Russia’s Banking Crisis
Businessmen believe the problems in the Russian economy are only just beginning
Illustration: Sergey Zheglo
This week the Russian government is due to set out a strategy for the long-term economic development of the country. It’s worth discussing the long-term prospects, having analyzed beforehand the real reasons for today’s crisis, the mechanisms of its development and the inevitable consequences that are already now evident.
The possibility of an autumn crisis in the Russian financial system has long been apparent. In spring, Central Bank statistics unequivocally pointed to a significant slowing down of the rate of lending by Russian banks, mainly due to the problems with funding stemming from the crisis in international financial markets.
Despite the worrying signals, the financial authorities have focused their energy on combating inflation - that is, on the liquidity squeeze: in the five months before the crisis the level of refinancing and the rates of banks’ contributions to the Compulsory Reservations Fund increased threefold. “Attendant factors” put an end to the matter. To begin with, Putin criticized the company Mechel, which business reacted badly to, especially abroad. Then there was the war with Georgia, which served as a pretext for a further withdrawal of foreign assets from Russia. Not by chance, the next increase – from September 1 – of the contribution rate to the Compulsory Reservations Fund occurred, sucking about 100 billion dollars from the banking system. As a result, by the autumn peak of payments (quarterly VAT payments and significant payments for the lending debts of the largest Russian corporations) the Russian banking system had reached a worse state of liquidity than by August 1998. It is no surprise that a short-term fall in oil prices and a corresponding strengthening of the dollar from September 10 to 13 was enough for a collapse in the crisis.
It appears that the refusal of the Bank of Russia to support the ruble during this time was a big mistake: together with the weakening of the ruble there was also a depreciation of shares and securities denominated in Russian currency. As a result, investors began to actively sell Russian securities, the RTS index dropped considerably below the level of 1500-1600 points which analysts believed to be the “bottom” of the market, and many investors began to buy up securities in the hope of quick growth.
Under normal financial conditions the problems would be restricted by the fall in the stock market. However, with the credit crunch, repo operations have become one of the main instruments for refinancing Russian banks. As a result, the crisis in the stock market quickly affected the banking system, since obtaining loans now required far more securities, which lenders priced with huge discounts up to 30%. Relending in order to settle obligations for previously taken liabilities became impossible.
On September 12, the first victim of this situation emerged: KIT-Finance was unable to settle obligations with Gazprombank to repurchase Rostelecom shares. Gazprombank - one of the 3 pillars of interdealer repo (along with Sberbank and VTB) - simply left the market, as a result of which on September 15 a total closing of limits began, and obtaining credit on mortgage securities became virtually impossible. Then Svyaz Bank, which is close to state structures and a major net borrower heavily dependent on market repo and interbank credit, collapsed.
Before the banking crisis nothing was left. Then the authorities finally began to react to the dangerous situation: On Wednesday 17 September, the head of the Ministry of Finance, Alexey Kudrin, announced the allocation of budgetary deposits totalling 1.1 trillion rubles for a period of 3 months to the three largest banks - Sberbank, VTB and Gazprombank. Later, the Bank of Russia got involved in saving the lending institutions, significantly reducing rates of contributions to the CRF, thanks to which about 300 billion rubles were returned to the financial system from the bottomless reserves of the Central Bank.
Meanwhile, the situation on the stock market situation had deteriorated. A number of the banks that obtained loans on mortgage securities, having received back somewhat depreciated bonds and shares, preferred to keep the money to themselves rather than return the cash to the creditor. And lenders have had to jettison securities on the market to get even some vitally necessary cash. Stock indexes have fallen and analysts have begun to seriously discuss a new “bottom” level of 500 points on the RTS.
It is quite possible that this would have indeed happened had bidding at the two stock sites, for the first time in modern Russian history, not been stopped by order of the Federal Financial Markets Service – i.e., the government. By the time trading stopped the RTS Index had managed to come close to 1000 points – a level unthinkable during the past three years.
Every Man for Himself
There has been some effect from the decisions of the government. Trades on the stock market grew microscopically in the first week to about 1300 points on the RTS index – and went into overdrive. On Wednesday, interbank lending rates in the financial market dropped to 2% annually – this only happens in the most profitable periods. Even in the second tier of banks rates fell sharply to 4-6% annually. On Wednesday 24 September, the banks took a total of 67.5 billion rubles from the Central Bank, nearly five times less than a week earlier. At the same time, bank funds in deposits at the Central Bank have increased several-fold, and most significantly, the level of funds in correspondent accounts. However, the mass opening of limits on the interbank market never happened. There is only short-term money in the market: banks are not willing to give loans any longer than overnight, or to buy securities, fearing that the lack of liquidity could come back at any moment.
The basis for such fears seems to be the firm belief of bankers that the money the government has allocated to Sberbank, VTB and Gazprombank will be left over. However, many second and third tier banks believe this is justified, because the main problems lie ahead. The stock market has reached the bottom, but in the banking sector problems will be caused by the need for businesses and organizations to make tax and budgetary payments. But the main financial steam of system-forming industries - oil, gas, the military-industrial complex - runs through Sberbank, Gazprombank and VTB. And they have no interest in refinancing their competitors.
The reports about the restrictions imposed by banks on giving out cash could serve as proof of the continuing tension of situation. Everywhere, rates at rising, especially consumer and mortgage rates, and credit limits are being reduced. There are even rumours about banks withdrawing already approved and allocated credit lines for small businesses.
The actual losses from the banking crisis are still unclear. On the assumption that the greatest challenges face those lending institutions that are actively working with all securities, we have produced a lists of banks with the largest portfolios of securities (see tables).
Return to Earth
Perhaps the only thing that can save those banks actively working with securities from serious problems is the rapid restoration of the stock market. But this hope is practically unrealizable. In the current situation, the return of the stock market to pre-crisis levels will only be possible as a result of the inflation of a new speculative bubble.
The current level is more than normal for the domestic market - it is adequate for the level of return on capital that was possible for the economy over the past 10 years, and it must be said, that is not small. From 1999 and until the autumn of 2005, the growth of the stock index was about 30% a year. This efficiency of investment was typical for the Russian economy as a whole (the payback period of projects amounted to 3 years). As the money market is in principle integrated – both for the real and financial sectors - the results of the work in each market should be approximately equal to one economic cycle (which began in 1998 and ended in 2008). If we acknowledge that today's normal RTS index level is more than 2000 points, it would mean that over the past three years our financial markets considered the real rate of return on capital to be 200% per annum. In that case, the real economy should show the same rate of interest - which, in theory, is impossible.
The current situation does not suit investment companies, nor banks closely related to the stock market, nor the Russian government, which harbors the idea of turning Moscow into a world financial center. Therefore, the Federal Financial Markets Service has decided “with a view to improving liquidity of stock market” to repeal from September 26 bans on short positions, unsecured and marginal transactions “to improve the liquidity of the stock market”. In addition, the government has adopted a decision to allocate 250 billion rubles a year to maintain the course of state companies’ shares.
However, the banking sector is in a very deep crisis. According to some estimates, in the coming months, the number of banks in Russia will decrease by one third. Some consider such prospects as a recovery of the banking system. It is quite normal that those banks that were only able to exist during the economic boom will have to cease or cut down their activities. It is important that this does not turn into a flight of depositors from other banks.
It seems that the authorities have considered this danger and taken preventive measures: the Deposit Insurance Agency approved the decision to increase the maximum insurance on bank deposits almost twofold - from the 400,000 to 700,000 rubles. The amount that will be returned to investors in full will also increase from 100,000 to 200,000 rubles. There is no doubt that the relevant bill will be passed in the State Duma in the near future. So it is likely that a stampede of investors will be avoided.
But comparable measures to support corporate lending have not yet been adopted. Meanwhile, in refusing to support the wider banking sector, the government is not taking into account the consequences in the real economy that this might provoke.
Changing in Order to Survive
Assessments of the duration and depth of the crisis vary widely. Officials believe that the worst of the crisis is virtually over. Businessmen, whose interests are closely tied in with the stock market, think that the depth and length of the crisis in Russia will depend on how the Americans implement the “Paulson plan” to rescue the national economy. Businessmen and analysts in the real sector of the domestic economy say that the seriousness and duration of the crisis will depend entirely on the willingness of the government to introduce amendments into economic, budgetary and tax policy.
In any case, it will soon become impossible to act as if there is no crisis. The problem is not only the inevitability of a sequence of takeovers and bankruptcies in the banking market. No less dangerous are the problems facing the property market. A drop in construction, in turn, will inevitably affect the metals industry (the crisis in Western property markets has already led to a fall in world prices for metals and for shares of metals companies). In addition, by next year retail will begin to feel the effects of stricter regulation around consumer credit.
All this will only add to the severity of an already noticeable, unfortunate trend - industrial growth in Russia is slowing down. According to the Government Statistics Service, in August production grew only in the food industry; in other sectors, either stagnation (oil production, engineering and others) or a drop in production (construction, manufacture of building materials and others) was observed. Indeed, the fall in the rate of investment, which is steadfastly fixed from the beginning of the year, will certainly increase as a result of the shocks in the stock market. In the next few months, stimulating investment and production will be the real problems, not “ensuring macroeconomic stability” or establishing an international financial center in Moscow. The difficulty is that for the current government this task will be fundamentally new – in the last ten years it has not had to deal with this issue. Will officials want to get down to resolving this issue, and if they do, will they be able to do anything?
We will soon get some clarity with the country’s strategy of economic development. It will undoubtedly deal with issues of reform, taxation, the pension system and tackling inflation. It will be possible to draw a conclusion from what decisions are made as to the depth and duration of the crisis one should prepare for.
Olga Zaikina and Marina Talskaya contributed to the preparation of this article.