious expansion plans.

For investors, the distinction between bank and online venture has been a confusing one. TCS raised $1.1bn in an IPO in October 2013, issuing GDRs at $17.50 each, which valued the bank at $3.2bn. However, the bank was priced as an internet venture and coupled with Russia’s political and economic woes, the share crashed shortly afterwards and now trade at around $5.