Fragmented banking system teeters on the edge

  • 31 Oct 2008
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Russian financial markets are in turmoil despite the comprehensive state bailout measures introduced in the past month that total more than $200bn in new liquidity. The developments mark a turnaround for the bloated banking sector, which had been growing fat on foreign loans and increasingly affluent consumers. A bank consolidation scramble, already sanctioned by the government, looks inevitable. By Jason Corcoran.

The Russian banking system has, so far, defied foreign sceptics and withstood the global credit seizure far better than its counterparts in Europe and the US. State bailouts of financial institutions have been few and far and between but the fallout has to a deposit flight from private to state banks which could trigger a rush of consolidation in a market saturated by over 1,200 banks.

Despite its low exposure to US subprime loans and toxic debt, Russia has been sucked into the global credit crisis because its economy relies on the international capital markets for cheap credit.

The Russian authorities and state banks are working to insulate the economy and to re-liquidise the domestic equity market until the time comes when the Western credit market thaws.

"Confidence will return to the Russian banking system as bankers realise the worst is behind them," says Richard Hainsworth, chief executive of Global Rating, the Moscow-based bank rating agency. "This will repeat a process seen in Kazakhstan. The country’s banking system faced substantial pressure in 2007, but its banks were able to refinance their foreign borrowings from new sources, and the pressure is behind them."

Russian banks are likely to face the same deposit outflows and deterioration in asset quality that has hit the Kazakh financial sector over the past 12 months, but analysts believe the Russian system will not be quite as seriously affected.

Hugo Swann, equity analyst at Credit Suisse in London, says the two most important consequences for the banking sector are a slowdown in lending growth and an increase in non-performing loans as Russian corporates and consumers struggle to refinance.

"Russia has experienced two banking crises in the past decade — a more serious crunch in 1998 and a brief confidence crisis in 2004," says Swann. "Russia has entered the current crisis in a much stronger shape than previous ones. The economy is under-leveraged and macro risk is relatively low in a global context."

Russian banks are suffering from many of the same problems as Kazakh institutions as they lost access to the wholesale markets on which they heavily relied, while non-performing loans are expected to double to about 4.5% by the end of 2009.

Kazakh banks began to get into trouble roughly one year before Russian institutions and have since had to rely on government and foreign support in the form of capital injections from sovereign wealth funds to finance themselves.

Government authorities have already pledged nearly $200bn of investment in the Russian economy through a series of anti-crash measures, as well as putting restrictions on the amount of money individuals and companies can withdraw from financial institutions.

The resilience of the Russian banking system comes from a solid asset base, attention to liquidity and capital, and the lack of a derivatives market.

Up to 200 on the block

However, Russian central bank chairman Sergei Ignatiev says he expects 50 to 70 banks to go under while financiers believe that over 200 banks will collapse or be on the block for sale.

"Crisis impact on the sector is uneven," says Dmitry Dmitriev, global head of financial institutions, consumer goods and services at VTB Capital in Moscow. "Small players, especially those which relied on wholesale funding or had excessive investments in securities or long term assets are indeed in trouble while the largest ones, especially state-owned ones affected to a lesser extent are enjoying all the benefits of size, strong credit quality, high level of trust from depositors and counterparties and support of the state."

Fears the crisis is sparking a system-wide run on the banks led the Russian government to guarantee savings of up to 700,000 roubles ($26,800), which covers the bulk of private deposits.

Analysts have so far reported withdrawals of up to 10% with the biggest transfers coming from companies shifting funds from commercial banks to state-controlled banks.

Analysts at UniCredit in Moscow say the leading account gainers were Gazprombank, which increased the amount on its corporate accounts by a third to Rb359.6bn ($14bn), and VTB with a 17.4% jump, compared to around 4% growth for the industry.

A more widespread run on the banks could yet be triggered by a collapse in the value of the rouble, which the government has already spent an estimated $50bn defending.

"A deposit run is one of the major risks now," says Marina Vlasenko, a senior credit analyst at Commerzbank in Moscow. "It’s quite a material prospect for the banking sector which has over 1,100 banks. We should instead have about 200 banks and it seems the government also feels that way."

The crisis has so far has been limited to state bailouts for four small to medium sized banks and brokerages; Globex Bank, Kit Finance, Sobinbank and Svyaz Bank.

"We are focusing on industries of federal importance and industries accessing federal funding such as minerals and extraction, food, machine building and transportation," says Yuri Lekarev, a director at Nomos Bank in Moscow which accessed funding through auctions by the central bank. "We don’t have much exposure to large Russian retailers or developers and our non-performing loans are historically quite low."

Mid-sized SB Bank has also tapped federal funding to shore up its liquidity. "We are a corporate bank and we don’t do much consumer lending," says Elena Ignatieff, a managing director of SB Bank. "We are focusing on SMEs with less than $40m in turnover. Our deposits are up and we haven’t seen our NPLs yet for the third quarter but they were 0.08% during the first half of the year."

The State Development Bank (SDB) moved to take over both Svyaz Bank and Globex and is expected to play an important role in future consolidation.

SDB is responsible for channelling $50bn to help companies refinance foreign debt, $17.3bn in subordinated loans for the largest banks, and $6.7bn to invest in stocks and corporate bonds that the government sees as undervalued.

Flagship state banks VTB and Sberbank have been bulwarks throughout the crisis and are continuing efforts to maintain liquidity in the interbank lending market.

Cuts inevitable

In order to support the banking sector, VTB is gradually expanding the list of banks eligible to operate in the interbank lending market. The total number of banks now eligible has reached 76, compared to the early crisis period in mid-September when 18 were eligible to operate in the interbank market.

"Today, the total volume of loans granted to Russian banks has approximated to $2.5bn," says VTB chief executive Andrei Kostin, in a statement to EuroWeek. "If the Guarantee Law is passed allowing the Bank of Russia to guarantee the recovery of most of the loans in the interbank lending market, we can increase the number of the banks to 100-120."

Russian brokerages have been reeling from the steepest capital outflows since the 1998 crisis which have brought Russian stock markets hurtling down as much as 70% and led to spasmodic closure of its exchanges.

Renaissance Capital has so far been the worst affected of the brokers, having been forced to sell 50% of its shares to oligarch Mikhail Prokhorov. The bank has announced 100 job cuts across the bank and has received $250m in a collateral-free loan from the central bank.

"We could have run the gauntlet and we may well have made it but we were looking at an environment where Goldman Sachs and Morgan Stanley couldn’t make it as an investment bank," says RenCap’s chief executive Stephen Jennings. "People who have taken their medicine, dealt with their counterparties, will be rewarded."

VTB, which has recently launched aggressively into investment banking, said it had frozen recruitment in selected areas and had suspended a move into its new headquarters in the emerging business district of Moscow. Board member Yulia Chupina said VTB would soon open new sales offices in New York and Dubai and would play a role in the consolidation of Russia’s banks.

However, a deal whereby VTB would take a stake in Renaissance Credit floundered after parent company Renaissance Capital declined to cede control of the consumer bank.

Russian investment banks Alfa Bank and MDM Bank have reduced their headcounts in Moscow as expectation grows that Western banks will be forced to cut back in a tightening market.

Recruiters and bankers in Moscow suggest that banks which had paid multi-million dollar three-year guarantees to attract talent during Russia’s capital markets boom would be the first to pull back.

"Overall, we have reduced our number slightly but we have upgraded the talent over the past year," says Edward Kaufmann, head of Alfa Bank’s investment banking business in Moscow. "We are going to be building out in structured products and we will change some people’s roles to reflect market activity."

Kaufman said Alfa had recently added five to six bankers to its London operation, including Mark McCracken and Julia Dawson from Deutsche Bank, and Roland Glassford from Goldman Sachs.

HSBC said it was pushing ahead with expansion in Russia with launches of private banking and retail operations on track for later this year.

John Nicholls, deputy chief executive of HSBC Russia, said the bank had approved a $200m increase in the charter capital of its Russian subsidiary in early October.

The bank has quadrupled its Russian team from 90 to 360 people in the last 18 months and has no plans to cut staff.

A UBS spokesman in London said the Swiss bank’s closure of commodity trading operations around the world would not affect Russia where cuts will be minimal.

Nick Jordan, head of Lehman Brothers’ Moscow operation, says all of his team remained signed up following its takeover of the bank’s European and Asian operations by Nomura.

He says: "Neither they nor us could on our own build a platform in Russia and now we are closer to achieving this."

But more than staff cuts, Russia watchers will be focused on the extent of the bank consolidation process, in both the public and private sector.

Last week billionaire Alexander Lebedev’s bank, National Reserve Corporation, acquired control of Russian Capital bank for a "symbolic fee".

Promsvyazbank, Russia’s 11th biggest bank by assets, announced that it has acquired Yarsotsbank, a bank in the Yaroslavl region in northern Russia. And MDM Bank deputy chief executive Andrey Ilyin has told the press his bank has the capital, liquidity and willingness to act as a consolidation centre in the Russian banking sector.

The bank industry urgently needs to rationalise to improve banks’ cost of funding and the financial crisis has served to move this process much further up the agenda. Many see this as no bad thing in the long term.

  • 31 Oct 2008

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
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1 JPMorgan 317,793.98 1355 8.72%
2 Citi 301,114.13 1092 8.26%
3 Barclays 259,580.63 846 7.12%
4 Bank of America Merrill Lynch 258,842.43 934 7.10%
5 HSBC 224,273.23 905 6.15%

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1 JPMorgan 32,854.00 58 6.73%
2 BNP Paribas 31,678.29 142 6.49%
3 UniCredit 31,604.22 138 6.47%
4 HSBC 25,798.87 114 5.29%
5 ING 21,769.65 121 4.46%

Bookrunners of all EMEA ECM Issuance

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1 JPMorgan 14,633.71 80 10.23%
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3 Morgan Stanley 9,435.23 48 6.60%
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5 UBS 8,781.68 42 6.14%