To pity Gennady Melikyan or to scold? Was the man in charge of monitoring the health of Russia’s leading banks complicit in a series of humiliating bank failures, or a willing soldier guilty merely of following orders?
“I wanted to leave long ago,” he said on announcing his resignation. “I’m psychologically tired. I can’t relax in this job, not in my car, not at home.” Melikyan’s predecessor Andrei Kozlov was shot dead in 2006 following a brave campaign to clean up Russia’s banks.
But by stepping down on September 9, Melikyan, deputy chairman and head of the Central Bank of Russia’s (CBR) supervisory committee, saved the Kremlin the bother of pushing him first.
The question now is not who will replace him – Russian press reports suggest the central bank’s Alexei Simanovsky is the frontrunner, but no official announcement had been made at the time Emerging Markets went to press.
It has, even by Russian standards, been a banner year for financial incompetence and malpractice.
To lose one lender last November – Mezhprombank, a marginal lender often referred to as “Putin’s bank” thanks to its close links to the Russian premier – at a time when most global banks are shoring up their capital bases may be regarded as a misfortune. To lose a second – Bank of Moscow (BOM), the recipient of a $14 billion state-sanctioned bailout in July by VTB group – looks like carelessness.
BITTER PILL
The failure of BOM was particularly galling for the Kremlin. In many ways, Russia’s fifth-largest lender, as it was before being absorbed by VTB, summed up all that is wrong financially in this resource-rich nation of 143 million people.
First, it highlights the power of political patronage, a sense that within any institution or corporate there is always a single, tribal leader: all-powerful, often unaccountable and sometimes fatally so. So it was, with BOM’s leading figures – chief executive Andrei Borodin and his patron, the former Moscow mayor Yuri Luzhkov.
When Luzhkov was sacked in September 2010 by President Dmitry Medvedev, it spelled the end for BOM. The Kremlin finally had a reason to take a good look at the bank’s books and what it saw staggered even them: VTB, the nation’s leading private-sector bank, was immediately ordered to take over, acquiring a majority stake in the city lender.
Billions of dollars of loans, it was alleged, had been siphoned off to friends of Borodin and Luzhkov, including the latter’s wife. Much of this, routed into overseas accounts, was untraceable, the Kremlin said; overnight, a third of BOM’s loan book ceased to exist. Borodin, disgraced and fired, fled Moscow for the safety of the Jumeirah Carlton Tower hotel in London’s Knightsbridge, from where he is suing VTB for $5 million for breach of contract and unpaid wages.
This patronage system matters, if for no other reason than loans tend to get channelled to people who are on friendly terms with the bank’s owners. “At the end of the day, many Russian banks are run by management connected to main shareholders – which may also have other business interests – and this inevitably creates problems,” says Vladimir Savov, head of equity research at the Russian investment bank Otkritie.
Corporate governance is a concern at every level of the financial economy and not just within banking. Buyout firms, for instance, struggle to work out the true value of a company.
Olga Plaksina, chief executive at one of Russia’s largest indigenous private equity firms, the $11 billion IFD-Kapital, advises foreign buyout firms to buy majority stakes in local businesses. “You need to invest in controlling stakes here,” she says. “Buying smaller stakes particularly in smaller companies here is dangerous as the level of transparency and corporate governance is worse here than in other places.”
RIGHT AND WRONG
Financial information is available on demand – lots of it. But often, the wrong sort is provided, or the right type is available but wantonly overlooked.
Take the central bank’s financial reporting regime. This is where logic and reason take a back seat to the prevailing rule-based orthodoxy. The CBR demands that banks deliver a full list of all transactions, including fixed income, on their books at the end of every trading day.
Yet the figures delivered to the CBR present, in every case, the face value of every transaction at its origin, rather than its current value. This fails to take into account the liquidity and net worth of the client; other loans or fixed-income transactions they may have taken out with the same or other banks in the meantime; or any changes in the market value of the transaction.
“It’s a Soviet measure for accounting activity,” says Nataliya Orlova, chief economist at Alfa Bank. “When a transaction is closed, only then does it reflect the profit or loss.”
ACCOUNTING METHODOLOGIES
Another oddity lies in the accounting methods used by local banks. All banks report to the CBR, the country’s banking regulator, using both local (Russian Accounting Standards) and international norms (based in large measure but not replicating International Financial Reporting Standards (IFRS) norms).
Most banks (particularly the large ones, and then not always) collect data relating to IFRS standards to report to investors, but are under no obligation to report that data to the CBR, which in any case couldn’t do anything with that information. So, under IFRS norms, “the central bank can ask questions of a bank, but the data has no actual meaning,” says Orlova at Alfa Bank.
This in turn permits the lack of oversight that allows banking problems to be overlooked until it is too late. Russia’s antiquated financial reporting system allowed both BOM and Mezhprombank to fail. After its bankruptcy in late 2010, the ratio of non-performing loans at Mezhprombank, owned by senator Sergei Pugachev, a good friend of premier Putin, jumped from 1% to 99% overnight.
To be sure, regulators can be deceived, but some say that in Russia’s case, they appear to be content to deceive themselves. Otkritie’s Savov says: “Unless supervision becomes more proactive and the banks become more transparent [problems will continue].”
Much needs to happen to get there, and much can go wrong. Russia needs a central bank that is strong, and which has the clout to question, if necessary, its political overlords and the oligarchs who run the Kremlin.
Jason Hurwitz, senior financial analyst at Alfa Bank, says: “As with many countries, the Russian banking system needs a CBR that has the manpower and senior political support to perform its oversight duties well. Investors may be concerned, however, that improved oversight would turn up even more skeletons.”
The nation also needs fewer banks and greater financial stability.
No definitive list exists, but Russia is believed to have between 1,000 and 1,200 banks, many reliant on a single client – more than the rest of Europe combined. In short, the system and the country could do with a period of consolidation.
Over the past year, that 1,000-strong list has only been tempered by banks failing (BOM, Mezhprombank) or fleeing the scene, such as the UK’s Barclays.
A handful of genuinely powerful banks should emerge from this process – led as ever by Sberbank, which holds 58% of all retail deposits – and these are set to remain in government hands. VTB Bank, 85.5% owned by the Kremlin via the Federal Property Management Agency, is likely to be systematically privatized, with a stake of around 10% sold to institutional investors, in Russia and beyond, either this year or 2012.
Other leading banks are likely to continue to emerge, notably Gazprombank, owned by the energy giant of the same name. Problems however may emerge for oligarch-owned banks, which suffer perhaps from too much name recognition.
“Many corporates don’t want to put their money in an oligarch bank, as they worry that the bank’s owner, who may well be a rival of theirs, will dip into their accounts personally, and get to know their weaknesses,” says one Moscow investment banker. “They probably are correct in worrying that this will happen.”
Another interesting aspect of Russia’s banking sector is the fact that, post-financial crisis, retail and corporate clients are keener to park their cash with state-run lenders. Financial analysts across Moscow attest to this shift.
Alfa Bank’s Orlova says: “During the financial crisis, Russian private banks took a very tough line with their borrowers, forcing them to pay back loans, while Sberbank and other state banks opted to restructure loans rather than force repayment. Added to which, state banks are increasingly seen as being more reliable than private banks.”
FINANCE HUB MOSCOW
But some things are slowly and quietly improving.
President Medvedev desperately wants to create, in Moscow, a regional financial hub driven by a select band of local lenders and augmented by global lenders vested with the task of helping to educate and expand the market.
Before that can happen, the capital’s infrastructure needs to improve markedly. Many hope that process of improvement has already started.
A more pro-active city government is in place – already the city elders have rolled out grand plans to relocate a large chunk of the city to virgin land directly to the south, tackling head-on the gridlock that makes Moscow’s streets a giant parking lot for the majority of the day.
Moscow does have a number of appealing attributes as a potential financial hub including, says Alfa Bank’s Hurwitz, “its large size, its polar location in a good time zone, and Russia’s potential for a well-balanced economy in the long term.”
In addition, the economy contains enormous resources of energy-based carbon as well as a host of agricultural commodities.
Other things are changing too. A merger of the RTS and the larger MICEX stock exchange should be complete by the end of 2011, with a view to a future initial public offering. That, Russian officials hope, will push the dream of turning Moscow into a leading financial hub a step closer. Plans to develop the short-selling market, by streamlining the long drawn-out process of gaining a licence, are also in the pipeline.
“The merging of the two main Russian stock exchanges is clearly a step in the right direction,” says Otkritie’s Savov. “Having a central depositary rather than many regional ones is a step in the right direction. Removing limitations on investors, such as quotas restricting the amount of equity a Russian firm can list on an overseas stock market, is good.”
Since its formation two decades ago, the Russian Federation has been stuck between two worlds: unable to shake off the shackles of paranoia inherited from the Soviet era and stride forward into a brighter, more transparent era.
Proper corporate governance is still largely a pipe dream, from failed banks like BOM and Mezhprombank disasters that report data that is either false, or is ignored by various levels of bureaucracy.
Worse, Russia’s financial system lacks quality banking talent – much of which has emigrated to the US or London – or a vigorous reporting system, driven as it is by the politics of bank ownership, rather than via a strict regimen of financial accountability.
Again, this echoes back into the country’s dominant tribal structure, in which pronouncements boom down from the top of the system to be acted upon immediately and unquestioningly.
Tackling this problem may prove, ultimately, to be impossible. “Changing the hierarchical style of management in Russian companies may be challenging,” says Alfa Bank’s Hurwitz, “as it seems to be a deep-rooted part of the regional culture.”
Given all this, should we pity or scold the central bank’s former supervisory chief Melikyan? Probably neither. Western banks have hardly covered themselves in glory this past decade, but when faced with problems, western officials have tended to react proactively, albeit belatedly.
In Russia’s financial system, willing soldiers like Melikyan follow orders – even at their own peril. By any measure, this is no way to run a financial, banking and reporting system.