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Banks face up to Basel III with funding diversity plan

Wholesale change is sweeping through the Russian banking sector. Basel III is earmarked for implementation in Russia this October and the country’s banks are having to grow accustomed to complying with the new banking regulation framework. Euroclearability of the rouble domestic market for banks and corporates is also expected later on this year, with the effect of potential foreign inflows therefore yet to be seen. Meanwhile, bank funding teams are busily diversifying funding and working on strategies for coping with increasing US Treasury volatility. The Russian banking sector has boomed in the years since the financial crisis first hit, grabbing market share in both retail and investment banking from the big international banks. But with these new challenges ahead, it is questionable whether they can continue with the same pace of growth. At EuroWeek’s Russian financial institutions roundtable held in Moscow on June 11, borrowers and bankers exchanged views on whether the introduction of new regulations is right for Russia and what are likely to be the best opportunities for funding in the capital markets over the next 12 months.

Participants in the roundtable were:

Konstantin Chernov, deputy head of debt management and investor relations, Gazprombank

Marina Kareeva, deputy director of financial institutions and international capital markets department, Promsvyazbank

Ksenia Nefedova, head of the debt finance and investor relations division, Vnesheconombank (VEB)

Tim Nicolle, adviser to the management board, Svyaznoybank

Natalia Peksheva, head of the securities sales and

service division, Raiffeisenbank

Alexander Smolin, head of debt finance, global treasury, VTB

Moderated by Francesca Young,

emerging markets editor, EuroWeek

EUROWEEK: The implementation of Basel III in Russia is set for October 2013. Will it will help provide stability to your banking sector or is it too soon for Russia

Ksenia Nefedova, VEB: First, I would like to mention that VEB is governed differently from the commercial banks. Being a state corporation our aim is to foster development of the country’s economy. We are governed by a particular law on the Bank for Development and we are not subordinate to the CBR. Still, most of our methodology is based on CBR requirements. However, taking a look at this systemic change from the outside, you have to remember that it took Western countries about 20 years to adapt to these Basel requirements. Now we are trying to reach what the banks in other countries have done in a much shorter space of time. There’s been a nine month delay, but still, by end of the year, the whole Russian banking system is expected to comply.

It’s going to have quite an important and drastic impact on the system, burdening the commercial banks in terms of their capital requirements and as a result curbing their lending activities. That is likely to lead to much slower development of our banks within our system.

However, the implementation of Basel III certainly makes the banking system as a whole safer by making the individual risk profiles of the banks sounder. Bearing in mind that consumer lending is rapidly expanding in Russia, these measures from the CBR’s point of view are a necessary safeguard. 

EUROWEEK: Does it affect the growth ambitions of some of the smaller banks in Russia? 

Tim Nicolle, Svyaznoybank: Basel III, for consumer finance specialists, should actually be good news. Russian banking regulation currently sits somewhere between Basel I and Basel II, with some Russian features added on, and moving to more of a risk-based regulatory model sounds like a good thing. I imagine that if we adopt IRB, the internal ratings based approach, we would find that our capital requirements would reduce, relative to current Russian Central Bank requirements.

At the same time though, you can take an old-fashioned view of banking regulation, which is that no amount of mathematics will make the banks better or stronger. 

In the UK, not that the UK has anything to be proud of, there’s a concept of a fit and proper person running a bank, and that overrides any amount of capital regulation or capital requirements.

What’s impressed me with the interactions we’ve had with Russian Central Bank is that they do pay more attention these days to the spirit of the rules as well as the formality of them. That’s certainly been the case in how they regulate Svaznoybank. 

What’s probably more important than we’re under Basel I, I and a half, II, or III, is how the Central Bank polices the system in its substantive, rather than normative models. That’s the biggest concern in Russia. So Basel III sounds like an opportunity to pay consultants a lot of money. It also sounds like an opportunity for consumer finance banks to reduce the amount of capital they hold relative to today’s requirements. But at the same time, the focus should be on who runs the banks and how they are run, rather than the mathematics that are defining their capital bases.

EUROWEEK: Do you think that the central bank could be unfair in its implementation of Basel III? Could state banks be given a bigger say in how things unfold?

Nicolle, Svaznoybank: Svaznoybank is a well regulated institution by the Central Bank. They monitor the bank extremely closely, and very sensibly. I can’t speak about the relationship they have with other banks. But my sense is that the culture of banking regulation in Russia in 2013 is significantly better and stronger than it was in 2007, for example, and that’s a very good thing.

I don’t think the state banks get any kind of special treatment. They do have the luxury of a state treasury to help them with their capital needs, but that is a different question.

Alexander Smolin, VTB: In the case of VTB there is no question who runs the bank. The state runs the bank, and that is of course the main factor in the life of the bank. 

The change in regulation has definitely been quick and it’s continuing to be done quickly, with new initiatives, new laws and new regulations, especially in the field of capital treatment.

That means that for the state owned banks, particularly for VTB, life is becoming harder because we need to support our capital. Last year we used very innovative instruments to do this like the hybrid capital bond, which was half equity, half debt, but that has turned out unfortunately not to be in full compliance with the new regulation and will be subject to earlier amortisation.

The problem is that we have a part of our capital in the form of subordinated debt, not just from the state, but also from the international market in the form of Eurobonds — usually lower tier two — and also a hybrid tier one capital instrument. That means that we are going to be creative with regards to liability management ideas when planning the future of these instruments. 

EUROWEEK: There are close to 1,000 banks in Russia at the moment, which is a very large number compared to other countries.  Will Basel III will be used as an opportunity for the CBR to weed out some of the weaker institutions?  Can you see it prompting much M&A business between the banks?

Marina Kareeva, Promsvyazbank: I do not think that we will see many mergers and acquisitions in the next few years though there have been a couple of transactions already, such as Nomos Bank and Otkritie and MDM Bank and Ursa Bank. The market reception to these deals has been very varied though and no one can say with certainty that they were 100% successful.

There’s been a lot of talk about these mergers and acquisitions for many years, but we don’t see many happening in reality and I can’t see that changing in the future. The ones we have recently seen have just been one-offs, not part of a trend.

EUROWEEK: So will that mean a lot of defaults from banks that can’t comply with Basel III?

Kareeva, Promsvyazbank: No, but they will have to decrease their assets and growth. Large banks will have less capital so will not have much room for acquisitions. In 2008, and before that, Promsvyazbank considered a few small banks for acquisition, but after proper due diligence we decided not to do a lot of them. We did do three acquisitions but those were of small, regional banks, and the purpose of that was to acquire their market share in certain segments of business in these regions.

Nicolle, Svaznoybank: I think that the weeding-out process is independent of the flavour of banking regulation. It’s a policy matter, rather than a regulatory matter. I think the authorities have got plenty of tools to reduce the number of banks in the system already available if they wish to use them. Adding to the toolkit is not needed. 

It’s not necessarily a bad thing that there are hundreds of banks in Russia, because apart from the top 50, 75 banks, the balance of the banking system operates, effectively, below the international radar screen. It’s a domestic matter, and there are healthy reasons for having all these banks, and some unhealthy reasons as well. I’m sure the authorities pay very careful attention to it.

EUROWEEK: Bearing in mind potential changes in capital regulation, what are your plans for raising debt over the next year or so? 

Smolin, VTB: VTB has been active for a number of years in exotic currencies such as Australian dollars, Chinese renminbi, Singapore dollars and Swiss francs, though Swiss francs is not something new for Russia — many issuers use that market.

The number of potential new, exotic markets that could be immediately available for Russian issuers is not really big, but still we see particular opportunities. We’re considering some Asian ideas. We’re looking at other different structures and also considering some Islamic financing. We’re also thinking about tapping developing markets such as Korean won or South African rand.

There are always two potential routes to be used. The first is to use the usual Eurobond format, issuing in exotic currencies. The second route is to tap the local markets and try to reach local investors under local regulations, which is a much more complicated idea, but still sometimes that can work. When it works it can serve to increase your investor base and reach local accounts which would never participate in the Eurobond transactions.

The main target here though is not to issue in different currencies for the sake of it, but to use those currencies which can provide a good arbitrage opportunity on an after-swap basis. Those can be less expensive than the usual benchmark Eurobond dollar issuance. When issuing in exotic currencies we usually use a swap into dollars or roubles or whatever else suits the bank’s liquidity needs.

It’s a simple economic rationale — we don’t tend to need the exotic currencies directly so if a deal is more expensive on an after-swap basis, we will not issue.

Generally we are over-liquid now, so we don’t need money immediately in this part of the year.

EUROWEEK: But you mentioned that you are also looking to do liability management trades?

 Smolin, VTB: Right. We can spend our time looking at our existing and outstanding instruments and working out what is best to do. Some of our older instruments that we placed many years ago have different covenants to what we tend to use now, for example, so we may have some ideas on how to change the debt profile of the bank.

Chernov, Gazprombank: It has been an important development of the last two years for the Russian top borrowers that different markets have become available. It’s useful both for the expanding of an issuer’s investor base and also for doing opportunistic trades and saving costs. 

Earlier this year we raised Rb20bn in the Eurorouble market and Rmb500m in the Dim Sum market. Both those transactions represented a substantial arbitrage to the domestic rouble market or the dollar denominated Eurobond market.

The currencies we choose to use this year will depend on our liquidity requirements and the market conditions — what is available and what opportunistic situations arise in different markets. We’re currently working on developing several markets and actively undertaking investor relation activities there.

EUROWEEK: Is the recent volatility in US Treasury rates affecting your plans in terms of how soon you want to issue?

Chernov, Gazprombank: We’re expecting that high volatility in the US Treasury market will continue until the end of this year. That means that we will not have such prolonged open periods to place a transaction as we had during last few months. It will be a time of choosing the right windows to do a deal and being very selective in terms of the currencies and markets to use.

Smolin, VTB: We expect the rest of the year to be driven by the opening and closing of market windows. We will have to follow this volatility and that will probably determine when the best moment is to find good momentum for issuing.

The first half of the year was, for us and others, very good. Many Russian issuers were doing deals in dollars as well as more exotic currencies like renminbi. It is interesting how much the renminbi market has developed. VTB was only the third foreign issuer in this market in 2010, straight after McDonald’s and Caterpillar. At that point the market was so young and so new, but it’s been great how much China is trying to open itself to allow investment in international borrowers.

There is a special renminbi offshore market in Hong Kong which is available for foreign issuers. It shows that the regulators in China understand how to manage this process and make the market interesting for such emerging market issuers like VTB and Gazprombank.

Chernov, Gazprombank: Talking about the development of local markets, the Russian regulators have been rather active in developing the Russian local bond market. They’ve so far taken some good steps with the Euroclearability of OFZs and hopefully by the end of this year, it will also be easier for foreigners to invest in the corporate and bank issues as well. There is still a taxation issue, which needs to be resolved to completely open the Russian local bond market for foreign investors.

EUROWEEK: Natalia, what are you recommending with regard to banks accessing bond funding before the end of the year? Do you have any thoughts on the attractiveness of the dollar Eurobond market versus the local rouble market?

Natalia Peksheva, Raiffeisenbank: Actually I don’t think that bond market will ever close. If you are a borrower ready to issue and ready to pay, investors are in a place to buy bonds and even more sophisticated debt structures at any time. Of course, it depends on the price.

If a compromise between the issuer and the investor cannot be found the market is said to be closed.  In real life it’s not closed, because secondary trading goes on and investors do the trades.

Recently the market has become more volatile and there is a constant fear that rates will continue to rise. So investors are demanding a higher premium for taking the same risk. But if the issuer is ready to pay, the deal can be done even in the turmoil.

So it is mainly about whether the attractive yield levels from an investor point of view are acceptable for Russian banks.  It largely depends on their financial position — ROE, ROA, net interest margin, etc — and growth strategy.

As for the timing and currency preferences I believe that banks in Russia are advanced enough to consider all existing options, including currency, deal structure and price at the time they want to raise funds. 

We are certainly not in a crisis situation. Even after this recent minor sell-off, yields aren’t comparable to what we saw in 2008-2009. Russia is not an isolated island in the global financial ocean.

Nefedova, VEB: VEB is more conservative than our colleagues here today, but we have the same strategy of diversifying currencies and have done something new this year — our debut euro denominated Eurobond. That deal presented a good pricing opportunity for us as it was lower than our dollar curve. So it was a great success for us and we expect to do more trades like this, though perhaps not in euros later this year.

We’re most interested in roubles and dollar funding. As far as stepping into different markets, that’s again a matter of liquidity available there as we are very price-sensitive. Our mandate as the Bank for Development restrains us from competing with commercial banks. We provide project financing to corporates at levels which are not sometimes acceptable to commercial banks.

Aside from that, one of our focuses is implementing the possible ways of attracting foreign investors into our economy. To that end, we have just done some innovative work in updating our domestic bond programme — with the help of some banks such as Raiffeisenbank. The idea was to adapt our EMTN programme to Russian legislative requirements for use on the domestic market. Doing that provides investors with a certain sets of covenants, which is similar to what we have in our international EMTN programme, and increases the level of disclosure, such as providing risk factors.

We are hopeful that those measures will help attract foreign investors and thus expand the investor base in Russia.

Moreover, we’ve also pioneered issuing foreign currency bonds in the domestic market. We placed dollar bonds in it earlier this year. At the moment they work as a kind of commercial paper for the Russian local market because the tenor is not very long — it is three year paper but there is a put option after one year, so the instrument tends to be used mostly for liquidity management.

EUROWEEK: What other big changes need to be made to bring the local market to international standards?

Nicolle, Svaznoybank: In terms of conforming Russian domestic securities arrangements to international standards, in Russia we’re still missing collective representation of investors and the enforceability of a broad range of financial covenants under Russian law.

Nefedova, VEB: There is still quite a long way for us to go to bring the market to international standards. First of all, the markets are governed differently and the difference of law makes is quite drastic, but still we are preparing ourselves so that eventually the market moves in this direction and becomes more investor friendly.

Nicolle, Svaznoybank: But do you think general financial covenants (other than a covenant to pay) are enforceable under Russian law?

Nefedova, VEB: We believe so, yes. There are still some issues with regards to the way the court will decide on those matters. The legal platform which is being built is already quite an important step.

Nicolle, Svaznoybank: I think it would be excellent if there were a platform! Speaking rather generally, in Russian law nothing is allowed unless there’s a law that lets you do it, whereas, for example in the English legal system, everything is allowed, unless there’s a law that says you can’t. It’s a different approach (civil code instead of common law) and a different conceptual basis of the legal system. But if a platform is being built to uphold financial covenants, that is a good thing — what we have to do here to make something work is get laws passed that enable it to work. So all of these changes inevitably involve the state institutions and the regulators, whether that’s securities regulators or banking regulator, or the Duma. There’s a lot of work to get from where we are to where we’d like to be.

Nefedova, VEB: We’re working pretty hard together with the financial monitoring authorities, the regulator, and the stock exchange. It’s a co-operation between all these institutions.

Pekcheva, Raiffeisenbank: I’ve participated in several workshops to monitor, improve and develop the legislation. The concept of investor representation in the fixed income market is just underway, and I hope that the respective amendments should be soon in the state Duma for the second reading.

It’s not that the regulator doesn’t care about these differences between the international standards and the local ones, but the defaults during the crisis affected both Eurobond and the local markets. Some defaults on the Eurobond market ended up in bankruptcy with zero recovery for investors. Even if the market is governed by the English law you still may not get anything back.

Nicolle, Svaznoybank: Collective representation is only a good thing if you have a representative that does something. One of the lessons we learned from the Eurobond market and the CLN market through the crisis — not specifically in Russia — was that trustees often don’t move when they should because they wait for instructions. And because investors don’t know who their fellow investors are, they can’t easily group together to make decisions.

Pekcheva, Raiffeisenbank: That’s why the Russian approach to these situations is expected to be a bit different. We’re hoping to build on the experiences in other markets.

Nicolle, Svaznoybank: It’s a great opportunity to do it better.

EUROWEEK: But at this point is it worth altering documentation to look more investor friendly when the rest of the system is not yet in place?

Smolin, VTB: We’re continuing to work with the financial regulators in Russia and with the stock exchange and discussing these things. We are doing the same thing as VEB — we are in the process of preparing our own local rouble bond programme, which will be of a more international style. 

We are finding that the regulation itself is being changed. Starting from July 1 there will be some new tools for the local rouble bond market. The market will become a bit more flexible in terms of the tenors available and some matters of documentation, all of which shows that the regulator is trying to be flexible.  

But I would completely agree with the people here, that the difference is so big between the international standards and local that there is still a long way to go. 

If you look just at the Russian bond prospectuses and the international ones, there are big differences in the style of disclosure and the style of how the document itself is prepared. The Russian one is much more formal. The international one is a bit more creative, there are risk factors included, it is split into sections and it is more readable.

It’s a big thing for the regulator and the banking community to modify but it’s in the interest of all the participants to get it done. 

The other big technical problem — this one in the international market — is that on a practical level Russian issuers cannot issue directly into the international markets still. Formally there is a law saying that borrowers can issue foreign bonds, but in terms of registering those bonds it’s much too complicated. 

So instead, Russian borrowers have to issue through a loan participation note structure using a special purpose vehicle as an intermediary in another jurisdiction. That’s another thing that should be investigated by the regulator. There are still a lot of changes that could be made in local laws to benefit the development of the market.

EUROWEEK: How else is the market changing? Russian banks seem to be becoming more flexible with regards to currency, but are they also getting more adventurous with regards to private placements, ECP and other structures?

Kareeva, Promsvyazbank: This year we’ve already been in the market with a private placement and a lower tier two subordinated issue, but our strategy is not wholly dependent on Eurobonds or the financial markets in terms of funding. We think that our loan portfolio should also be funded by local customers’ deposits with us. 

That kind of funding now represents around 60% or more of the total liability mix of Promsvyazbank.

 We’ve considered setting up an ECP programme for the sake of diversifying our instruments but we have not yet done anything because our liquidity remains at a very high level and we don’t need to fund ourselves from the financial markets at the moment. But that ECP programme should be registered very soon and we will just use it as a tool for short-term liquidity. 

In terms of diversification we are also working on funding via mortgage securitisations, which is a part of the state programme to support the mortgage market and AHML [The Agency for Housing and Mortgage Lending).

AHML has introduced several programmes that Russian banks can participate in — we know that there are no independent market investors who are ready to buy Russian mortgage-backed bonds, but AHML is offering to purchase them. Quite soon you should see Promsvyazbank issuing mortgage-backed securities.

This year our situation is unusual as we don’t have any particular plans to go to the capital markets as our liquidity remains high and we don’t have any major maturities that we have to repay by year end. Because of that our funding will be opportunistic. We may consider the syndicated loan market later this year but we have not decided yet.

Nicolle, Svyaznoybank: Svyaznoybank is a very different animal to the institutions represented by my colleagues here today. We’re at a much lower end of the credit spectrum and a very young institution as well. Our bank is pretty much entirely funded by retail. That actually gives us some problems because the Central Bank would much rather we had a mix of wholesale and retail in our funding mix. So as we grow over the next 12 months we’re planning to increase the amount of wholesale funding for the bank by a significant amount — maybe to 25%-30% of the balance sheet.  

Whether we do that through domestic transactions or international transactions will depend on what opportunities are there in each market. It’s unlikely the funding we need to do can be satisfied entirely from the domestic market with conventional rouble bonds.  

Our view of the domestic market rouble bond market is that liquidity in the second half of the year is going to principally be driven by where inflation is sitting and the Central Bank interventions in the market to manage liquidity, particularly in the banking sector.  So if inflation looks like it is within policy parameters — somewhere near 6%-8% — there will probably be a bit more liquidity in the banking system and we’ll probably then be able to do more domestically. Our rouble bonds trade at 12%-13% whereas OFZs levels are at 6%-7%, so we look attractive.  

For wholesale funding, the securitization market is also very interesting for us. There is no domestic securitization market outside mortgage-backed securities because there’s no law that allows it. But we have designed a structure which will allow us to issue domestic rouble bonds backed by credit cards, which is the asset class we have, as we don’t have mortgages to securitize. We are working actually with some of the banks around this table on a transaction to come in the fourth quarter of this year which we are expecting to trade significantly inside our rouble bonds but also substantially above the credit curve of the rating of the transaction.  

We’d really like to see a Ba2 securitization market developing rather than an investment grade market. That is important for Russia because there are a lot of banks that will struggle to do a structured transaction to investment grade. Developing some colour and depth within the market would be very helpful for the Russian markets generally and we’d like to try to foster that.  

We won’t be the first bank bringing a domestic, non-mortgage securitization transaction. My team is also advising one of the other consumer lenders on a transaction that will be based on cash loans, which should be coming to the market in July or August. So there’s a new market developing here in Russia for domestic securitization and a lot of technology involved, which my team is very much part of.

EUROWEEK: In terms of currency risk, are you exclusively focused on issuing in roubles because of your Russian retail business?

Nicolle, Svyaznoybank: Yes. We’re a rouble-only bank. So when we look at the international market the main challenge for us is the basis swap. There’s a clear set of comparables on a relative value basis so we can see where we would price. We’re not well known outside the Russian market, so before even considering an international deal, it would be essential for us to do a non-deal roadshow and then follow up a month or even two or three months later with a transaction. 

 The main challenge would be cost because the basis swap cost of swapping the dollars that we might receive into the roubles can be as much as six points.

There’s a chance that we could issue internationally in roubles, but that’s a complicated market and investors tend to see it as more of a substitute sovereign play, and prefer not to mix currency risk with credit risk. It works well for some of the state owned banks. We’re a B3 rated credit so I think Eurorouble paper from us is not something that would find an easy home.

Kareeva, Promsvyazbank: Even for Promsvyazbank the Eurorouble market is challenging. And when you compare the prices available on the local rouble market and the international market it is not advantageous for us. 

EUROWEEK: Before the OFZ market became Euroclearable, there was a lot of forerunning of that event and yields declined considerably before it even happened. Is the same happening for bank bond yields and/or do you expect a tightening of yields after domestic financial institution bonds become Euroclearable? 

Pekcheva, Raiffeisenbank: There’s been no yield compression yet and I can’t see huge yield compression in the future as a direct result of Euroclearability. Euroclearability of OFZs was actually my personal project brought to the Ministry of Finance three years ago and I’m very happy with how successful it’s been for those government bonds. Last year we saw a soaring OFZ market due to speculation on the market liberalisation.

But I’m not sure that this will happen for the banks and financial institutions because the issuers that could be of interest to foreign investors from a credit perspective are already present on the international market. So the investor who wants to buy that credit risk can do so just by investing in the Eurobonds. And if you compare the yields, then in rouble terms once a swap is applied, it is much cheaper for an investor to buy bonds in the international market. So at the moment there is no great economic sense in foreign investors entering the rouble market to buy Russian FI paper.

Those investors who want to play the currency use government debt. The Russian Federation doesn’t have a big presence in the international market — there are some nine Eurobond issues outstanding compared to 34 local OFZs — and the curve is not as long and liquid as on the local market. The Ministry of Finance is not a bank and cannot swap all its dollar exposure to roubles so they naturally prefer rouble funding of the budget deficit.  

The Eurorouble market was originally opened because foreign investors really wanted the rouble risk.  But due to infrastructural problems they couldn’t invest directly into the local market so this Eurorouble market was the only opportunity for investors to get the right currency risk under the infrastructure that they had been using for decades. And that’s why only top issuers from our country are welcome there. It’s as Tim said, not a very easy market for issuers with a real credit risk.

Last year we talked to many funds who invest precisely in the sovereign debt of emerging market countries and they said they were waiting for the Euroclearability of the state bonds as they were keen to invest. But on the corporate and bank bond side, there are other asset managers and funds, and they say they have the Eurobond market to invest in so they don’t care that much about the Euroclearability.

EUROWEEK: The Russian banking landscape has changed significantly over the last couple of years as the state-owned banks have grown quickly both domestically and abroad — Sberbank’s acquisition of Troika Dialog for example, and VTB Capital’s international expansion. How is this changing competition between the banks in Russia?

Nicolle, Svyaznoybank: From our point of view, Sberbank’s main challenge is that they know where they want to get to but they’re starting from where they are. They are a huge bank but one that by virtue of its size is quite clunky and not easy to implement changes in. 

Svyaznoybank is much smaller and only three years old. Our business is based on customer service, technology and on being easy, accessible and simple for customers to use. It’s similar for our competitors in the consumer finance market — Tinkoff Credit Systems, Russian Standard and Home Credit.

Sberbank, with its tens of thousands of branches and thousands of employees, is a slow giant. They are doing a lot of things really well but it’s going to take them a long time to get there. There are still going to be plenty of queues in Sberbank for quite a few years to come.  

But if you roll the clock forward 10 years I think the picture could be different. So in the medium term, things will be fine. Sberbank does, however, have a big competitive advantage and sooner or later they will get it right.

I don’t see the banking landscape in Russia really changing yet, but certainly you can see the direction of travel.  And that actually is good news for everybody as competition is good for a sector.

EUROWEEK: That seems a very optimistic response. Surely Sberbank’s size and rapid growth is going to inhibit other banks in Russia?

Nicolle, Svyaznoybank: No, I don’t think so. The introduction, for example, of the deposit insurance scheme, which insures retail deposits in the same way that we have in Western countries, has meant that it’s become been quite easy for Svyaznoybank to raise funding. There was one month last year when Svyaznoybank actually took more in retail deposits in the month than Sberbank did. We have, effectively, the second largest branch network in Russia because we operate through 3,400 points of Svyaznoy shops and each of those shops provides banking services now on an affiliated basis.

So I don’t think it’s a glass half full response. All that is happening is that our business models and our investments in technology and customer service mean the Sberbank is sharpening up its act quickly — or as quickly as Sberbank can. But as Sberbank sharpens up its act we’ll have to sharpen up again. It’s a continual process of healthy investment and healthy change that will make Russian financial lives for ordinary people here easier. That is a welcome change because it’s not very easy today.

Kareeva, Promsvyazbank: I would agree with Tim. We cannot compete with the likes of Sberbank, VTB or Gazprombank in terms of the pricing offer to our customers. But for sure we can be better in terms of the quality and the relationship with our customers. We’re paying a lot of attention to improving our internal processes, implementing innovative products and developing our internet banking platform. That’s why our customers want to stay with us.

EUROWEEK: What are the ambitions of the state banks here today? Is there any particular part of the banking business that will be especially pursued in the next few years? Is there a risk of crowding out other Russian players?

Smolin, VTB: VTB consists of three major lines of business: corporate commercial banking, retail via VTB24 and investment banking. 

We’re definitely seeing a growth of competition on the investment banking side. VTB Capital has been very active in this over the last few years and has been a leader of this market. There is now definitely more competition, first of all from Sberbank having merged with Troika Dialog. They are the biggest competitor to VTB Capital and are getting many mandates here internally. Gazprombank too is doing very well with its strengthening in capital markets activity. Both VTB Capital and Gazprombank are on the mandate for the new Russian sovereign bond. 

 So competition is definitely there and it’s a positive thing for the market generally because a high concentration of big players doesn’t compel people to innovate and make services better. 

I know the VTB Capital team works very hard. I see the rotation of the personnel there and them trying to be ever more competitive. That very much means that life is not becoming easier for them. They are having to now compete with players — both Russian and international — who have not been as active in previous years. That’s a big challenge for VTB, but again, it’s a positive thing.

But as Tim mentioned, it’s really hard to compete with Sberbank in this country because they have a retail network dating from the Soviet area and because of that they are popular still and famous. Some people in the country, I believe, still don’t know other retail banks exist! We need to change this, obviously.

The Russian banking system consists of two major parts — the big state-owned banks, which cover the major part of the banking business in the country, and the rest. But this is a model that has worked for 20-25 years. The story is changing though and if anything we’re seeing increased competition from smaller players rather than a crowding out of them. That’s positive.

Chernov, Gazprombank: Gazprombank is developing  the same three key businesses: corporate banking, retail banking and investment banking, with corporate banking being the backbone of our business profile. In corporate banking we focus on the top Russian corporates. We continuously occupy one of the top three positions in the investment banking field competing primarily with Sberbank and VTB. We’re also actively developing our retail banking franchise where we’re using our corporate relationships to expand our client base.

EUROWEEK: In the syndicated loan market, how aggressive are banks being when extending funding to Russian banks? 

Kareeva, Promsvyazbank: At the moment this is not a very active market, especially when you compare it to what it was like before 2008, when all the major Russian banks could drum up participation in syndicated loans from investors all over the world. I recall some of our transactions having 50-60 banks participating in our syndicated loans! These days they are very much done as club deals and it is done strictly on the basis of relationship lending. So I wouldn’t say that the banks are back to being aggressive in that market. They are just doing enough to gain some other business from borrowers.

EUROWEEK: Is it the same for the bigger banks?

Smolin, VTB: Lenders are definitely not aggressive in the syndicated loans market, but borrowers are trying to be. We’ve closed one this year for $2bn, but I completely agree with Marina that it has become a club deal market.

We understand that it is becoming more and more difficult for lenders to participate because the rates we are offering are really low. It’s definitely a relationship market. We speak to those banks who are interested in developing their business with VTB. But the number of banks who are available for these deals, even with VTB, is decreasing.  

Having said that though, we closed a deal for $3bn two years ago, which was the biggest ever from Russia and we moved to the next idea of this $2bn deal and have now closed that too.  

I believe that this market will become more and more a refinancing market with borrowers raising money to refinance maturing loans.

Nicolle, Svyaznoybank: Some of this is driven by regulation because Basel III is not designed with emerging market risks in mind. Speaking as a B3 bank, lending money to us is effectively a deduction from capital. So can we do a syndicated loan? Forget it, because it’s like an equity transaction for an internationally regulated bank.  

Even for a triple-B bank, the economics for a Western commercial bank of lending money to VTB, for example, are pretty poor unless they’re using a sophisticated IRB approach for their capital allocation, and that’s really only the bigger players who do that.

So you end up with club deals because it’s only the bigger players that have a sophisticated capital allocation and regulation model and are also providing sophisticated added-value products, which in combination make up the capital return that they need on the balance sheet they’re employing.

That means that inevitably you end up with smaller players not able to participate because they’re not using sophisticated capital regulation models and they don’t have the income make-up opportunities of more sophisticated products. So it closes the market to some investment grade emerging market risks.

This brings us back to our first discussion on the implications of Russian banks adopting Basel III. It has to be with significant caution because it’s not completely designed for a triple-B rated country.

EUROWEEK:  Who are the banks that can offer the likes of VTB these relationship levels?

Smolin, VTB: There are three big teams of banks. US banks — big players like Citi, JP Morgan and Bank of America Merrill Lynch. There are European banks who are traditional participants of this market, like Barclays, BNP Paribas, other French banks. And now we are seeing more demand from Asia, which is a great development. Chinese banks are trying to explore the market here in Russia so they are trying to be very flexible with the local big players to build their relationship with us. We had two Chinese banks in this year’s loan.

Nefedova, VEB: It’s not only Chinese banks but the Asian banks more broadly are entering the market such as the Japanese as well. It’s partly because of the different type of liquidity profile they have versus Western banks and their own funding, which makes it cheaper for them to get involved in those types of club deals.

EUROWEEK: Are there any obvious pitfalls for the Russian banking sector ahead?

Kareeva, Promsvyazbank: The slowdown in the Russian economy and just the suggested forecasts for Russia is one of the threats for the banking sector. When the economy slows, our customers become cautious with regards to further borrowing, which directly impacts on our business.

Nicolle, Svyaznoybank: There’s very little, apart from catastrophic events that affect the Russian macroeconomic picture, that could derail the Russian banking sector at this point. Even in the event of increased eurozone turmoil Russian financial institutions have largely become domestically funded and so with some exceptions, they are much more resilient than they were in 2007-08.  

There are things that can mean we have a good year and there are things that can mean we have an average year. But there’s very little domestically that is appearing in front of us that might mean that we get derailed.

EUROWEEK: For the Russian banks, what’s the ideal backdrop for the year ahead?

Nicolle, Svyaznoybank: The most promising elements are those within Russia. Lower interest rates and a lower inflation rate in Russia could make international borrowing a lot more attractive because the basis swap would move into a more attractive position. So macroeconomic factors could mean that Russia becomes a more interesting opportunity for international investors and provides more interesting borrowing opportunities for us. 

In terms of the domestic market, improving macroeconomic factors would also allow the Central Bank to improve liquidity in the banking system. Liquidity in the banking system leads in turn to an increase in the money supply and potentially greater economic activity.  But the opposite can unfortunately also be true.  w