State intervention sparks credit quality fears for Russian banks
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Emerging Markets

State intervention sparks credit quality fears for Russian banks

Government push for greater mortgage lending and reluctance to consider tighter prudential regulations would leave banking sector vulnerable in a downturn, say analysts

Ratings agency Fitch has warned that Russia’s banking sector could become the next victim of the continued role of the state in the national economy. Analysts also caution that rapid credit growth in a banking sector that is still fragmented and poorly regulated, compromises sound decisions about lending allocation, increasing the vulnerability to potential loan losses in an economic downturn.

“The threat of a crash is not impending since growth is from a relatively low base, but these banks are often making loan decisions not from a credit perspective but due to state-directed interests rather than economic ones,” said Ed Parker, head of emerging Europe sovereign ratings at Fitch.

In particular, Parker has been unsettled by the announcement last week from VTB24, the retail arm of Russia’s second-largest bank VTB, that its mortgage loan portfolio has almost doubled so far in 2007, to $1.5 billion at the end of July. The government is aggressively targeting 17% of Russian families to access mortgage loans, but surveys suggest that they are only affordable to 10% or less. (for more coverage of VTB, please click here)

Parker is concerned that VTB, whose supervisory council is chaired by the country’s finance minister, plans to offer mortgages to those with weaker credit profiles by the end of the year. He believes that there is a now a conscious relaxation of underwriting standards and heightened operational risks fuelling poor loan quality in the country, due to the state-dominated structure of the sector.

The country’s top three banks, Sberbank, VTB and Gazprombank are still state-controlled, and the next-largest player, Bank of Moscow, is owned by the city itself. The largest private bank, Alfa, ranks fifth, with about one tenth the assets of Sberbank. Parker argued that the continued clout of the state banks fits the broader Putin ethos of so-called sovereign-led development, whereby the government has reasserted its influence over key sectors of the economy.

“A trend of the recent years has been increasing government control over strategic sectors of the economy, but the huge increase in the capital bases of these banks is not healthy due to the credit concentration and lack of competitiveness,” Parker told Emerging Markets.

He is particularly worried that the dominance of these banks undermines the ability of small and medium size banks to diversify income streams, noting that the liquidity profiles of smaller banks are highly vulnerable and have not improved in three years despite the country’s robust economic growth.

Moreover, on the regulatory side, Parker warned that the central bank is failing to implement reforms necessary to head off the danger inherent in the fast-paced growth of the banking system.

“There are no great signs of reformist zeal, and the central bank regulator has a lack of political support, particularly since 2004 when the it strengthened the framework of prudential supervision by introducing deposit insurance legislation. After that, politicians were frightened and the central bank rolled back its reform agenda,” he told Emerging Markets.

These concerns were echoed by Dmitry Polyakov, credit analyst at Renaissance Capital in Moscow. “There are strong vested political interests behind many banks. This means the central bank does not have any free will to regulate without political impediments,” he told Emerging Markets.

Analysts are particularly anxious since the combination of a vast credit surge, real exchange rate appreciation and asset price growth is correlated with banking sector crises globally. Parker ominously cautioned: “Due to its structural weakness, the banking sector is a constraint on the sovereign rating and in an economic downturn it may significantly contribute to losses in the economy.” (for more coverage of the banking sector, please click here)

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