Will 'Second Wave' Strike? The Worries Facing Russia's Banks

As the number of nonperforming loans grows, the Russian government is beginning to take the threat to the country's banking sector seriously.

By Jason Bush

Is the financial crisis in Russia coming to an end? Or is it just beginning? That seems to depend on who you listen to.

In recent weeks, senior government ministers and officials have been striking an increasingly optimistic note amid signs the economic situation in Russia has stabilized. Russia's Prime Minister Vladimir Putin has been especially keen to emphasize the government's achievements in the banking sector. "Thanks to the actions of the authorities, the imminent threat of a banking sector collapse has been averted," he boasted to Russia's Parliament on Apr. 6.

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Indeed, it's no small achievement that, despite the financial turmoil of recent months, no major Russian bank has gone bust, and there have been minimal signs of depositor panic. But in recent weeks, a chorus of doomsayers has been warning the stability won't last. A "second wave" of the crisis is about to hit Russia, they argue -- and the epicenter of this coming shock wave will be the Russian banking sector.

The government now appears to be taking the threat seriously. It can hardly ignore the likes of German Gref, the chairman of Russia's largest bank, state savings bank Sberbank. In a conference presentation on Apr. 8, Gref pulled no punches when he warned of the scale of Russia's banking woes. "The banking crisis in Russia is in its very beginning," he said, accusing the government of "slow decision-making" in tackling the problem.

Gref's comments echo similar remarks by Petr Aven, president of Alfa Bank, Russia's largest commercial bank, who has also caused a stir by warning that hundreds of Russian banks could face bankruptcy this year.

More Bad Loans

At the root of these worries is mounting evidence that, as the recession bites, Russian borrowers are struggling to repay bank loans. As a result, the share of nonperforming loans appears to be mushrooming. "A month ago, 15% seemed like a negative figure. Now people are talking about (the share reaching) 20% to 30%," says Natalia Orlova, banking analyst at Alfa Bank. She estimates that around 10% of loans are already bad, but expects the figure to reach at least 15% to 20% by the third quarter.

The precise figure makes a huge difference, with the cost of recapitalizing the banks rising exponentially as the share of bad debts grows. According to estimates by Sberbank, if 10% of loans go bad, the government will need to inject some $6 billion to recapitalize the sector. But that figure skyrockets to $35 billion if the share of bad loans doubles to 20% -- and no less than $80 billion if the share reaches 30%.

True, it's still far from clear whether the bad loan problem is actually as bad as the pessimists fear. Elena Romanova, banking analyst at Standard & Poor's in Moscow, says that in general banks now regard around a third of loans as potentially "problematic." But it still remains to be seen how many of those loans will actually go bad and how many will be restructured. "The risk is serious," she says. "But it's difficult to say how the situation will develop in Russia, because we've never been through such a calamity before."

It doesn't help that Russia's system of accounting differs in important respects from Western standards, recording unpaid loans (including loans on which the interest is unpaid), rather than estimating which loans are fundamentally unsalvageable. Richard Hainsworth, the head of the bank rating agency RusRating in Moscow, believes the level of bad loans stated in banks' statistics is exaggerated, because many loans fell due at the end of last year.

Relative Health

He argues that for all their apparent woes, Russian banks are in a fundamentally healthier state than their Western counterparts. Whereas Western economies were awash with credit in the runup to the crisis, finance in Russia has always been relatively scarce, allowing banks to be picky about whom they lent money to. "Any company trying to grow was making reasonable investment decisions, which is why the strength of the capital is also reasonable," says Hainsworth. "They weren't blowing the money on building golf courses."

Indeed, the overall volume of corporate debt in Russia is currently around $780 billion, or some 52% of gross domestic product-a relatively modest figure. The bigger problem is that much of the debt is short term: Some $220 billion has to be repaid in the next 12 months, amounting to around 20% of GDP.

The uncertain expense of recapitalizing the banks isn't the only conundrum now facing the Russian government. An equally perplexing problem is how to do this in a way that enables banks to restart lending money. For all the efforts being made by the government to stabilize the sector, there's still precious little evidence that much of this is feeding through into increased finance for Russia's economy.

Even for the best borrowers, Russian banks are currently demanding interest rates in the 15% to 20% range, more than most borrowers are prepared to pay. "The government is very ticked off that they provided so much money-so far some 2.5 trillion rubles ($75 billion) -- and the banks still haven't increased their lending," says Alexei Moisseev, an analyst at investment bank Renaissance Capital in Moscow.

Avoiding Corruption

That's a conundrum governments are grappling with all over the world, not just in Russia. In Western economies, many have argued that regulators need to clean bank balance sheets not just by pumping in new capital, but also by transferring problem loans into special agencies-so-called bad banks. But in Russia, that idea has received a cool reception from the government, which argues the scheme will give too much discretion to public officials, making it vulnerable to corruption. Instead, Russia is now mulling plans to recapitalize the banks by swapping specially created bonds in exchange for banks' shares.

According to Moisseev, a member of the Expert Committee advising on the scheme, banks will be required to make 100% provisions for all problem loans, to be confirmed by an audit, possibly handled by private auditors or by Russia's deposit insurance agency. He estimates the scheme will cost around $30 billion. "The top 100 to 200 Russian banks will be well capitalized, so once there is a recovery in the economy they will restart lending," he says.

But not everyone is convinced the remedy will work. "The best thing that the government could do is nothing," says RusRating's Hainsworth, who argues banks will only be forced to start lending again when the government stops providing alternative sources of cash. But he admits there are no easy answers: "How you restart lending after a crisis is a problem that not a single government in the world has yet cracked."


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