Development of the Russian Banking System

     Federal State-Funded Educational Institution of Higher Professional Education

     «Financial University under the Government of the Russian Federation»

     (Perm Branch of Financial University) 
 
 

Library-research paper

 

«Development of the Russian Banking System»

Academic discipline: English language 
 
 

                                                                           Prepared by:

                                                                                   Pashkova Dasha,

                                                                                                 Group BBD 21

                                                                                 Full-time course

                                                                                            Specialty:  «Banking»

       (applied baccalaureate)

                                                                                        Scientific supervisor:

                                                                                 Kostareva N.Y. 
 
 

Perm, 2011

CONTENTS

§1. Introduction ………………………………………………………………...… 3

§2. The Appearance of the Russian Banking System in the Transition

      Period (1988-1998) ……………………………………………………...….... 4

§3. The Recovery of the Russian Banking System After the System

      Financial Crises in August 1998 (September 1998 -2002) …………….…….. 6

§4. The Current State and the Prospects for the Future Developments

of the National Banking System (2003 - 2006) ……………………………...…… 8 
 

 

       §1. Introduction

       The transition period of the market reforms in Russia allows the selection of the three phases of the national banking system developments. Each phase is characterized by the state of the national banking system connects with the certain model of the Russian economic developments. The contents of the first phase (1988-1998) were the appearance of the private banks, their developments under the provided privatization process and the rapid growth of the domestic debt market. Exactly the debt model of the Russian economic development determined the system financial crises in August 1998, which governed the crisis of the national banking system and led to bankruptcy of the some biggest commercial banks. Thus the second phase connects with the process of the national banking system recovery after that crisis. Third phase assumes the further positive developments of the national banking system under the task of the production rates acceleration – exactly this aim turns to be the key for the Russian economy in the medium-run. 

 

       §2. The Appearance of the Russian Banking System

       in the Transition Period (1988-1998)

       Russian banking system has its roots in the Soviet era. The economic reform course announced in the middle of the 1980s required that cardinal changes be introduced in the existing banking system. The first step towards reform of the banking system was made in 1987, when several special state banks were established in the Soviet Union. The first commercial bank was registered a year later, in 1988. A few years later, in 1991 through 1992, a wide network of commercial banks was created in Russia on the basis of special state banks' branches. This was done under guidance of the Central Bank of Russia, which assumed responsibilities of the USSR State Bank after the collapse of the Soviet Union. In this way a one-level banking system that actually existed under Soviet conditions was transformed into a two-level system consisting of a central bank (Bank of Russia) and a ramified network of commercial banks in a very short time.

       The reason for the rapid growth of the number of commercial banks in Russia was that banking sector provided ample opportunities to make significant profits. In view of this, a number of circumstances should be pointed out.

       First, there was an acute shortage of banking services in Russia, while the number of private business entities was growing rapidly. Even the simplest operation, such as the opening of a current account, often became a formidable problem. This made it possible for the banks to pay very low or even zero interest rates on account holders' balances (and thus reduce costs of liabilities) and charge high commissions for payment handling (and thus increase incomes).

       Second, since inflation in Russia was high in the early 1990s and the existing mechanism for fixing interest rates on borrowed funds was not tied to inflation, the long-term borrowings often devalued before the repayment day (devaluation of deposits at Sberbank of RF is a typical example). This meant that the actual costs of commercial banks' liabilities were low.

       Third, Russian banking legislation was rather liberal. For instance, it did not provide for direct control over interest rates that banks offered on deposits and charged for loans, while indirect regulation was possible only through changing the refinancing rate). Moreover, neither the Central Bank of Russia nor the Russian government exercised tight control over the structure of lending institutions' assets and liabilities. For instance, lending institutions made independent decisions on what share of attracted funds should be provided in loans to economic entities.

       Forth, Russian banks made money from the redistribution of the centralized loans. The mechanism was very simple: banks received funds intended that the monetary authorities provided to particular companies or sectors. The profitability of that operation was determined by the lending margin (the spread between interest rates paid on borrowed funds and charged on loans provided). Lending institutions often delayed the distribution of these funds between end borrowers. For a rather long time, banks could use these free resources (they were actually free because rates charged by central lenders were often below market rates) for making extra profits on various segments of the financial market, such as the interbank and foreign exchange markets.

       Further developments of the national banking system had been followed by the transition process – the privatization of the major enterprises and the fast growth of the domestic debt market. The development of the domestic debt market

determined the growth of the national banking system, which was formally isolated from the real sector. As the result the default on the federal bonds and the sharp ruble devaluation push the largest banks on the eve of bankruptcy. Russian households and the foreign investors faced the large scale losses, the financial markets were depressed. The prospects for the Russian real sector had been indefinite. 

 

       §3. The Recovery of the Russian Banking System After

       the System Financial Crises in August 1998 (September 1998 -2002)

       The crisis in August 1998 in Russia was the system financial crisis by its nature, including the foreign debt payments, foreign currencies, banking and financial markets crises. As the result the payments on the public and private external debts had been temporary frozen, the sharp devaluation of the ruble rate was observed, the biggest national commercial banks faced the liquidity problems, the turnovers and liquidity of the circulated financial instruments drastically dropped.

       Russian real sector had been relatively fast adapted to the new economic environment – the domestic and external. Moreover, starting from the 1999 the positive rates of growth were fixed by the most of the economic fundamental indicators.

       Directly after the system financial crisis in August 1998 the further development of the Russian banking system could be proceeded according to the three basic scenarios (or some combinations of them): the governmental support of the banking reform, the attraction of the foreign capital in the domestic banking sector or the banking recovery through the using the own banking capital and the banking own activity for its survival. As a result the development of the national banking system in the post-crisis period was followed the last scenario (the recovery of the banking system through their own funds and activity) and the first features of the recovery appeared only in the middle of 2002 compare with the 1998 (pre-crisis level).

       The scenario of the banking system recovery through their own resources after the financial crisis was quite comfort for the Russian monetary authorities, but its prospects are quite limited. In fact we should pointed out, that the potential of such scenario’s realization was over – the total banking assets had been grown on 33% in the real terms on 01.01.2003 compare with the pre-crisis level (using the PPI deflator) and the total own banking capital was only $18.3 bln. on January 1, 2003 ($20.8 bln. on August 1, 1998). It is evident, that the Russian banks by themselves could not get over the negative consequences of the financial crisis. As the best results the realization of this scenario would lead to the recovery of all the key indicators of the banking system compare with the pre-crisis level, but they were not corresponded with the demand of the Russian real sector on the banking services level and their disposable resources.

       The formal improvements of the financial position of the Russian banking system in 2002 had been reached mainly due to State Saving Bank (Sberbank of RF – controlled by the state). This state’s controlled bank occupies the monopoly position on the households’ deposit market, owning the state guaranties for the private deposit insurance, and thus has the comparatively cheap and long-term liabilities. Conducting the active policy of the providing banking loans to the enterprises the Sberbank of RF gained the profits as about $1 bln. in 2001 and about $2 bln. in 2002. Such volume of the profits was significantly high compared with the total of the Russian banking system and changed the trend of the aggregate profitability of the national banking system. In case of exclusion the Sberbank of RF the aggregate profit of the commercial banks has been much lower.

       The reaction of the commercial banks on their poor financial position was the initiating of the merge procedure for the increasing the disposable assets. As a result the size of the average assets of the Russian commercial bank had been increased from 2.2 to 2.9 bln. RUB during the 2002 (or on 32%), the average charter capital – from 205 to 240 mln. RUB (on 17%), the own capital – from 342 to 438 mln. RUB (on 28%), the average volume of the enterprises’ loans – from 0.9 to 1.2 bln. RUB (on 34%). Note, that the merge procedures in the Russian banking system were as the single deals, but not as the sustainable trend. Russian private bank is still characterized by low capitalization. 

 

       §4. The Current State and the Prospects for the Future Developments of the National Banking System (2003 - 2006)

       The key parameters of the Russian banking system reached their pre-crisis level only in the middle of 2002 – due to the own banking activity, the shareholders’ investments and positive economic environment. The participation of the government and foreign investors had been insignificant. Formally the achievement of the main banking indicators the pre-crisis level means the recovery of the banking system, but the domestic market already formed the new higher demand on the potential volume of the banking loans and the range of the banking services.

       The national banking system developments in the current moment are significantly depended on the external and internal factors. As the external factors we select the follows:

       - the high level of the world oil prices, which provides the stable financial state of the national enterprises (mainly exporters) and federal budget;

       - the low level of the interest rates on the developed capital markets, which is determined the low cost of the international loans and the high level of the investment demand from the international investors;

       - the growth of the demand on the energy resources ( in the physical terms), which determines the stable real level of the Russian fuel-energy sector’s export (not only in money terms);

       - the permanent growth of the Russia’s international investment ratings (including the sovereign and corporative ratings).

       As the domestic factors the following indicators affect the state of the national banking system:

       - the positive state of the Russia’s fundamental indicators (GDP, industrial production, capital investments rate and others);

       - the ruble rate appreciation toward the main world currencies:

       - the growth of the money supply (which was higher than the money demand from the real sector and households). As a result the volume of the free money resources (placed on the Central bank of RF deposits) was relatively high – about the $15 bln. in the beginning of 2004;

       - the shortage of the financial instruments circulated on the national market.

       The fundamental indicators of the Russian economy had been strongly positive during last five years. The growth rates of the produced GDP, industrial production, capital investments had been positive in the real terms, the ruble exchange rate has been stable, the federal budget surplus had been fixed and the inflation rates fell.

       The listed above factors (including the fundamental indicators) stimulated the developments of the Russian banking system. Most of them had the positive effect, but some formed the basis for the different local crises. In general the key current trends of the banking system after its formal recovery can be described as the following tendencies:

1. the rates of the banking assets increased, which were based on the improvement of the enterprises and households’ financial positions;
2. the rates of the individuals’ banking deposits growth had been on the high level, which increased the role of the Russian population as the investor;
3. the process of the “dedolarization” of the banking deposits (due to ruble real rate appreciation) was observed – the share of the banking ruble accounts reached the pre-crisis level;
4. the growth of the volume of the foreign loans to the Russian banks (the maximum level for the transition period as about $9 bln. had been fixed in 2003);
5. the growth of the volume of the banking loans to the real sector as long as the term of the banking loans;
6. the shift of the banking loans structure toward the “second echelon” enterprises – the financially stable enterprises, which are not belong to the fuel-energy sector;
7. the high growth of the volume of the banking deposits in the Central Bank of RF – as the excess liquidity volume in the national financial sector;
8. the increase of the volume of the banking loans to the individuals and corporate bonds (in spite of the higher risks and due to the weak national financial markets);

       Note, that in spite of some improvements the role of the banking system in the national production has been insignificant in the post-crisis period. The international comparisons show, that the steady growth of the emerging economies had been fixed only in case of the banking loans exceeding 40% GDP. Contrary Russian enterprises now mainly use their own recourses for the capital investments and the banking loans are only about 5% from the total capital investments. Further, the downward trend of the banking spread (the spread between average deposits and credit interest rates) partly stimulate the increases the volume of the banking loans to the real sector, but decreased the profitability of the banking business. The cut of the average margins of the banking operation (along with the low banking capitalization) potentially provokes the new banking crisis/instability.

       The further developments of the national banking system will be connected with the necessity to open domestic market of the banking services. Now the foreign financial institutions formally face with some restrictions in their invasion to the Russian banking services market. The Law on the banking system activity regulation in Russian is quite liberal, but regulated by the different instruction of the Central Bank of RF. For example it was the Instruction in the early 90-s, which limited the foreign capital participation in the total capital as 12%. Now such limitation had been withdrawn, but in fact the share of the foreign capital is about 10%. Further, there is the restriction for the opening the branches of the foreign banks (which can follow the foreign regulations and thus have the preferable position on the required reserve demand and others). There are some other restrictions (for example, the two years experience of the working in Russia before serving the individuals and others). Such restrictions are not follow from the Laws, but regulated by the CBR instructions, which can be principally changed due to the different political aims.

       In general the problems of the liberalization of the foreign banks’  access to the domestic financial market (including the problem of the Russia entrance to WTO) are hardly discussed within the possible positive and negative impacts. Between the positive factors are:

• the access of the Russian enterprises to the more cheap and long-term financial resources;
• the increase of the trust of the Russian households and enterprises to the national banking system after the foreign capital invasion;
• the increase of the total banking assets - as the basis for the loans increase to th real sector and for the support of the steady positive growth of the industrial production.

       As the negative factors of the domestic banking service market liberalization the follows have been strongly discussed:

• the shift of the Russian legal and individuals’ deposits in the favour of the foreign banks;
• the decrease of the competitiveness of the Russian commercial banks and the activization of the process of the national commercial banks sales to the foreign financial institutions – in the context of the national banking system security and independency.

       These set of the factors can principally change the appearance and structure of the Russian banking system in the nearest future – thus the political decision on this topic is so important.