Still stinging five years after a financial crisis wiped out the life savings of many, Russians are still reluctant to trust banks with their money. A sheaf of new legislation and the appearance of foreign-owned banks may change that trend.

When Raiffeisenbank Austria opened its first Moscow branch with a retail outlet in 1996, analysts saw the move as a measure of success for the Russian banking industry.

Its bright, spacious offices with bilingual tellers were a far cry from the dark, narrow corridors and dour employees found at many local banks. Here, clients could find Western-style banking packages and mortgages at, or near, Western-standard rates.

However, this bright moment aside, the Russian retail banking industry still has a long way to go before it can achieve even central and eastern European standards of success. Retail banking in Russia is sorely lagging, with residents still stung by the memory of a 1998 default in which many lost their life savings. Today, the average Russian generally opens the door of a bank only to pay utility bills, storing savings instead in hollowed-out books or under mattresses at home.

Russian banks do retain a role as intermediaries or third-party witnesses for large purchases or sales – of real estate or automobiles, for instance. But for the most part, those with substantial savings tend to turn to banks in Cyprus or Europe and depend upon credit and cash cards, rather than the branch up the street.

And Russian banks have done little to encourage a stop to these practices, focusing on budget money and corporate accounts instead of core banking services.

The result has been the lopsided development of the Russian banking system, and banks held back by a general lack of trust, overprotective official policies, a weak legal base and inept handling of reforms. Rather than handling traditional banking services – mortgages and loans to middle-class clients – banks are operating almost as financial departments for their shareholders, who are generally deep-pocketed industrial financial groups or cash-processing institutions.

Low income levels also detract from any attempt to create a Western-style environment for modern banking, forcing both foreign and Russian banks to target mainly the extremely rich – in some cases managing assets for those with millions stored in off-shore accounts.

Statistics show all these factors have combined to put Russia’s retail banking light years behind even that of Central and Eastern Europe (CEE).

In calculating retail deposits as a percentage of gross domestic product (GDP), Russia’s retail banking accounts for about 9 percent. Poland and Hungary’s retail segments account for 35 percent each, while the Czech Republic’s approaches 50 percent of its GDP, said Oleg Tumanov, a senior official at Alfa Bank.

The same picture is also seen in the loans sector. Russia’s index is only about 12-14 percent, compared to 50 percent in Poland and Hungary and about 60 percent in the Czech Republic. The index soars over 100 percent in more developed markets like in Germany, Tumanov continued.

Though Russian retail banking has grown from 16 percent to 24 percent over the past two years, to reach about $32 billion in December 2002, analysts say the market remains conspicuously small – especially when compared to other CEE countries. There, retail service-penetration rates measured as a percentage of citizens’ disposable incomes to gross earnings are much higher than a similar index in Russia.

Vladimir Tikhomirov, a senior economist at Russian investment and brokerage firm NIKoil, puts this index at only 15.5 percent, noting the Russian index is unreliable because residents do not readily disclose all their gross earnings.

Goskomstat, the federal agency in charge of statistics, put the total number of standard-size retail outlets at about 3,500 and gross deposits at 237.3 million rubles, or a per-capita volume of deposit of 2,526 rubles (approximately $80) in 2002.

Currently, there are 2,003 financial-credit organizations in Russia, out of which 1,319 have Central Bank’s general banking license. Of this, 1,223 have licenses to accept individual savings and deposits. Only 23 banks are fully owned by foreign banks, while in 12 others, foreign capital varies from 50 percent to 100 percent.

Statistical data on mortgages does not exist – mortgaging is still in its embryonic stage. Legislation setting out ground rules was passed only last year, and progress, if any, is expected in the next 2-3 years, Tikhomirov said. Some banks have started mortgage lending programs, which target mainly the small elite who can afford the draconian lending terms.

However, experts expect an explosive growth rate in retail banking in the next few years. A growing economy, rising wages – and higher disposable incomes – and new banking rates will contribute, as well as the need to borrow money to satisfy rising lifestyle tastes in cars, housing and clothing.

However, with uncertainty over a U.S.-led war in Iraq, which could prompt volatility on the oil market, the cash boom in the economy may also come to an abrupt end if oil prices nosedive, experts noted.

In the meantime, though, bankers are gearing up for the goodies. Alfa Bank’s president Petr Aven recently said that he plans to tap this boom by increasing retail activities this year.

However, it seems foreign banks are to be largely kept at bay from these booming times.

Apart from the banks’ poorly developed regional networks, analysts say Russian bankers use the perceived threat posed by foreign banks as a political bargaining tool. Low income levels, logistic and other infrastructure difficulties associated with operations in Russia are also discouraging factors.

So far, these limitations, legislation on foreign bank activity – the government limits their charter capital – and currency controls have all combined to make Russian banking, especially its retail segment, unattractive to foreign bankers, analysts noted.

It seems the majority of international banks have not considered Russian retail banking aimed at regular citizens, despite the untapped potential.

Alexis Rodzianko, CEO of Deutsche Bank Moscow, said his bank’s strategy for Russia doesn’t envision a broad retail presence at the moment. "This is the bank’s standing policy on most other emerging markets. Russia, therefore, is not an exception," he said.

A similar policy is held at most global banks, which limit themselves to corporate clientele without venturing into the retail market.

ZAO Raiffeisenbank is one of the few retail-banking pioneers, with retail services in its six locations in Moscow, one in St Petersburg and three more under consideration in the capital.

These are spacious and ultra-modern branches, something of a novelty in Russia, which offer comprehensive banking-service packages to clients, including mortgages, cash vaults, the presence of third parties such as notaries, and a confidential atmosphere are necessary, said bank Chairman Michel Perhirin.

"If automatic teller machines (ATMs) with advanced functions such as cash depositary and Internet-browsing capability are considered as separate business locations, then the bank has 32 additional outlets in both cities with 30 more ATMs to be installed in Moscow and 15 in St Petersburg by the end of the year," he said.

Natalia Nikolaeva, the regulatory-relations director at ZAO Citibank, the U.S.-based Citicorp Group’s Moscow affiliate, said her bank only launched its retail operations last November, but added the bank plans to boost its presence in the sector by opening one more branch during the year.

Despite some suggestion that Russians have been slow to test Citibank’s services, experts generally agree the presence of foreign banks will have a positive influence on the retail sector, as they bring their vast wealth of knowledge and global banking experience, a range of sophisticated products and transparency in transactions, and – most importantly – add an element of competitiveness.

"Other added advantages include more investing opportunities with diversified risks, better choice of lending products – since foreign financial institution have access to relatively cheap funds on Western financial markets, and therefore, are in better position to offer affordable rates locally – in Russia," Perhirin added.

However, these pioneers have limited their activities to Moscow and St. Petersburg – just a drop out of 89 regions in the federation.

Both local and foreign banks decry the hegemony of government-owned banks such as Sberbank and Rosselkhozbank as detrimental to the spirit of market competition.

Vladimir Savov, a banking analyst at UBS Warburg’s Moscow office, said foreign banks target mainly Russian corporations such as Gazprom, large oil, metal and mining companies – areas where most Russian banks would find it very difficult to compete.

He conceded, though, that in areas such as regional corporations, small- and medium-sized enterprises, and individual (retail) lending, local banks, and particularly Sberbank, will maintain their hegemony for some time.

Sberbank’s domination – with over 80 percent of the market share and about 20,000 branches nationwide, is overwhelming. Second place Alfa Bank, by comparison, has only a 2.3 percent share, and 100 outlets.

"We are aware of Sberbank’s clearly artificial, non-competitive, market advantages in the sector," Tumanov noted.

"But these artificial advantages will soon be over with the on-going reforms and introduction of the state depository-insurance guarantee in the banking sector, which will level the playing ground for all major players on the domestic financial market," he noted.

Raiffeisenbank, the largest foreign bank in the retail sector, ranking seventh in the country’s overall retail rating, has a far smaller market share than its Russian competitors.

"As retail bankers, we are very much conscious of the fact that Russian banks’ market share is close to 100 percent. But, as to competition we cannot admit that – for a certain segment – our customer-selection criteria do coincide with those of Russian banks," Perhirin said.

Foreign banks do enjoy one advantage – the element of trust. Russians who no longer trust their own banks after the financial crisis five years ago may still be willing to trust foreign competitors.

Sumon Bhaumik, a London Business School research fellow, said a lack of trust in banks is typical for many developing or transitional economies and it is a key issue for the future development of the Russian banking sector.

"Whether or not foreign banks would be able to convince people that it is safe to keep their savings with them in Russia would largely depend on which foreign banks are offering retail and wholesale banking services there. If large global banks with proven track records and huge capital bases such as Citibank and Deutsche Bank enter the Russian market, some confidence would certainly be restored," he noted.

"However, if these banks do cherry picking and cater largely to high net-worth companies and individuals, as was done in countries like India, they would not serve the purpose of converting the assets of the common people from cash to bank-related assets like savings accounts," said Bhaumik, an expert on new and emerging markets.

Russia-based experts are also not certain foreign banks can radically change the picture.

NIKoil’s Tikhomirov said clients traditionally view foreign banks as a safe haven for their savings. But he noted the banks’ attractiveness is limited by restrictions on foreign bank activities, especially in dealing with private clients, and their extremely limited regional networks.

UBS’ Savov does not believe foreign banks have a universal recipe to attract billions of dollars reportedly stashed away under mattresses or in foreign countries back into deposits at home.

"The foreign banks will likely serve a specific-market niche – mainly affluent individuals, who place high premium on the level of service a bank can offer and employees of large, often foreign, companies who earn significantly more than average Russians," he said.

He noted that trust in banks is gradually being restored, as individual deposits totaled about $32 billion, or 25 percent of sector’s gross assets at the end of 2002 – an impressive 40 percent year-on-year gain. This represents a rise of about one-percentage point of disposable income, from 14.3 percent in 2001 to 15.6 percent in 2002, he added.

The Russian Central Bank and government are finally putting together a series of measures to bolster the banking sector.

"Naturally, the more reforms we see the better, as they make the sector more trustworthy and resilient to economic shocks," UBS’ Savov added.

As examples, he cited Japan and China, which have lots of bad loans but huge and growing deposit bases. "From these examples, it has become obvious that it’s the political, macroeconomic and financial stability along with sufficient trust that are more important for banking sector’s growth, rather than the perfect health of the system itself," he added.

Bhaumik at the London Business School said over-indulgence in such artificial protectionist policy is harmful in the long run to the financial market.

Citing an Indian experience of similar protectionist policy in the ‘80s, Bhaumik noted that similar strict branching and takeover regulations slapped on foreign banks limited their ability to compete with domestic banks. Some of these restrictions were lifted only in 1992, while it only became possible for foreign banks to take over or buy controlling stakes in domestic banks in 2002, he added.

Savov, at UBS, said the Central Bank’s plans to lift its capital limitations on foreign banks, which provided a strong competitive advantage for Russian banks, are a positive step.

"Lifting these limitations on foreign banks will impact positively on the sector as foreign banks can readily open branches in Russia, rather than wholly-owned subsidiaries," he said.

Only time will tell, then, whether the Central Bank and government can summon the political will to ease protectionist policies.