Publications. Financial Articles : # 25

Specialization as an alternative strategy for Russian banks

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(English translation of Article in Russian language)

Information Bulletin of Assotiation of Russian Banks, # 2, 2003, pages 60-63

Dmitry Lyubomudrov, Expert on Banking and Finance, State Duma (Parliament) of Russian Federation, Commission Europeenne pour rapports economiques internationaux (Luxembourg) - Head of Working Group for creation of the "Bank for Project Credits of Russian Federation", ,

Tatiana Harlamova, General Director of Audit Company "ARNI" (Member of Consulting Group "ARNI"), ,


Russian economy has serious claims to Russian banks. Mostly all sectors of Russian economy are in need of vast investments for modernization programs which are vital for being competitive on the world market. Enterprises' own funds do not cover current modernization needs whereas short-term loans of Russian banks are expensive and insufficient. Foreign investors such as banking consortiums, investment funds, direct investors, Russian funds transferred and returned via offshore etc. seem to be real sources for cheap, long-term investments for large programs. On one hand Russian investment climate is improving. Russia keeps the third place on the list of the most prospective emerging markets following China and India, says James Wolfenson, president of the World Bank (AK&M, 14.11.2002).

The investment attractiveness in Russia has increased - it rose from 32-nd to 17-th place, according to ratings of A.T. Kearney Consulting Co., whilst China takes the leading place first in history. However, real investments are much lower then the need of Russian economy. According to Goskomstat of Russia (Governmental Statistic Body), Russian economy received in total $12.9 billion for the period of 9 months 2002. At the same time, it is Russian banks that is one of the slowdown factors of foreign investments to Russia, as stated by foreign investors and banks.


Opinions of executives of western banks 

  1. According to Michel Periran, the President of Raiffeisenbank (Austria), the volume of investments to Russia for the year 2002 will not exceed $3 billion. "Despite the investment risks have been much lower since 90s, investors are still cautious about the long-term perspective of Russian economy,” he pointed. According to Mr. Periran, primary factors that affect investors’ trust to the Russian market are weakness of banking sector, ineffectiveness of corporate management system, as well as the lack of financial information about most of Russian companies.

  2. Today foreign brokers invest no more then 3 % of capital to emerging markets, says Peter Styler, managing director of Van Eck Global. "We are not to expect a decent flow of investment while Russia is being considered a country with developing market," he said. (AK&M, 23.10.2002. Issue 560,

  3. Weakness of financial intermediary system in Russia is one of the main features of business climate in the country, according to World Bank. The above is stated in the annual 2001 report on Russia. (AK&M, 29.01.2002).

  4. Christoph Ruhl, chief economist of the International Bank for Reconstruction and Development, compared Russian banking sector with a clot, which blocks further economic transformations. The main reason for a crisis of the banking sector is an absolute mistrust between all economic parties. But even apart from the crisis, large banks such as "Investment Banking Corporation" still turn bankrupts, which definitely results in mistrust.

  5. European Bank for Reconstruction and Development (EBRD) invests more than ˆ200 million to Russian financial sector in 2002, announced Kurt Geiger, director of the EBRD. At the same time a reform of banking sector is needed, said Mr. Geiger. "The faster it will be going the quicker the economy will grow in Russia." (RBC, 22.10.2002. Issue 559.

  6. Luigi Dante, general director of "SIMEST" (Italian Financial Institution for the development and promotion of Italian business abroad), commented on the problem of Russian banking system: "The problem is that the efforts on making a true financial reform and turning Russian banking system into a trustworthy one are totally inadequate."

  7. The risk of crisis of banking sector in Russia still exists. This was stated in a telephone press-conference by Ekaterina Trofimova, leading banking analyst of Rating Agency "Standard & Poor's" in Russia. "There are many factors which may directly or indirectly cause such events," she said. Russian banking system is "sensitive to even slight changes on the market". "Russian banking sector is excessively concentrated on individual corporate clients" - she said. Consequently, serious financial problems with any large Russian corporations may cause a crisis, according to the analyst. (AK&M, 02.09.2002).


While negotiating with investors' representatives it becomes clear that one of the obstacles towards increasing investments is the lack of investment infrastructure. This includes the absence of banking control over allocation of investments among beneficiaries (especially holdings which comprise several legal entities), control over financial activities of beneficiaries, their suppliers and dealers' networks as well as securing timely accumulation of reserves to pay back investors. According to investors, they appear reluctant to entrust the last function to Russian banks.

The major problem is as follows: Russian banks have too much risk and too little capital. The capital is indeed scarce (including that of subsidiaries of foreign banks). Total capital of all Russian banks is $10 billion. There is a growing trend but still it is quite slow, few percent per year. Only 12.3% of banks had total capital of more then ˆ5 million (the minimum required for newly opened banks) as of the beginning of the year 2002, according to the Central Bank of Russia. Small capitals do not allow issuing substantial loans (loans of $100 million are considered substantial for Russia) to large borrowers or holdings. Whereas large enterprises (RAO ES, Gazprom, oil and metallurgical companies) demand substantial credits. In order to keep clients, banks have to find tricks, split up credits, make up several short-term credits, invest to subsidiaries' promissory notes etc. However all these tricks are not as harmless as it seems. They inevitably weaken the legal base for such credits and, as a result, lead to defaults or even worse - banking bankruptcy which we unfortunately see all the time.

The banking crisis of 1998 showed how difficult it is for universal banks to provide stability of settlements in the period of crisis. Rouben Indjikian, head of a Banking, payments & trade finance Unit of UNCTAD (United Nations Conference on Trade and Development) in his report of September 20, 2000 on international conference "Banking and finance technologies serving real economy" concluded: "one of the reasons for banking crisis of 1998 in Russia was, for many Russian banks, integration of multiple functions: clearing, credits & deposits, and venture funds". General managers and owners in their attempts of gaining maximum profit against the lack of liquidity of instruments mentioned above often end-up in bankruptcy. And it is investment projects that suffer most for they have longest economic cycles and it is difficult for them to terminate financing in cases of bankruptcy of their operating bank.

"The Bank of Russia can not always adequately estimate situation with banks and forecast its progress", said Sergei Ignatiev, chairman of The Bank of Russia, at the conference of Associations of Russian banks. He mentioned "Investment Banking Corporation" as an example. Financial report analysis of this bank did not reveal any indications of insolvency, he pointed. "We, in the Central Bank, still have not learned how to adequately analyze the banks' positions and make forecasts. (AK&M, 24.04.2002).

Nontransparent and complex ownership structures of Russian banks make their owners inaccessible for creditors or regulators. (M.Matovnikov, Expert, 11.02.2002).


Constructive proposals

Standard solution, based on the experience of banking crisis in different countries, is to follow development of banking specialization, diversification of risks, segregation of risk management and control over various financial risks (credit risks, currency risks, stock market risks, political risks, currency fluctuation risks on commodity markets etc).

Both the Government and Central Bank experts as well as international experts have long approved the development of specialized banks. However, only initial steps have been made so far. For instance, the law "Of construction saving institutions" has been prepared by efforts of the State Duma's mortgage commission, which is a classical example of specialized banks successfully operating in Germany for more then 70 years.

"Technology of no-risk banking servicing and project budgeting" (it is registered in the “Russian Authoring Administration” as intellectual property of Dmitry V. Lyubomudrov, Certificate of registry # 4315) has been developed based on cumulative experience of developed countries in creating specialized banks. This is a technology for specialized credit institutions, which has been successfully put into practice with some operating credit institutions (bank and non-banking credit institutions) and received a high appraisal by both Russian and foreign experts. They confirmed that applying this technology greatly reduces investment risks, ensuring at the same time investors (foreign in the first place) against possible losses quite considerably. Comments and articles on this subject can be found at

Following the initiative of the State Duma - Parliament of the Russian Federation, a report on our efforts in working out ways of banks' specialization was made in Washington, at World Bank and International Monetary Fund headquarters, American Bankers Association, and other bodies. Our listeners' common opinion was that creation of specialized (low-risk in particular) credit institutions would positively influence the investment climate in Russia and increase protection degree of foreign investments by reducing the risk of loss or wrong utilization of funds.

Specialization is the only survival strategy for a great number of small banks (comprised more then 87% of Russian banks as was mentioned earlier) which are obviously unable to accumulate the required ˆ5 million of capital (Information Bulletin of Assotiation of Russian Banks, ¹2, 2002). Indeed, the CBR does not require banks to match their capital to the new requirement on the spur of the moment. Still, the deadline is coming and it seems strange that management and bank owners do not undertake drastic measures to change the current situation. Besides obvious ways such as merging with other banks, there are possibilities of forming non-banking credit institutions (NBCI). NBCI's capital requirements are 10 times lower then those in regards of the bank's capital (ˆ500 000). This idea was proposed by Victor Gerashenko (at that time - Chairman of the Central Bank of Russian Federation) is quite old and has also been dwelled upon by Vladimir Volkov, director of financial institutions audit, UNICON Audit Company (auditor of the Central Bank of Russian Federation), in his article "Russian business without accent" ("Russian Focus" Magazine, 17-23.09.2001, ).

Such steps are undoubtedly not easy ones but there are a number of experts of consulting and audit companies who are able to help small banks (especially regional banks) to adequately evaluate their perspectives, market situation, competitive environment and resources at hand, as well as help develop various strategies and realize them together with negotiation with potential stockholders. The practice shows that "pocket" banks are out of fashion. There are few of those to trust the "bank of one owner." Still, it is possible to negotiate the sale of a stagnating bank (but not making much losses) to an investment pool of a large project. It might need a stable clearing bank to work under more strict rules then a large universal bank, facing at then same time smaller risks and making its profit out of technology and increase of low margin operations instead of high profit and consequently high risk assets. It is clear that unprofitable universal bank by itself will not turn into a balanced and technological specialized bank with a great turnover. This can only be a result of the tremendous expert and consultant work, which in turn are invited by the bank owners unsatisfied with performance of the bank.

Some moves towards the development of specialized credit and financial institutions have already been made. Economic Council of Central Federal Region (CFR) passed a resolution on October 23, 2002 within the limits of the project "CFR concepts of economic development." This resolution set strategic directions for creating necessary base for investment process in Russian regions: specialized banks (including mortgage and investment), non-banking credit institutions, direct and venture investment funds, credit bureaus, custodians and others. At present, on the basis of the fund "Center of strategic research" a group of developers of this concept works with Russian regional administrations, making proper amendments into the concepts based on their feedback. The experience of some Moscow Banks has been considered in the process of implementing the concept. Those banks already follow the difficult but prospective road of specialization (examples are Bank 'FRAM", Runa-bank" and others).

It seems appropriate to have Russian regional administrations arrange special seminars on the subject mentioned above and invite local banks, representatives of local CBR branches, regional banking associations and unions, investment, finance, consulting and audit companies as well as experts specializing in this area. Among the issues of the seminars might be: working on concepts of developing local banks, possibilities and mechanisms of their specialization and capital increase, developing ways of cooperation with foreign banks and investment institutions. Thus, together with the theory we will be advancing towards practical realization of proposed mechanisms involving regional and center economic entities, increasing the effectiveness of federal districts' development. Hence, by increasing reliability and professionalism of Russian banks we will be making real steps towards the improvement of investment climate in Russia and increase in inflow of long-term investments to the real sector of Russian economy.