By John Manning – john.manning@internationalbanker.com
The political and economic landscape across the nation of Russia continues to face turbulent, volatile and challenging conditions. As a central part of the economy the Russian banking and financial services sector is facing tougher and tougher conditions. At the end of last year, on December 22nd 2014, the Russian Central Bank (RCB) made a public announcement stating that it would be extending a bailout programme of up to 30billion Roubles (equivalent to US $500million). The RCB added comment to their statement that the action has been designed in particular to protect the prominent and sizeable Trust Bank from facing bankruptcy. As a key Russian lender within the domestic banking sector the government and central bank is making protecting this financial institution and its contemporaries a top priority with the hopes of preventing further runs on the currency and the collapse of the Russian banking sector. In the meantime the RCB has decided that its Deposit Insurance Agency will oversee a phase of interim administration of Trust Bank. The Russian banking sector has been facing increased pressures as the Rouble’s value has tumbled and the price of oil has plummeted lower and lower. The conflict between Western nations and Russia stemming from the conflict of Russia with neighbouring Ukraine has only further hampered economic and political development. International sanction action has placed strain on economic activity across the nation. Further to this the country is operating within conditions of a phase of tight monetary policy and this is placing further strain on the banking and financial services sector. The profitability of banking and financial services businesses is dwindling and the conditions are forecast for further deterioration through 2015. Likely to make matters worse through the course of the year is the estimated large holdings of assets of poor quality on bank balance sheets that will eventually have to be brought into the light for real capital reconciliation.
Major banking institutions nationwide are struggling and are short on options when it comes to boosting the resources and investment backing behind them. External sources of finance have been closed off to Russian banks and political tensions and sanctions across the global landscape are making it difficult for these banks to keep business moving forward, or at the very least, survive. Without the capacity to refinance debts or to roll existing debt positions into the next trading period banks are struggling to keep afloat. This is particularly the case with foreign, external counterparties and the position does not appear to be resolving over the short to medium term. Further adding to the strain on the banking business are the capital adequacy ratio regulations that global regulators have been setting in motion over the past few years. These capital buffer ratios, designed to control bank balance sheet holdings so that they are capable of surviving market shocks and provide long term stability and prevent a future global financial crisis, are expected to be further tightened over this year and next. According to RCB reports, capital adequacy for Russian banks was recorded as 13% in August 2014, which has actually fallen lower from the 13.5% level that was recorded at the start of the year. Unfortunately the parameter has grown even worse by the third quarter of 2014 slipping to 12.6%.
Sberbank of Russia is the largest bank in Russia and Eastern Europe Photo © Depositphotos.com/S_Kohl
Since autumn of last year, the risks to the banking sector have increased substantially as a result of three factors: the imposition of international sanctions, the worsening economic outlook and the rapid depreciation of the rouble. Over the course of August and September of last year sanctions were brought upon some of the primary state-owned Russian banks from both the US and the EU. These sanctions have been imposed by Western nations as a response to Russia’s actions as part of the conflict with eastern Ukraine and were further precipitated following the shooting down of a Malaysian passenger aircraft. For the short to medium term it is very likely that the RCB will work alongside the Finance Ministry to provide further support to the financial system – most likely in the form of further capital injections to provide liquidity boosts to the banking sector. In the meantime the nation is braced for potential banking institution failures on the horizon. Although the RCB might be prepared to divert funds and resources towards propping up ailing financial institutions there will eventually be a limit to the amount of support provided. Systemically vital banking and financial services firms will be a top priority for the RCB with other smaller firms potentially facing failure later in the year given the tough economic climate. The Russian banking sector has been experiencing persistent deterioration and weakening since the time of the global financial crisis of 2007 – over 7 years ago. However, the condition has been severely weakening over the past year – with banking profits 14% lower by mid-year of 2014 as compared year on year, and further to this over 25% of Russia’s banking institutions reported losses during June of last year – a much larger proportion than the 18% recorded for the previous year. Unsecured consumer debt has risen by 2 percent between April and September 2014, to reach 11.3% demonstrating that at the same time the proportion of non-performing loans of Russian bank balance sheets has also grown. Loans issued by banks in foreign currency accounted for approximately 23% of the total loan stock as of October 2014 and this figure is forecast to rise significantly for the following months as a result of the further currency devaluation. The figure is expected to reach approximately 30% of the total loan stock for the start of 2015. Sanctions from the US and the EU have meant that some of Russia’s largest lenders, such as Sberbank and VTB, have since been prevented from access certain types of debt. In particular, these major Russian banks will not be able to obtain short term debt structures – specifically any product with a maturity under 30 days has been prohibited. However, when comparing the second and third quarter figures for Russia’s banking sector debt inventories and payments indicate that foreign debt experienced no change in level over this period of time. The sanctions imposed on banks have isolated Russian banks – and left them cut off, without access to international capital markets and the financial options and products these markets have to offer. Additionally, these banks are facing increasing foreign currency liabilities as they no longer have the ability to roll over debt and are having to contend with redemptions on top of all other challenges.
Officially these sanctions are meant to apply to state owned banking and financial services institutions. However the knock on effects into the marketplace has meant that borrowing costs have risen across the board in the Russian banking sector, only rising further upward as foreign investors perceive the risks of the Russian economic and political landscape as high, significant and volatile. Central to political concerns, as with any nation across the globe, is the action and behaviour of the nation’s leader, President Vladimir Putin. Less than reassuringly, after the Russian head spoke publicly in December 2014 at an end of last year’s Moscow based news conference, the Rouble weakened further. His statements failed to indicate any plans to restore stability and growth to the Russian economy and traders responded by positioning themselves so that the Rouble fell, especially against the dollar. How Mr Putin will revive the Russian economy remains unclear – with few suggestions being put on the table for discussion – and this has left investors uneasy about the Russian economy. Without investor support the Russian economy, currency and banking sector will continue to struggle. A clear and methodical agenda of rebuilding the economic mechanism will help restore investor confidence and drive growth sustainably into the future. In today’s increasingly globally interconnected marketplace restoring some stability to the Russian financial sector and Russia’s wider economy would reap benefits for all economies across the globe. The risks of collapse of the Russian financial sector have the potential to trigger and spread a further downturn globally – especially given the vulnerability of the Eurozone, which has failed to gain traction in rebuilding growth and continues to struggle.
The government has been taking steps towards reinforcing the banking system – with one example being through strengthening tier one capital buffers for major banks. As part of these efforts, in autumn of last year the government made a public announcement of its intentions to purchase shares to cover outstanding debts to the National Welfare Fund (one of the country’s largest sovereign wealth funds) in both Rosselkhozbank and VTB in the value of Rb239billion (US$6.6billion). Although publicly the banks faced with sanctions are making statements and comments that the sanctions will have only minimal impact on their business operations and effectiveness, reported figures have indicated that Russian bank balance sheets are under significant pressure. However, all is not lost with the imposition of sanctions from foreign counterparties. Flight of capital deposits have yet to materialise in substantial size for the domestic economy for Russian banks. The Russian banking sector’s total external debt for the 2014 third quarter was recorded at US$192billion – a value approximately equivalent to 22% of total domestic claims. Further to this measure, the Russian banking sector has reported a positive net foreign-asset position over the same period. On the positive side default is mitigated by the fact that a sizable proportion of corporate loans will have been to companies in energy and natural resource industries, whose revenue is typically earned in foreign currency and this has created the potential to restrict exposure to exchange rate risk. Also on a more promising note, in contrast to some east European nations, the proportion of personal loans issued in foreign currency is fairly low for Russian banks, currently under 2% of the total.
Perhaps most worrying is the intertwined fate of the currency, the Rouble, and the banking and financial services sector. Between June and November of last year the rouble lost 25% in value against the US dollar, pushing up the price of foreign debts for the banking sector. This has only further increased the risk of default on foreign currency denominated debts issued by the banks. The currency has fallen in value as the perceived risks of the Russian economy have soared over the past calendar year – weakened by political turmoil, sanction activity, commodity price slumps and the tumbling oil price. As an economy dependent on its oil and energy sector, Russian output has suffered considerably by the slumps in these markets through 2014. The falling value of the Rouble has put increased strain on the banking sector. Pressures from exchange rate markets have impacted capital levels, external liabilities and asset quality. Towards the end of last year, when the Rouble took a rapid tumble against the dollar, the risk of an all- out currency crisis became a more real one. Following a plummet of over 10% in the rouble on December 15th 2014 (the Rouble’s biggest decline in one day since the crisis of 1998), the RCB raised its key policy rate by 650 basis points, to 17%, in an effort to stabilise the currency.
However, this move proved to be counter- productive and has since led to increased uncertainty and failed to calm investor concerns, leading to further falls in the currency followed only by some very moderate and partial gains. This move has led to the development of more realistic concerns that a deposit flight may be around the corner. Following this activity the Ministry of Finance announced that it would sell up to US $7billion of foreign currency to support the Russian currency.
With these parameters and market conditions in place it would not take much of a market shock to lead to another volatile move in the Russian currency. Faith and confidence in the RCB and government policy setters is falling day by day, for both domestic and foreign investors. Sentiment is in a delicate balance, as are the economic, political and market conditions of the Russian nation. Currently there are over 800 banks operational in Russia, many of which have weak balance sheets, low capitalisation levels and poor strategic planning to navigate the tough climate ahead. The RCB has withdrawn licences from over 80 banks through the course of 2014 and further consolidation and banking institution closures are likely for 2015. Failures in the banking sector need to be managed effectively as they risk sending the entire Russian economy into a deeper recession. Further bail outs are likely for 2015. The banking and financial services sector will be tasked with navigating this challenging climate through 2015 in order to survive and at the same time will have to work help restore the wider economic climate hand in hand with local governments, businesses and individuals. Another fall in oil, energy and commodities markets has the potential to lead to another Rouble fall and the RCB will need to put in place plans to counter and remedy this potential, yet likely, outcome. 2015 is likely to see a number of failures of banks and financial services institutions – the challenging combination of a liquidity contraction, economic weakness, and the dropping exchange rate will be tough to survive.