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Analysis & Opinion
21.10.10 Cooking Up A Crisis
By Tai Adelaja

A new banking crisis looms right around the corner in Russia, as domestic banks perpetuate the practice of issuing huge loans only to their core customers and big companies, Moody's international rating agency said in a report on Wednesday. Russian banks have traditionally favored well-heeled corporate clients, such as large industrial groups, in their lending practices, Moody’s analysts said in the report. But the practice, if allowed to continue unabated, could precipitate another country-wide banking crisis, the agency said.

Moody’s report also said that related-party transactions – the practice by banks of dealing only with someone with a close personal interest – are still widespread, and could threaten the stability of the entire domestic banking system. Huge loans given to selected clients, the agency said, remain the main threat to domestic banks’ asset quality.
According to Moody's the nation’s 20 largest borrowers account for on average 240 percent of liquid capital in the banking sector, or twice the average in developed markets. "We are aware that three or four of the 20 largest borrowers from Russian banks rated by Moody’s are currently in default or in the process of debt restructuring. This affects the quality of the loan portfolio as a whole," Moody’s analysts said in their report.

Related-party deals are particularly rampant in the country’s banking sector and could spell doom for the future of banking, the report states. By the end of 2009, loans issued to a single borrower or group of borrowers in related-party deals accounted for ten percent of the total loan portfolio or 45 percent of the total capital of banks rated by the agency. "In 2010 banks have actually increased the percentage," Moody's senior analyst Eugene Tarzimanov said in the report. This level is five times higher than that of banks in Central and Eastern Europe, and two times higher than that of credit institutions in the Middle East, experts say. During the crisis, the excessive dependence by banks on related-party transactions resulted in default in 50 percent of cases, Moody’s analysts found.

Russian banking analysts said, however, that while domestic lenders have traditionally relied on well-heeled clientele and big corporations, the situation is unlikely to push banks to the brink of a new crisis. “Russia’s banking sector is still young and evolving and domestic banks have traditionally built their business around big borrowers and corporations,” said Leonid Slipchenko, a banking analyst at UralSib. “Small and medium-sized businesses are very few in Russia and banks are lending to huge companies and corporations in order to reduce risks.” Slipchenko said the Russian economy is peculiar in that almost all sectors are dominated by one or more big corporations, giving the bank no alternatives in their lending practices. Services in the banking sector are in the throes of structural change as more and more foreign banks participate in the domestic economy and more regulations are introduced, he said.

Last week Moody's changed its outlook for the Russian banking system from negative to stable to reflect positive changes, such as improvement of the operating environment, the banking system's sizeable capital and loan-loss provisioning buffers. "The outlook change to stable for the Russian banking system is based on Moody’s view that the fundamental credit conditions within that system have become more sustainable following the recent financial crisis. We expect slow but positive economic growth to continue in the near to medium-term, which will improve the outlook for the banks' asset quality and profitability," Tarzimanov said in the agency's Banking System Outlook on Russia. Tarzimanov, who also authored the report, added that while the regulatory environment remains weak by international standards, Russia has registered some improvements. "Russian banks have a sufficiently large buffer of accumulated loan-loss provisions and capital to cope with the still-weak asset quality; our assessment is that current loan-loss allowances and capital levels are sufficient to absorb expected credit losses," Tarzimanov said.

Central Bank Chairman Sergei Ignatyev told foreign investors on Monday that Russian banks have essentially overcome the financial crisis, adding that bank profits will soon return to record levels of 2007. The Central Bank chief said banks’ revenue structure has changed, with most banks now relying more on commissions and securities transactions rather than loan issuance. "In terms of profit margins, we are closer to the record level of 2007, when revenues reached 500 billion rubles ($16.6 billion)," Ignatyev said. The Russian banking sector raked in 508 billion rubles ($16.9 billion) in net profit in 2007 and 409.2 billion rubles ($13.6 billion) at the height of the crisis in 2009. Net profit shrank to 205.1 billion rubles ($6.8 billion) last year as the liquidity crunch took its toll on domestic banking institutions, figures from the Central Bank revealed. A combination of factors, including timely and adequate actions by the government and the Central Bank in creating a better operating environment, have helped banks to crawl out of recession at the beginning of this year, analysts said. The banking sector recorded an aggregate gain of 320.1 billion rubles ($10.6 billion) in the first eight months of 2010, the Central Bank reported.

Alfa Bank Chief Economist Natalia Orlova said the banking sector now enjoys sizeable capital and loan-loss provisioning buffers, while its liquidity profile has increased considerably. “But the system still suffers from a lack of good borrowers and this is why the loan growth has been very modest this year,” Orlova said. “It is crucial for Russian banks to continue to maintain balance sheets that are highly concentrated on selected clients even if this deteriorates asset quality in the short term.” Right now Russian banks are unlikely to precipitate a crisis through their lending practices because the economy is delivering only modest growth, Orlova said. In the long-run, however, a combination of negative factors, including poor risk management and lack of transparency and disclosure, could spell doom for the domestic banking system, Orlova added, saying that both the Central Bank and the government are aware of the dilemma.

“Both the Central Bank and the government are crucial to implementing tight and prudential banking regulations to avert a crisis in the long-term,” Orlova said. “However, the reason the Central Bank may not insist on better risk positioning right now is that it may want to generate long-term growth in the banking sector, which is crucial to propping-up the real sector and improving economic indicators such as employment. Certainly the Central Bank and the government do not believe the time is ripe to tighten regulation in the banking sector.”
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