After the 2008 crash, Russia took measures to reduce the damage to its financial system. Its banks continue to fight back
The crisis of 2008 and 2009 illustrates just how closely the Russian economy and its financial sector interact with the world’s global markets, with externalities remaining a strong factor in shaping the resilience of Russian banks. To understand future developments in the national banking system, it is necessary to understand three factors: the current state of the Russian banking environment in the wake of global events since 2008; areas where Russian financial institutions are susceptible to the European debt crisis and available mitigants; and long-term trends in the Russian banking system, which suggest that 2012 may not be like 2008.
The current situation
To bail out their banks in 2008 to 2009, countries worldwide had to go beyond monetary measures and resort to a wide range of budgetary levers, from direct nationalisation and troubled asset acquisitions to state guarantees and capital injections. The scale of asset purchases brought about inflated budgetary spending and mounting state debts, as toxic bank assets became state-owned. The burden proved unbearable for some countries as extensive state intervention in the economy, inflexible labour markets, and rampant red tape thwarted prospects for effective competition and growth. Attempts to put things right by slashing budget deficits and capping state debt produced lacklustre results, and even aggravated the plight, which brought Europe to the brink of a major sovereign debt crisis.
Russia was among the countries that took measures to shore up its national economy. According to the IMF, budget spending grew by more than seven percentage points of GDP, resulting in the country’s first budget deficit in a decade at 6.3 percent of GDP.
However, a swift recovery helped prevent the accumulation of debt, which peaked in 2010 at slightly above 11 percent before beginning to fall back gradually. The favourable external backdrop brought the budget balance above zero again as quickly as 2011. The economy has been on the rise since 2010, and is projected to grow at around four percent annually over the next few years.
The banking sector was hit by the 2008/09 crisis, but managed to resume growth as early as 2010, extending its vigorous recovery well into 2011, when the Central Bank of Russia reported a 23 percent year-on-year growth in banking assets. While the growth remained moderate for corporate lending which was up by 26 percent, retail loans quickly resumed pre-crisis growth rates at around 36 percent. Bank deposits continued to increase up to 24 percent, the share of bad loans fell to 4.1 percent, and banks posted record-breaking earnings.
In 2012, the year-to-date performance is clearly pointing at something of a slowdown in growth. Consumer lending is the only exception, enjoying rapid expansion even exceeding what was seen in 2011. Further slowdown is likely to creep in over the next few months, but healthy double-digit growth is on the cards for all banking segments for the full year.
Crisis influence channels
Today, it is still unclear how the situation with troubled eurozone economies will unfold, but it is obvious that the measures being taken by governments are insufficient, with the threat of a Greek exit from the euro still looming large. Given the circumstances, ‘hope for the best but prepare for the worst’ is probably the required strategy.
The crisis in Europe potentially affects the Russian economy mainly through oil prices and international capital flows. The two factors are closely intertwined as any declines in export revenues, which are bad for the GDP, contribute to Russia’s lower investment appeal and prompt investors to take capital out of the country. The combination of both factors adds to anxiety in the Forex market, putting pressure on the rouble exchange rate.
The impact of the crisis on the Russian banking system could extend to reduced availability of external funding and less market liquidity. However, given today’s situation, there is reason to believe that the scale of the impact will be relatively minimal. Firstly, Russian banks have learnt the lesson of the previous crisis well, cutting their exposure to risky foreign assets, in particular to peripheral eurozone debt. Secondly, they have used the past three years to evolve and create a funding system that relies chiefly on client deposits. Only limited external debt refinancing is required in 2012 and 2013, accounting for no more than four percent of GDP. The economic activity of European banks in Russia is already low, and those who view Russia as a core market are unlikely to leave.
Nevertheless, banks may face issues with the unstable rouble rate and mounting bad loans in case of a major economic downturn. Even though the past few years have taught large banks to expand their use of currency hedges, improve credit risk management and exercise more caution in screening potential borrowers, the Russian banking system remains vulnerable to external forces just as every other country does. While banks are working hard to cushion themselves from a possible crisis, the state is also on hand to step in and support the financial sector. Monetary policy is viewed as the cornerstone of future assistance to the economy and the banking sector.
The Bank of Russia is already an active liquidity provider as repo transactions hit an all-time high in June 2012, leaving space for further expansion since it is no longer forced to support the rouble rate. This greatly contrasts 2008 and 2009, when it had to raise base rates and sell foreign currencies, leading to tougher monetary measures and a shrinking monetary base. Regulators have a range of other instruments to choose from, including the expansion of the collateral-eligibility list, suspension of capital adequacy requirements, and syndicated loans.
The budgetary measures can go a long way to shoring up the performance of the banking system should problems arise. The government has already set aside approximately 350bn roubles as a crisis cushion, with the potential to further increase that amount should a crisis scenario materialise. However, it is important that the state understands spending constraints in fiscal opportunities.
The long-term trends
In the long-term, the Russian banking sector has huge growth opportunities, boasting low penetration of banking services and strong economic potential, including the benefits of WTO accession.
In 2011, total banking assets were worth 76.3 percent of GDP. Loan portfolios were at 42.6 percent, and client deposits at 47.3 percent. Russia clearly has plenty of room for expansion in its banking services market, most notably in consumer lending, which includes mortgage loans, as overdue debt currently stands at just four percent of GDP, and new corporate lending products are being rolled out regularly.
Russia’s largest banks have already embarked on a project to broaden their business model to encompass Russian regions, push digital and online services, and step up cross sales. Healthy input is expected from the industry’s consolidation trend, which has shrunk the number of banks from 1,100 to 900, while raising average capital per bank to 5.8bn roubles. This is expected to keep banks’ margins attractive.
The Russian economy’s dependence on oil revenues is expected to gradually decline, as physical oil exports have been fairly stable since 2004. The share of oil and gas exports in GDP fell below 15 percent, and is set to continue the trend in the future. As recently exemplified by China, joining the WTO might soon mean larger investments in industrial production and other sectors. Overall, the Russian economy is ripe for growth, seeing quality expansion driven not by reckless exports of natural resources but by a stronger legislative framework for all businesses, and the promotion of initiative and entrepreneurial spirit. The country can no longer afford the costs of ineffective management.
The crucial ingredient here is the end of turmoil in the global economy. What is desperately needed is a more consistent switch from pumping liquidity into the market, financing consumption, to boosting savings and industrial production. Any structural problems take a long time to tackle, but being locked in constant crisis management means driving the attention and resources away from growth.
Both the economy and banking system of Russia have become an integral part of the global market and, should the debt problems of eurozone countries persist, there will be another period of turbulence. However, Russian banks, the Central Bank, and governments are better positioned to address the possible crisis today more than ever before. There is a strong argument for a more optimistic outlook for the Russian economy and its banks in the long-term.