Russian banks out of the woods, but no walk in the park

Russian banks out of the woods, but no walk in the park
Russia's banking sector is on the mend, but still delicate
By Ben Aris in Berlin June 19, 2018

Russia’s banking sector has returned to profit and the Central Bank of Russia (CBR) said in June that the sector clean up is nearly over. After more than two decades of “wild cat” banking, the dead wood and dodgy banks have largely been expelled from the sector, which is starting to look increasingly “normal”, even if there is still a lot of work to do.  

Russian banks have had a terrible few years and now the recovery has started it is the state-owned banks that are benefitting the most. In June Rosstat revised its growth estimates up and said that the financial sector was the biggest driver of improving growth figures in 2017. The entire sector was loss making for most of 2015 and 2016 if you count out the state-owned retail banking behemoth Sberbank. In 2015 Sberbank accounted for all the profits in the sector by itself.

Banks turned the corner in the middle of 2015 and began to recover from the effects of the collapse and the low oil price at the start of that year, earning RUB875bn ($13.6bn) for the full year. The pace picked up in 2016 with RUB945bn of aggregate profits and would have topped RUB1 trillion in 2017 if it weren’t for the collapse of some of the country’s biggest commercial banks, the so-called Garden Ring banks, in the autumn that nearly caused a systemic meltdown of the sector. The sector’s profits for 2017 were only an aggregate RUB788bn at the end of the year after banks as a whole lost a massive RUB322bn in September 2017 alone.

This year the sector is back on track to earn over RUB1 trillion again. The sector took in RUB148bn of net profit in March and if it can keep up the average from the first three months of this year it will finish the year with some RUB1.3 trillion in profit.

However, the numbers are distorted somewhat by the huge capital injections into the sector made by the CBR as part of its rescue operations, which reduces the aggregate profit to around RUB81bn in March. Subtract from that Sberbank’s profit of RUB67bn as well and the overall picture looks a lot less rosy. And in June the CBR announced the aggregate earnings for the sector in May was a net loss of RUB10bn -- not a huge amount but the result highlights the fact there are still a lot of problem banks in the sector. 

“For the fourth consecutive year, the average EE return on equity remained in the single-digit territory in 2017, on the Russian market the RoE dropped from 10% in 2016 to around 8% in 2017,” reports Raiffeisen International. There are several exceptions to this with Sberbank consistently earning RoE over 20%, but the sector average remains low.

The bottom line is the banking sector remains delicate, which is why the CBR’s reforms are important. In June CBR governor Elvira Nabiullina said that the clean up of the banking sector is “nearly over” as the number of banks fell to 534 and is approaching the 300 target Putin set several years ago that would give Russia a banking sector “similar to Germany’s.” However, there are still several years of work left to do.

While Moody’s said in June that Russia's banking sector is able to withstand another wave of US sanctions, the collapse of the top commercial banks in September last year showed that the system is still not solid. After a massive clean-up effort under Nabiullina the CBR is launching an across-the-board calibration of the supervision mechanisms of the banking sector, and has been cracking down opaque ownership and intends to force owners to sell off their other assets to pay back any bailout money the CBR needs to inject.

Still, thanks to the ongoing economic recovery the outlook for banks is improving. Loan growth was RUB1.1 trillion in the first quarter of this year, up 2.1% y/y, of which RUB400bn was retail loans (up 3.1% y/y) and RUB700bn was corporate loans (up 1.8% y/y). However, the level of lending is still down from the boom years: the loan-to-GDP ratio has been reduced from 58% in 2014 to around 46% in 2017, which is also well below the average ratio in CEE of 56%, reports Raiffeisen International. There is still a lot of growing room for the lending business.

“In case of the EE markets we see an untapped financial intermediation potential of some 3-7pp that can be realised over the next few years. In case of Russia, we see potential to exceed the loan-to-GDP ratio by at least 50% in the medium term,” Raiffeisen said in its annual banking report released in June.

And the net interest margin (NIM) for banks — the difference between the rate they borrow money at and what they lend it at — has improved, making lending more profitable: the sector average NIM was a healthy 4.4% in the first quarter, up from 4.2% in 2017.

If this pace keeps up then Fitch predicts the overall loan growth for 2018 will be about 10%, of which corporate loans will rise 7% and retail loans by 15% — much better than the 7%, 5% and 13% respectively seen last year.

State banks are increasingly driving the business, accounting for 73% of all lending (68% of corporate loans and 80% of retail loans) and have been aggressively cutting rates to encourage more borrowing by their clients. As a result of the nationalisations of last year the state-owned banks now account for some 70% of the sector’s banking assets and even more in some key businesses. For example, the biggest five banks in Russia account for eight out of ten rubles lent to home buyers and mortgage loans were up over 80% in the first four months of this year.

The CBR has said that it wants to sell off the stakes in the commercial banks it took over last year, but with the budget in surplus the government doesn't seem particularly interested in privatisations at the moment and recently said it won’t revisit the question until 2020.

Deposits are growing too and were up by RUB425bn or 0.9% in the first quarter, and Fitch is predicting deposits will rise 5%-7% this year.

Non-performing loans (NLPs) increased marginally and now account for 10.6% of the aggregate loan book, but these potentially bad loans are 92% provisioned for so while they act as a drag on banks’ business they are not a danger.

The improving profitably from the fat NIMs and growing loan volumes means that banks are starting to build up their buffers again. The capital adequacy ratio (CAR) — the amount of cash a bank holds to cover withdrawal demands — has risen from around 13% in the last few years to 14.7% as of the end of March. This is not the 20% that banks used to have in the boom years, but it is still well ahead of the mandatory minimum level of 8%.

However, it will be a while before banks are really playing their traditional role as financial intermediators in the economy that can catalyse growth. For the meantime it seems the CBR's main goal is simply to get rid of the badly run or criminally owned banks that have cost the state so much in rescues and bailouts over the last decade.