Russia Central Bank Cleansing Banking Industry

Cleaning up the Russian banking sector is likely to take between one and two years, said Elvira Nabiullina, chairwoman of the Central Bank of Russia.

Over the last four years, the regulator has revoked the licenses of about 350 lenders, bringing the number of banks in Russia to about 600 and removing weak players or banks with dubious business models, Nabiullina said. In the late 1990s, she added, Russia had around 2,500 banks because requirements for entering the industry were very loose at the time, IntelliNews reported.

However, the CBR has no plans to allow only state-run lenders to remain in the industry, according to Nabiullina. Currently, the CBR is in the process of rescuing two major ailing lenders through its Banking Sector Consolidation Fund: Otkritie, which went bust in late August and Binbank which went under in early September.

The CBR provided a 380 billion ruble ($6.5 billion) bailout loan to Otkritie and an unspecified loan to Binbank. In late October, the regulator said that rescuing struggling lenders had cost it nearly 458.3 billion rubles ($7.8 billion) from July to September.

The CBR chose to save Otkritie and Binbank as opposed to revoking the lenders' licenses and letting them collapse as they are deeply integrated into the Russian banking sector and their fall could have had a domino effect on the entire industry, Nabiullina said.

They have all come under increased pressure since the spring as the CBR tightened its supervision of the sector. Problems first surfaced in June when Russia’s new Analytical Credit Rating Agency downgraded Otkritie to BBB, which precluded it from holding state money, like pension funds.

Treading a Fine Line

As Russia slipped into recession in 2014, the big state banks gave some of the country's largest private banks—Otkritie, B&N Bank (also known as Binbank) and Promsvyazbank—low-interest loans to take over their struggling rivals.

The goal was to bolster non-state banks, since Western sanctions had targeted most of the state banks. And the move paid off: B&N Bank's assets, for example, have grown fivefold since 2014 to reach $20 billion. But most of these assets were in worse condition than expected.

To make matters worse, Russia's private debt has soared over the past decade, rising from 50% of GDP in 2005 to 90% of GDP in 2009, according to the Bank for International Settlements. Private debt holders have struggled to repay their loans over the past few years as low oil prices sent the ruble's value plummeting, unemployment rose and salaries fell.

The percentage of bad loans in Russian banks officially grew from 6% at the start of 2014 to 10% today, though the International Monetary Fund believes the actual figure is closer to 14%.

The central bank, meanwhile, has been forced to tread a fine line between closing ailing banks, nationalizing them and letting them fail. The head of the central bank has created a new designation for banks that are too big to fail: "systemically significant".

Among the institutions in this category is state-run Vnesheconombank, which received a bailout in 2016 reportedly worth $16 billion. Offering funding to state-owned banks is nothing new, but when the government started nationalizing some of Russia's largest private banks, it unearthed a larger problem.

State Extends Its Reach

According to the central bank, only 40% of the assets purportedly held by the banks it has shut down or nationalized actually existed. When the state shut down Vneshprombank—one of the country's top 40 banks—in 2016, for example, investigators discovered that the $50 million the institution claimed to hold in a foreign bank was, in reality, only $10,000.

The bank had forged records using a copy machine. And the problems don't end there. Since the central bank took over  Otkritie and B&N Bank, in August and September, investors have been dumping Eurobonds from other banks rumored to be in trouble, such as Promsvyazbank and Credit Bank of Moscow.

Russia's Finance Ministry claims that by stepping in, the Kremlin prevented a domino effect in the banking sector. The central bank has established a fund to bail out struggling private banks and has reportedly spent an additional $47 billion over the past three years to compensate depositors in failed private lenders.