Commentary: Don't Bank on Russian Bank Reform

By Catherine Belton

Anyone wondering how desperately Russia needs a normal banking system should look at Elizabeth Wallace's list of collateral for loans. Wallace runs the European Bank for Reconstruction & Development's small-business department, which has a big Russian fund. Wallace has approved credits for her clients--shopkeepers, craftspeople, and entrepreneurs--backed by a dog, a television set, even a flock of geese. She drew the line at a set of gold-filled teeth.

The EBRD's borrowers are the lucky few. Russia has some 1,300 banks, yet loan programs for small businesses and other rudimentary banking services are virtually nonexistent, Wallace says. Businesses typically get by with a mix of cash and barter. Any money they accumulate goes into a jam jar or under a floorboard. So it mostly falls to a multilateral institution like the EBRD, whose mission is to foster Eastern European development, to fill the need for what Wallace calls "an old-fashioned neighborhood type of banking." Since 1994, the fund has lent $540 million to some 35,000 Russian businesses. It now makes 2,250 loans a month, averaging $5,000 to $10,000 each.

The dearth of banking services is an age-old problem in Russia, dating back even to czarist days. What exists now is a murky, poorly regulated network that primarily serves state agencies and conglomerates run by the notorious "oligarchs." President Vladimir V. Putin has made only symbolic gestures toward fixing the problem. But if Putin wants Russia's economy to evolve past its primitive dependence on commodities, banking is a crucial place to start, and reforming the Central Bank should be his first priority.

As it is, for the average Russian, banks are irrelevant. Mortgages, car loans, mutual funds, and other consumer-finance services are a dream. Total bank deposits are only 6% of gross domestic product, far less than in other Eastern European countries. Most people keep their money--an estimated $40 billion--at home. Banks supplied just 3% of investment capital last year.

The huge state-controlled savings bank, Sberbank, with $19 billion in assets and over 23,000 branches, is the only bank whose deposits are insured. With a quasi-monopoly on deposits, Sberbank does lend, but it's hardly a healthy influence on the banking system. By issuing loans at below-inflation rates, Sberbank forces out competitors and undermines its own balance sheet.

Without a trustworthy system for storing the savings of individuals and businesses and circulating them through loans, Russia is choking the development of its middle class, the bedrock of a stable economy. And with economic growth this year expected to be less than half of last year's petroleum-driven 7.7% rate, that's a serious issue.

Yet you'd never know it from the lackadaisical way Putin and the Duma have handled bank reform. On the surface, there has been real progress recently. On June 6, almost three years after the 1998 debt crisis and devaluation wiped out hundreds of banks and the savings of millions, the upper chamber of Parliament passed a package of solid-sounding bank-reform laws. One provision makes it easier for the Central Bank to force insolvent institutions into bankruptcy, giving investors and creditors a legal framework for recovering assets. Another gives the Central Bank new power to revoke banking licenses. A third clarifies what constitutes a bank--making it harder for financial companies to escape regulation.

But the laws are nearly three years late. Many banks that went under in 1998 long ago shifted their remaining assets to new companies. Depositors may yet get some savings back--$1.5 billion remains unrecovered--but few creditors will recover more than a fraction of what they lost.

Of course, there will be other crises, and the new legislation would presumably protect Russians from unscrupulous bankers in the future. There's a bigger issue, though. The laws are only meaningful if the Central Bank, the sole entity with authority to regulate banks, enforces them. "The Central Bank already has an enormous potential to regulate the sector," says Andrei Melnichenko, the politically well-connected CEO of fast-growing MDM Bank, "but it doesn't use it." And that's unlikely to happen as long as Viktor Gerashchenko, its chairman, remains at the helm. Gerashchenko, age 63, whose term expires in September, 2002, isn't an easy man to dislodge. Putin can't legally fire him. And it isn't in his political interest to force him out, since Gerashchenko's friends include powerful Russian tycoons who appreciate his lack of regulatory zeal and depend on Sberbank loans.

Observers say that Gerashchenko has done so little to clean up the sector during his three years in office because the Central Bank benefits from the status quo through its stakes in some 23 commercial banks in Russia and abroad, including 63% of Sberbank, the main beneficiary of the 1998 bank wipeout. Gerashchenko's response: The Central Bank plays a stabilizing role via Sberbank. "Before the crisis, the West, for some reason, was calling for more accounts to go into other banks beside Sberbank. What happened then? The money of the middle class disappeared in the oligarch banks," he told BusinessWeek recently.

But this statement skirts the real issue, which is that the Central Bank has done nothing to stimulate the creation of an honest consumer banking system. For instance, for seven years, successive Russian governments have tried to institute deposit insurance for all banks, but the Central Bank has blocked it. "I don't think this idea is promising," Gerashchenko told a reporter recently. People who lost their savings in 1998 might differ. Meanwhile, as the only bank with deposit insurance, Sberbank has 87% of the nation's ruble deposits and 70% of its hard currency. "Sberbank is one of the biggest gridlocks in the Russian banking system," says Alexander M. Knaster, CEO of Alfa Bank, which is the second-largest retail bank after Sberbank but has just 4% of all deposits.

Putin has proposed several reforms recently that would help banks. He would cut the tax on bank profits from a punitive 43% to 25% and would require businesses to adopt international accounting standards by 2004. More transparent corporate accounts would improve risk control in the banking system by making banks more comfortable handing out corporate loans. And closer supervision would make it harder for undercapitalized banks to circumvent capital-adequacy standards by faking their accounts. But such standards will only be meaningful if the Central Bank monitors risk in the system and sanctions those that don't comply.

Unfortunately, the outlook isn't very promising. The Central Bank says it's all for international accounting, but it needs to train its 86,000 employees to use it first. A plan to spin off the Central Bank's commercial empire has been drastically watered down; that decision won't change until Gerashchenko goes. Rumors surface periodically that he's on the way out. And Putin has recently been willing to show other ex-Soviet fossils the door. So some are encouraged. "The president has signed three bank laws," says Anders Aslund, senior associate at the Carnegie Endowment for International Peace in Washington. "If you take the trouble to pass the laws, it makes sense to appoint someone who would enforce them." Don't stop now, Mr. Putin. You won't transform Russia into a modern power with a sick banking sector.

Belton covers Russian finance from Moscow.

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