The number of banks in Russia has fallen below 500 for the first time since the 1990s, as the Central Bank of Russia (CBR) campaign to clean up the sector moves into its end game.

Since taking over in 2013 CBR governor Elvira Nabiullina has steadily closed about 100 banks a year. Altogether the central bank has revoked licences from more than 400 banks and sanitised more than 30 credit organisations, according to Nabiullina. Those sanitised include three “very large banking groups,” Nabiullina said at the Congress of Financiers of Kazakhstan.

There was an explosion of banks in the 1990s during what came to be know as the “wildcat” banking days. Regulations on starting a bank were eased and as only a small amount of capital was needed to establish a bank companies and businessmen established thousands of what Renaissance Capital analyst Kim Iskyan famously called “bank-like institutions.” At the peak there were some 4,500 banks registered in Russia.

However, few of these banks actually did any real banking business. At best they were “glorified treasury operations” (another Iskyan epithet) and at worst they were “money chutes” established to facilitate capital flight through non-transparent schemes.

Sod business bank

The sheer number of banks is a major headache for the CBR, which was overwhelmed and so unable to physically regulate the sector. That poses a systemic risk to Russia’s entire financial sector, which is otherwise one of the most sophisticated in the emerging markets (EM) universe. A lack of manpower meant the CBR was simply unable to prevent the stealing, scams and schemes to whisk cash overseas as it doesn't have enough inspectors to oversee everyone.

The need to clean up the sector has been obvious for years and dovetails with President Vladimir Putin’s “deoffshorisation” initiative which at first banned Duma deputies from holding bank accounts abroad, but has since been broadened to include managers of state-owned enterprises as well as “encouraging” Russian companies domiciled overseas to bring their legal structures back onshore.

But Nabiullina’s predecessor, the camera-shy Sergei Ignatiev baulked at the challenge. There was an opportunity following the 2004 “mini-banking crisis” that saw up-and-coming retail bank Guta collapse and several of the top tier banks like Alfa Bank wobble as panicked depositors withdrew their savings.

With the bank sector weakened in the aftermath of the 2004 crisis there was a perfect opportunity to close down some of the more obviously nefarious small banks, but fears of sparking a systemic crisis meant Ignatiev dodged the issue. However, in his parting speech to the Duma, he railed against the scams that lead to the tens of billions of capital flight a year. “One group is responsible for half of all the capital flight,” Ignatiev said in a verbal tongue lashing of Duma deputies. He did specify which group was responsible, but he made it pretty obvious to his audience who he was talking about by his ire.

Part of the problem for the CBR is that the smaller banks make most of their business from borrowing cheaper than companies can on the interbank market, where big banks put their spare cash to earn a little extra revenue. However, what started the 2004 crisis was the CBR’s decision to pull the licence of the aptly named Sodbiznesbank for egregiously running a money laundering operation – the first time the CBR had cancelled any banking license for not doing banking business.

Rumours quickly circulated that the CBR had a “blacklist” of other dodgy banks that it was going to shutter and as a result all the big banks cut off the small banks from their funds on the interbank market. As the liquidity evaporated most of the small banks quickly started to get into trouble. The CBR ended up having to intervene and pump huge amounts of cash – about 3% of the entire sector’s assets – to reflate the interbank market business and head off a full scale banking meltdown.

And it used to be dangerous to close banks. While Ignatiev shied away from closing banks, the decision to close Sodbiznesbank was actually taken by his deputy Andrey Kozlov, who was gunned down by an assassin in 2006 for closing another bank owned by Aleksei Frenkel who was eventually jailed for ordering the killing.

Nabiullina has been braver and started closing banks as soon as she took over in 2013 and has steadily continued the process since, despite Russia facing a major economic crisis at the end of 2014 when the price of oil collapsed, leading to a massive devaluation of the ruble that also destabilised the banking sector.

DIA to the rescue

The way this has been done so that the interbank market doesn't seize up again was to make sure that the Deposit Insurance Agency (DIA), that insures all retail deposits up to RUB1mn ($15,000), is rigorous about compensating all deposits affected by a bank closure. The DIA has been so good at its job that some Russians interviewed by bne IntelliNews went out of their way to find small banks paying extraordinary interest rates of as much as 25% vs the overnight rate of 17% at the time, confident that if their bank went bust (which was highly likely) the DIA would reimburse their money, including the interest payments.

This is an expensive way to work and the DIA has run out of money at least twice; the agency now owes hundreds of millions of rubles to the regulator.

In 2013 the DIA allocated RUB103.9bn o payments of affected depositors, in 2014 RUB202.4bn, in 2015 RUB369.2bn, and in 2016 RUB663.4bn, whereas in 2017 the DIA spent RUB438.9bn.

As the clean-up moved up the food chain and the closed banks became progressively bigger, so did the depositor bail-outs. Starting in 2015 the central bank was forced to start giving the DIA loans so it could meet its commitments.

The regulator issued a five-year unsecured loan to the agency that year which has grown to more than RUB1 trillion. The debt of the DIA to the CBR by the end of 2017 amounted to RUB821bn rubles, according to the agency.

Now the clean-up has moved into a new phase and the lead is being taken by the banking sector consolidation fund rather than the DIA, the agency has begun to settle its accounts, paying back the first RUB17bn last year.

“It is possible, with a certain, perhaps cautious and optimistic, to say that the Deposit Insurance Fund is quietly moving towards some kind of relative self-financing,” the agency’s general director Yuri Isayev said as quoted by Interfax at the time.

At the beginning of 2018, the DIA also increased the base rate of banks' contributions from 0.12% to 0.15% of the average balance on deposits for the quarter, which is its main source of funds.

The last time the state increased the size of deposit insurance contributions by banks was at the end of 2014 following a sharp devaluation of the ruble and the depositor panic that followed. At that time the maximum amount of deposits guaranteed by the DIA was increased from RUB700,000 to RUB1.4mn.

And in the first week of November some members of the Duma floated the idea of increasing the minimum guaranteed amount again to RUB2mn as well as upping the contributions retail banks have to make to the fund – effectively a tax on holding deposits. The CBR’s clean-up is not just about closing dodgy small banks: a raft of new regulations and other measures to shore up the solidity of the sector have been introduced. Next up will be the application of the so-called Basel III rules, which mandate bigger provisions and other prudential measures to further improve the solidity of the sector.

For these reasons, and Nabiullina’s super conservative monetary policy, she has been dubbed “the world’s most orthodox central banker.”

Garden Ring crisis

Things changed up a gear in September last year when the CBR closed its first too-big-to-fail commercial banks. The so-called Garden Ring banks went bust and had to be rescued by the CBR. These banks were too large for the DIA to compensate their depositors, but the CBR had set up a new mechanism, the Bank Sector Consolidation Fund, in April that simply took over the troubled banks — Binbank, Otkritie FC and Promsvyazbank – and kept them open so there was no need to compensate depositors.

The government itself precipitated the September 2017 near miss banking crisis. In April last year the newly formed domestic ratings agency Russian Analytical Credit Rating Agency (ARCA) pulled its AAA ratings for the Garden Ring banks. Under new rules, also launched at the state of last year, state-owned enterprises (SOEs) are not allowed to hold cash in banks without these AAA ratings, so the decision led to the outflow of large deposits at these commercial banks, plunging them into crisis.

Even though the de facto reorganisation of these commercial banks was clearly planned long in advance it nearly ran out of control as the collapse of one large commercial bank threatened to undermine the whole sector. Bank sector profitability, which had been growing steadily for two years after a barren 2014-15, collapsed, with the sector as a whole losing over RUB300bn in September alone.

The Garden Ring banks turned to the CBR for help, as can clearly be seen by the spike in repo transactions, where banks use their assets like bonds as collateral for expensive short-term borrowing from the CBR. After two months of growing worries, the CBR stepped in, took the banks over using the new bank stabilisation fund, and abruptly ended the crisis.

 

While some have criticised the government for closing the Garden Ring banks and see it as a ruse for the state-owned banks to increase their market share – the state now owns some 70% of banking assets as a result – the problem with the Garden Ring banks is they had all bought pension funds and were using their cash to pump up their balance sheets. That was fine as long as pension premium payments continued to rise, but when this sector reached maturity the pyramid would crumble. The Garden Ring banks were a systematic crisis waiting to happen.

There are a few more banks to close. Several years ago Putin said he believed the optimal number of banks was 300, and pointed to the German system as the model for Russia.

The banking sector has now entered the endgame. If the CBR continues to close banks at the same steady pace it has been then Russia will reach this target in about 2020 and the clean-up will be over. The next phase will then begin: the privatisation of the sector as the CBR attempts to sell all the formerly commercial banks it picked up in last year’s crisis that are currently residing in the Bank Sector Consolidation Fund and more sales of stakes in Sberbank and VTB bank.