The countries in the CIS (including the Caucasus and central Asia but excluding the Baltics) are undergoing rapid change. Their banking industries, however, are developing more slowly. Much still needs to be done to make banking an integral part of these countries' culture, especially from a regulatory and legal standpoint. Even so opportunities are growing, especially for foreign banks that have the expertise and nerve to invest in this volatile but exciting region. Returns can be high, though the risks are obvious.
Emerging Markets gathers together a panel of senior bankers and financial analysts from local and foreign institutions to discuss how they think banking in the CIS will evolve.
Topics covered include: the political and economic outlook for the CIS; the opportunities in retail and corporate banking; the reform process in Russia; the role of foreign banks and the multilaterals in developing banking.
The panel
Sudip Roy (chair)
Editor,
Emerging Markets
Herbert Stepic
Deputy Chairman
RZB
Jeff Millikan
Managing Director
RZB
Nick Tesseyman
Senior Banker, financial institutions
EBRD
John Gibling
Director, financial services
Standard & Poor's
Timur Issatayev
Chairman
ATF Bank
Vasily Vysokov
President
Center-Invest
The roundtable took place on January 12, 2005 at the Marriott Hotel in Vienna. Emerging Markets would like to thank all the participants and RZB for sponsoring the event.
Sudip Roy: What's the economic and political outlook for the CIS for the next six to 12 months?
Jeff Millikan: From an economic perspective, it's very positive for the region. I don't think any significantly sized country will experience a slowdown in 2005 compared to 2004, notwithstanding the fact that oil prices ought to come down and stabilize, and that two of the countries [in the region] are major oil and gas exporters [Russia and Kazakhstan]. Politically, it's been an interesting year, particularly in Ukraine but also in Russia. But I don't think the political situation in either country will have much impact on our activities.
Timur Issatayev: I think the "Orange
Disease" [ie the democratic revolution in Ukraine] as we call it is likely to spread.
Jeff Millikan: To where?
Timur Issatayev: We have elections coming up in Moldova and in 2006 presidential elections in Kazakhstan. So those are the likely countries to catch some form of Orange Disease.
John Gibling: Do you think that because of these elections that economic reforms may be slowed down and the politicians focus on more populist policies?
Timur Issatayev: It's always a possibility.
Sudip Roy: What about the economic
outlook?
Timur Issatayev: I see the positive trend in Russia continuing where we have seen very high growth rates. In Ukraine, we have had a few hiccups, though the country is at a new beginning, which is good. There are certain difficulties facing the new government, mostly because of people's high expectations. But Ukraine is experiencing strong growth – its steel industry is booming and I see further developments.
Belarus is a totally different political animal. It has a relatively autocratic president. Having said that, the economy is improving, with a growth rate close to 10%. Also, one must remember that Belarus has low levels of debt and the only reason anyone talks of difficulties there is because of the political situation.
As for Kazakhstan, I am very positive. There is a constant influx of investment – yes, it's oil-driven, it's gas-driven and it's mineral-driven but the country is doing well. So all in all, from an economic perspective I see a continuation of the very positive developments that have occurred over the last few years in the region.
Sudip Roy: Has anyone, though, got any fears about a potential asset bubble arising, particularly in Russia?
Herbert Stepic: I see no sign of a bubble as far as Russia is concerned. The government debt ratios are quite comfortable and it is striving to repay debt early to international creditors, to the Paris Club and to the IMF. Of even greater importance is the fact that Russian companies remain under-leveraged. I admit that [credit] spreads are still on the high side. That is partly due to the stronger rouble. That makes the rouble very attractive, but having said that,
there are no signs of hot money flowing into Russia, which is in contrast to 1998. So the market is very liquid and the banks are sitting on lots of cash.
As for Belarus, I see no fundamental threat of a financial market bubble because the conditions for a bubble are absent.
Finally, in Ukraine, again I see no threat of a financial market bubble. The public debt is at a modest 27% of GDP and
leverage in the private sector remains
relatively modest.
Banking opportunities
Sudip Roy: If we move on specifically to the banking sector in the region, where do you think opportunities lie?
John Gibling: If you look across the region, the opportunities are very much in retail banking, and we've seen growing interest from foreign banks in the Russian retail market. Last year we saw DeltaCredit being bought by GECC; Cetelem, the consumer banking subsidiary of BNP Paribas, attempting to purchase Russian Standard Bank, and more recently, Societe Generale's Russia-based subsidiary announcing its interest to buy the small retail orientated, Promek Bank.
Vasily Vysokov: As a regional banker I support John's view – retail banking is developing in the regions and we see huge potential in this area. But also, we see opportunities in lending to SMEs, which is a rapidly growing area. SME lending makes up more than 50% of our loan portfolio. Technical and financial support, which we are getting from the EBRD and IFC for SMEs lending, is a big aid for SME development in the regions.
And I can't help mentioning leasing – there is a big future for it in Russia.
Sudip Roy: What's pushing this move
into retail?
John Gibling: First, there's not a huge
number of lending opportunities in the corporate market.
Sudip Roy: Because a lot of them are
cash-rich?
John Gibling: Some are cash-rich but many of the large corporates are part of financial industrial groups that have their own banks. On the savings side, the banks are trying to get people's savings into accounts which, hopefully with regulatory changes in Russia and in Kazakhstan, will be a safer place [than under the mattress].
Also, wealth levels are gradually increasing in these countries, so there is a greater demand for higher living standards and better housing.
Sudip Roy: Are you seeing a big surge in the development of a credit culture in this region?
John Gibling: It's starting, I think it began with consumer loans. The mortgage market is still under-developed, there are very few institutions looking at that market. But obviously as time goes by and as a credit culture and credit history develops, then there will be a move from consumer loans to credit cards and mortgages. Then there are other issues, such as: how do people who have not had debts in the past, manage all of these debt instruments in the future? That could be crucial.
Jeff Millikan: The inhabitants of this region are largely conservative, they've never borrowed before, though that's starting to change. What we're seeing happen in the CIS is what we've seen happen in central Europe and, to an extent, in south-east Europe. Initially corporate loans
are made (there's not much in the way of consumer business), spreads tighten,
competition picks up and wealth occurs. People get more educated in banking
services and you get a demand for higher consumer spending, which usually means credit. I think we're still in a customer educational phase.
The other contributing factor, apart from the blip last spring/summer in Moscow and recently in Ukraine, is that people are becoming more confident about the banking system. The banking system in Kazakhstan is very stable, in Belarus it's stable. We've seen increases in the overall level of deposits because people are bringing their money out from under the mattress and investing it and getting nice returns, because they finally believe that the banks will be there to redeem their deposit on maturity. So it's a combination of factors. I agree with John that we are at the beginning of a push in retail banking.
Vasily Vysokov: Credit culture existed even in the USSR when Sberbank was offering consumer loans. People used to realize their responsibility to redeem the loans (more in the regions). The situation now, with the huge demand for retail financing and with the low percentage of bad debts, shows that this credit culture is reviving but at a new level, which gives significant returns to the banks. This creates tough competition between the banks, which pushes the development of the credit culture even more.
Sudip Roy: Timur, are you concentrating on retail banking at ATF?
Timur Issatayev: That is definitely one of the fastest growing areas for our bank and for our peers. Another important factor is that there is still a significant grey economy in Kazakhstan and Russia and capital disappears. Unfortunately, retail lending is one of the ways of legalizing the outflow in capital so that is also pushing up the demand for consumer credit.
Sudip Roy: How is the culture changing? What are governments doing? What are banks doing to encourage development of the consumer culture?
Jeff Millikan: In Russia certainly a big step this year will be the deposit protection fund [a central bank scheme evaluating Russia's banks]. In other countries it's collaboration, if not active support – collaboration between the banks or active support of the central bank or credit bureaux for exchange of information, for proper register of property and collateral. All of those things are essential.
Vasily Vysokov: Perhaps even more important than the retail market is the SME market. Many SMEs can't access international capital and rely on domestic funding. For example, the target for our credit portfolio for next year is 30% corporate clients, 30% SMEs and 30% retail.
Nick Tesseyman: Retail banking has become very fashionable; you read almost every week of some new medium-size Russian bank that is going to put in place a retail banking strategy.
Quite frankly, it's impossible for all
of them to be successful – some will
lack the know-how or discover that the amount of investment required in technology will be prohibitive.
However, banks in general realize that growth in funding is going to come from retail deposits rather than corporate deposits, and if they're going to take in retail money then they need to lend it out in the form of higher margin retail loans, because retail deposits represent one of the most expensive forms of funding there is in Russian banking. Retail lending and SME lending are still under-developed, so there is plenty of room for banks to grow in this sector.
Herbert Stepic: Borrowing for private individuals in these countries is in the neighbourhood of 3% of GDP, that's nothing. We are at the beginning of an educational process in which private individuals get the chance to do something positive with their money.
Therefore consumer credit is very important, and in particular there is a real opportunity in mortgage lending. There is a vast need for new homes throughout central and eastern Europe, not just in the CIS countries.
So that is a field that will keep us banks busy for the next 10-15 years, especially in Kazakhstan, where pension and banking reforms have had a very positive influence.
Russian reforms
Sudip Roy: John, your report suggested that Kazakhstan has made the biggest advances and that Russia still lags.
John Gibling: Yes, the reforms in Kazakhstan have really stuck and they've been very responsible in the reforms they've brought through. As for Russia, it will be interesting to see what happens with the deposit protection fund and whether that can weed out the problem banks, and help develop a more stable banking system in Russia. It will be difficult though.
Jeff Millikan: Because of imperfect execution? Because of political influence?
John Gibling: Probably a little bit of both. There's not a willingness to really close down a large number of banks. Hopefully a lot of the banks that do have problems within Russia are the small banks, which wouldn't really create instability within the banking market. But we saw during last summer, when one or two banks had some problems, it perpetuated a mini blip.
Sudip Roy: Nick, you were smiling at the mention of the deposit protection fund. You don't have high hopes for it?
Nick Tesseyman: It's important to look at the real purpose of the fund, which is to protect individuals' deposits. I agree with what John is saying, it's not going to be the panacea that perhaps some people were hoping it would be. I don't think that many significant banks will be excluded from the scheme. I think the large majority of banks will qualify and therefore it's not going to be quite the measure of quality that people were perhaps looking for when the plans were first announced.
Sudip Roy: Do you reckon it's just a case of the government paying lip-service?
Herbert Stepic: The deposit protection fund in Russia is very much psychological. To tell consumers that there is a quality differentiation between banks and to let them know if their money is protected or partially protected, is a very important step.
Nick Tesseyman: I think the fund does that job very well – a large proportion of deposits are going to be protected going forward. It's an important step in promoting the development of the banking system. There are other reforms that will need to be implemented effectively in the coming years in order to strengthen the regulatory environment.
Sudip Roy: In terms of the regulatory environment, is it fair to say, though, it is moving forward, albeit slowly in many cases?
Jeff Millikan: I think in the four countries where we have investments clearly it's moving forward albeit slowly, even in Belarus.
Sudip Roy: So foreign shareholders' interest are safeguarded and upheld?
Jeff Millikan: Yes.
Herbert Stepic: There's a huge difference to only a few years ago. Foreigners are now seen much more favourably.
Sudip Roy: How easy was the process of investing in Belarus, for instance, and why did you decide on there?
Herbert Stepic: For two reasons. First, it was an untapped market. Second, it fits very well within our regional strategy. For us the CIS is a very important, if not the most important region.
Sudip Roy: And was the investment process fairly smooth?
Herbert Stepic: Absolutely.
Jeff Millikan: Yes, absolutely straightforward. Our concern was not commercial, because we believe in Belarus; our concern was political. But EBRD was already there, they had a 27% stake in Priorbank, and based on their experience and our impressions and contacts with the government, we went ahead and so far it's been a good relationship for both sides.
Herbert Stepic: But you have to be very transparent, that is very important.
Sudip Roy: Do you see other foreign banks showing interest in Belarus?
Herbert Stepic: The Russian banks are. The government plans to liberalize the banking sector, in particular it is talking about privatizing the bigger state-owned banks, so within the next two years we should see non-Russian interest too.
Regional mergers
Sudip Roy: One of the issues is that there are too many banks in the CIS. Is the environment conducive to mergers and acquisitions?
Jeff Millikan: The regulatory environment, absolutely. I don't think that from Kazakhstan we're having difficulty with the mentality. Everybody wants a foreign strategic partner.
Sudip Roy: Why? Is it because of the need for money and technology?
Herbert Stepic: It's not the money in Kazakhstan. It's primarily to gain a strategic shareholder though the local banks are
not very keen to get majority shareholders from abroad.
Timur Issatayev: I think the reason for that is that the banking industry, at least in Kazakhstan, is still extremely lucrative. If you look at the rates of return, they are extremely high. Last year we produced a 20% return on average equity and, given that our equity requirements are much more stringent than in the rest of Europe, if we adopted European standards, our return on equity would be close to 30%. So banking is a very profitable business.
Jeff Millikan: But I'm willing to bet that as these banks get into retail banking, they're going to need that know-how and technology.
Timur Issatayev: Yes, but we are catching up very quickly in terms of knowledge. It doesn't take the whole bank to understand how to run a mortgage programme, you just send a couple of guys abroad and then they bring back the knowledge. So I believe it's going to be some time before the realization will come that they need a strategic partner. In my view, the realization will come not so much from the need for know-how, but the need for capital.
If you look at the Russian banking system, if you look at the Kazakh banking system, total assets-to-GDP is still at a relatively low level, only 40-42%. The prospects for growth are massive. We as a bank grew our assets by 105% in 2004 and we are forecasting another 50-75% growth this year. How are we going to support that given our strict capitalization rules?
Sudip Roy: Is foreign investment the easiest way to get an injection of capital?
Timur Issatayev: It's the only way.
Sudip Roy: There are capital markets too.
Timur Issatayev: Yes, but subordinated debt has limitations and then the alternatives are that you either do an IPO, like some of the banks in Kazakhstan are trying to do this year, including us, or you get a strategic investor. And that's where the real difference comes in. In an IPO, we, meaning the owners, will lose cash. However, if we can gain a strategic partner we can realize more cash.
Vasily Vysokov: I agree. In many of these countries the banking industry is a very attractive investment for a number of reasons. First, it's a very dynamic and competitive industry with possible returns of 30-40%. It's also becoming a more transparent industry, Finally, from an intellectual point of view, it's a very interesting industry because of the need to understand and assess different types of risk.
Jeff Millikan: What has EBRD brought for you? Know-how? People? SME lines?
Vasily Vysokov: After becoming a major shareholder in Bank Center-Invest, the EBRD has provided us with financial resources, international know-how and banking principles, training and banking experience. Also, the EBRD has created a reliable image of the bank for our international partners as well as helping to attract new reputable partners.
EM: John, do you see the need for capital as being the pressing issue for the banks in the region?
John Gibling: It's one of the pressing issues, particularly in somewhere like Kazakhstan, which is growing so quickly. The pockets of local shareholders are only so deep. I think it's only a matter of time before the banks look for foreign capital.
Transparency
Sudip Roy: Is transparency, or the relative lack of it, a big concern?
Timur Issatayev: The banking system in CIS is one of the most attractive because it's one of the most regulated. We have a dozen agencies that are supervising us on a daily to annual basis.
Herbert Stepic: I find it quite interesting that, in spite of the attractiveness of the industry in the CIS, in almost every country the share of foreign banks is still relatively low. In Russia it's about 4% of total banking assets, in Ukraine 8%, in Belarus 10% (primarily because of us).
Compare that to other countries, such as the Czech Republic where it's 96%, Lithuania about 90%, and Bulgaria 80%. It's a sign, firstly, that the liberalization process started much earlier in central and eastern Europe.
Timur Issatayev: And that they have less bureaucracy.
Herbert Stepic: Absolutely, yes. Bureaucracy is still a big impediment for us
in the CIS.
Nick Tesseyman: Transparency and governance are only gradually improving. There are improvements, but we're all impatient about the speed of those improvements. Our approach, and this is probably the reason that we work well together with RZB, is to engage in the banking sectors in our countries of operation.
It's very easy to wave your hand and say "I don't do anything". We don't have that ability, because we're in the region and we must do business, but I think if you engage, if you talk, if you try to get to know the best of the banks, then you can do business.
You can't do business with 1,300 banks in Russia. But there's a layer there you can do business with and our approach is to try to find the banks, where we feel comfortable with the corporate governance, with the financials and so on, and come
up with project structures and conditionalities that support improved business
conduct.
Sudip Roy: How easy is it to integrate these local banks?
Herbert Stepic: The key issue is for everyone to be on the same wavelength. When we begin to integrate a bank, I spend a lot of time talking to the management because we need the cooperation and the collaboration of all staff members.
Sudip Roy: How do you manage your subsidiaries?
Herbert Stepic: We have a very simple principle. We have a totally decentralized management system, because we believe in local strength. We do not believe in sending 50 people to a bank that we are about to take over, and we do not think that we know everything best. There are some things we know well but in other areas local experience is essential.
Also, we try to expand the horizons of our local staff – obviously that's easier with the younger staff members than the older ones. Finally, we implement very good risk control mechanisms.
Timur Issatayev: About 10 years ago, EBRD and other organizations ran a so-called twinning programme in the region. It failed miserably at the time because it was premature. I think now is the time to re-introduce this idea because of the need for modern technology, corporate governance procedures, risk awareness at all the big banks. We are getting some knowledge now and then, getting training now and then, but there is no system-wide inhouse training brought at those banks.
Vasily Vysokov: We are responsible not only for own training but that of our clients too. We organize 10-15 seminars for our clients on corporate governance and other issues. It's also necessary to develop relations not just with big companies but with SMEs too.
Role of foreign banks
Sudip Roy: Is foreign ownership generally seen as a good thing?
John Gibling: To date it's been pretty positive, particularly in the way that it's helping to develop the banking systems in central and eastern Europe and, hopefully, it will be the same going forward in Russia and the CIS as well.
Herbert Stepic: Specifically in Russia, it's extremely important that the government and the central bank begin the consolidation process as all except the 100 biggest banks are under-capitalized. The process cannot happen overnight, but it would greatly benefit the entire industry.
Nick Tesseyman: I don't think i's one of the priorities of the central bank or the authorities, but at the same time there are no restrictions in place. Many commentators would support tougher minimum capital requirements as a means to boost consolidation.
Sudip Roy: Another forward step would be to tackle Sberbank's monopoly.
Herbert Stepic: That would be of enormous importance. I repeat it should be done in a very structured fashion and the final result would be extremely positive for the country.
Vasily Vysokov: I think we'll be waiting a long time for central bank support of
consolidation. In the meantime banks
must prepare new products and new
technologies to take advantage of market opportunities.
Sudip Roy: How profitable is the CIS for a foreign bank?
Jeff Millikan: We had high ambitions and we've exceeded them.
Herbert Stepic: There has not been a single market where we have made a return on equity less than 20%. So it's a highly rewarding business, but you have to be very stringent on the risk side.
You can be very good in acquiring customers, you can be very good in servicing the customer, but you have to be able to manage your risks.
Sudip Roy: Nick, have you had a similar experience?
Nick Tesseyman: I would say that you have to stay close to the client – that's the key to doing successful business in any of these countries.
Risk management, I think in the past, at least in Russian banks, has not been the top priority. Acquiring customers has been a higher priority, and I think they're beginning to understand that the key to long-term profitability and sustainability is having that balance.
Sudip Roy: And is that something EBRD brings to the table?
Nick Tesseyman: I don't think that we bring it in the same way that RZB brings it, because we're always a minority investor without the ability to bring large personnel resources to bear and we don't take management roles in the banks in which we invest.
But what we do seek to do is to identify the areas of weakness and find ways to attempt together to fix them.
Sudip Roy: And do you see yourselves as a pioneer as well?
Nick Tesseyman: We do and we have to be, because if we're not pioneers then, according to our mandate, we shouldn't be doing the deals.