MDM BANK

AndreI Melnichenko, chairman.

What are the main characteristics of the Russian banking system?

Competition in the banking market has become much tougher with the general improvement of the economic situation in the country. What we see now is a strong pressure exerted by foreign banks that have begun to return to the Russian market after they escaped in the wake of the 1998 crisis. On the other hand, there is tough competition offered by Russian state banks, which have considerably increased their share of the market after the 1998 crisis. Their advantages include large branch networks, state guarantees on deposit insurance, etc. Russian commercial banks can survive only though mergers and alliances with each other.

What do you think of banking reform?

We can discuss various drafts, but I would rather focus on the main positions that are shared by the country's leading bankers. Why is their position important? Because the Russian banking system is poised to play the main role in the investment process. As things stand today, company owners prefer to invest in buying other companies rather than in investment projects with a payback period of above three years. The government does not have spare cash, and foreign investors will make strategic investments only in those enterprises which they control. Therefore, the government should clearly understand that only by having a healthy domestic banking system operating on the basis of fair competition, will it be possible to resolve the problem of investing in the economy. Therefore, what needs to be done is to destroy Sberbank's monopoly, which is based on the anti-market practice where the government provides insurance to people's deposits in Sberbank. Should this pernicious monopoly be destroyed there would be some 10 to 15 equal players on the market. This will boost competition between them and will force them to improve the quality of service and to accumulate capital. The government should assume supervisory functions, watch that proper order be observed on the market and give up attempts to control financial flows by means of state banks and the state treasury. Fair competition is only possible with market structures, not with monopolies.

What are the prospects for the development of retail banking in Russia? What about crediting activity?

Sberbank absolutely dominates the market of banking services for individuals. Therefore, it is almost useless and uninteresting to analyze which bank gained what percentage of the retail market. Prospects for retail banking depend strongly on what position the government assumes. If it goes on with the consolidation of budget funds and the funds of state-run enterprises in state banks, it is difficult to imagine what resources will be directed to the development and asset build-up of the commercial banks. Without asset build-up, the profitability of the banking business will inevitably go down, even with the current rate of inflation. Consequently, the investment attractiveness of the banking sector will remain low. Without investors, it will not be possible to resolve the capitalization problem. The only way to survive in this situation is to unite.

GARANTI-BANK MOSCOW

Murat Agabeyoglu, president and CEO.

What are the main characteristics of the Russian banking system?

The system is over-banked, poorly capitalized and not supervised effectively. This refers to the lack of political will to clean up the system from the agents of the gray economy in the banking sector. When we look into the financial records of the banks with international standards, we trace many banks with negative net-worth figures.

Banks do not fulfill their primary functions, so the sustainable growth of the real economy is in doubt.

What do you think of banking reform?

Minimum capital requirement is the key issue. A minimum 5 million euros should be applicable to all banks and not be limited to new applications. The capital adequacy ratio has to be set according to the Basel Accord standards, and banks which do not comply should not be permitted to operate. Then the minimum capital requirement may be increased to higher levels, at around 50 million euros.

What are the prospects for the development of retail banking in Russia?

This will be a derivative of the future of the banking reform. Under the current status of the sector, only Sberbank will lead the game, with its state guarantees on deposits. This has to be abolished. If the government changes its passive attitude toward banking reform and shows solid signs of action toward a transparent and Western-standard regulated sector, new players will appear and provide all retail/private banking products to this big market. In that sense, yes, there is a large potential there.

What about crediting activity?

Loans are a scarce element for an industrial enterprise, if the company is not a bank owner as well. That is why the non-performing loans-to-total-loans ratio is rather high, at around 3.5 percent. Once a loan is obtained, it should not be paid back because you may never be granted [a loan] again. This is the fact now. Again there is a correlation between the fate of the reforms in the banking sector and the future of lending activity. The supply of credit facilities to economic units will definitely increase, in line with the implementation of changes for the better. The real economy badly needs the financial support of the system in order to sustain growth. Transparent banks will supply these facilities to transparent enterprises, we believe.

ROSBANK

Yevgeny Ivanov, president, chairman.

What are the main characteristics of the Russian banking system?

First, domestic financial organizations are very versatile. There are 1,300 functional banks now, and they can be roughly divided into three groups:

1. Large state-owned banks that are well capitalized, like Sberbank, which accumulates nearly 70 percent of private deposits, and Vneshtorgbank;

2. Large privately owned banks with limited capitalization and a sound client base. These banks make up a competitive medium and can become full-fledged members of the world banking community;

3. Numerous small banks, which represent a minor proportion of the total banking capital and assets.

The second peculiarity of the Russian banking system is its poor capitalization. Discounting Sberbank and Vneshtorgbank, the combined total capital of Russia's banking system is comparable to that of one bank selected from the largest Western banks. The lack of capital limits the investment opportunities of the Russian banking system.

The Russian banking system can draw capital from both internal and external sources. External sources are foreign banks, and if this option is chosen the situation is likely to develop according to the scenario of Eastern Europe. Internal sources are either the funds of domestic industrial enterprises, which are unlikely to arrive, or domestic capital markets, i.e. attracting money via issuing bonds, a method used by all countries during periods of banking system formation.

The latter option appears preferable, especially given the shortage of funds in the enterprises and in the economy in general. Shrunken by inflation over the last several years, the country's money supply is rather meager. Industrial enterprises are reluctant to keep their money in the banks, leaving them no possibility to function properly.

One possible way out of the situation is to saturate the economy with money, and this is acknowledged, albeit timidly, by the Central Bank. The law "On the Central Bank" does not oblige the Central Bank to take care of the industry and the economy. Under the law, the Central Bank's cares are limited to maintaining the exchange rate and, partially, the rate of inflation. In line with that, the Central Bank only acknowledges the fact of insufficient money supply and implements some schemes of funneling money into the economy, but on a very limited scale — 1-2 percent annually.

The last peculiar feature of Russia's banking system is the high "concentration" of clients. I mean, 1,300 banks are competing for the money of only 100 enterprises. To make things worse, many enterprises have their own banks.

What can be done to improve things?

First of all, it is necessary to increase the money supply for the banking system using the Central Bank's emission mechanisms. We should use all methods accepted in the world to get financial resources and channel these resources into the economy.

RAIFFEISEN BANK

Michel Perhirin, chairman.

What are the main characteristics of the Russian banking system?

Within the first half of 2001, the banking system unfortunately remains to a large extent insulated from supporting growth in the economy. Despite banks' financial status improving within the last year or so, the system as a whole remains rather a beneficiary than a donor of the general upturn.

The banking system continues to be characterized by the strong domination of state banks, excessive liquidity and a very low level of conventional bank lending. Though the total stock of loans given is increasing, still it is four to five times lower than in developed countries with mature banking systems.

On the positive side, such factors as build-up of banking capital and growth of lending to private sector should be mentioned. However, though undoubtedly helpful, both factors nevertheless are rather flawed.

For both, the worrisome pattern remains lack of funding. The two major sources of banking capital are currently state capital and profit of the banks, while availability of borrowing for the purpose of capital increase remains rather limited. Meanwhile, the demand for long-term investment loans is increasing in Russia, the banking system is incapable of saturating it, lacking liabilities of matching maturity. The corporate sector's funds continue to dominate in the structure of bank deposits, making only short-term lending feasible. The problem of attracting private savings deposits remains not only the issue of efficient functioning of the banking system itself, but also a matter of maintaining macroeconomic and political stability, as well as achieving progress in institutional reforms (pension, banking and labor reforms).

Apart from that, the nature of lending also causes concerns. A vast majority of loans are given not on a competitive basis, but rather are "closed" within the financial-industrial groups.

What do you think of the existing types of banking reform?

In summer the banking community was shaken by the sudden appearance of the so-called "Mamut Program," a radical version of banking sector reform suggesting a "three-tiered" banking system and imposing stringent criteria for financial institutions to obtaining banking licenses.

The proposed sector restructuring was based on administrative rather than economic measures, even though the plan was produced by an organization which claims a commitment to liberalization and free-market principles. As such, the cost required to implement the plan would be considerable, both from the economic and social points of view, and could therefore cause distortions in the banking sector similar to those under "shock-therapy" measures already applied to the Russian economy (the extreme version of which was default in 1998).

A "compromise" version of the banking-sector reforms was worked out by the Central Bank, and, according to the CBR itself, incorporates the major ideas of the RSPP's program. The program was discussed at a Cabinet meeting on Sept. 27.

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1. The state's role in the reform process. The government's participation in banking capital should be limited and decline over time;

2. Reform of Sberbank is not provided for under the plan. This actually makes sense in the short-term perspective. Like it or not, Sberbank currently plays a role of "safe haven" for most private depositors, and any quick and sudden change in its status can only wreak more chaos in the industry as a whole;

3. The CBR should withdraw from Russia's banks abroad. This measure has long been under discussion and stands a good chance of being implemented;

4. Restructuring and/or bankruptcy of insolvent banks. The program stresses that all processes related to concentration in the banking sector and allocation of business across the regions should be implemented exclusively in accordance with market principles, and strictly in accordance with the legislative base (as a reminder: the Law on Bankruptcy was adopted in summer 2001). The wording is exactly right. Its implementation, though, as usual, causes grounds for misgivings, especially regarding the role of ARCO, which first of all relates to its financial capacity;

5. Foreign banks. Twice in the program it is repeated that the government intends to lift all limitations for foreign banks operating in Russia. This comes as welcome news, but should have been done long ago. Foreign banks will undoubtedly bring more stability, financial capacity and improved technology into the banking industry;

6. Protection of creditors' rights. This involves amending legislation, and improving control over banking risks – a much-needed and extremely important point;

7. Guaranteeing deposits. This measure has also been a matter of long discussion. Most suggestions relate to long-term deposits, however. In our opinion, the major focus should be short-term deposits and current accounts protection. It could be more costly, but should be quite effective in preventing runs on banks;

8. Bank supervision, risk assessment and corporate governance issues. This item mainly involves legislative amendments and incorporating prudential ratios for risk assessment in accordance with international standards (the Basel Agreement), and switching over to IAS by 2004. Again, the wording is exactly right, but implementation remains to be seen.

All in all, the policy statements in the program are rather sound, and the measures envisaged are exactly those required. The problem, as usual, is how rapidly and effectively the program will be fulfilled. On the upside, the government's pro-reformist commitment leaves no room for doubt, and there is obviously sufficient political will to press ahead with this reform as well.

How do you view prospects for retail banking in Russia?

Broadly speaking, there are three major aspects to be thought of for improvement in the situation with retail. These are:

• Overall macroeconomic and political stability. Within 2000-01, growth of household incomes has eventually started to transfer into increase of private deposits held in the banks. Still, the phenomenon of "under-the-mattress" money remains and the population is still concerned about the overall economic and political risks;

• Implementation of structural reforms (pension, banking and labor). These are important not only from the point of view of creating long money in the economy and a system of institutional investors. The reforms are equally important for the restoration of depositors' trust, to the banking and overall financial system. In this respect, governmental guarantees for private deposits should be among the top priorities for implementation;

• Improvement of banking-sector efficiency. This does not require much comments. Trustworthiness and efficiency are the core characteristics for retail banking development. The latter implies not only a more diversified and flexible product basket, but upgraded technology. A crucial point remains the development of competition in retail banking, which, in particular, means reforming Sberbank.

How do you view the prospects for crediting activity of Russian banks?

The development in the future is subject to a combination of two broad sets of factors. One of them concerns the functioning of the banking system itself, while the other relates to the status of Russia's corporate sector.

The major issues related to banking sector are:

1. Availability of funding. Apart from the retail deposits just discussed, such sources as capital and borrowing should be equally important. However, currently both are limited. As discussed, the availability of capital is solely a matter of retained profits. Both domestic and external lending to Russian banks is as yet at its infancy.

2. Risk management, including the ability of banks to share risks (i.e. to create syndicated loans). Though the portion of bad loans in the total banking system's loan portfolio has declined sharply since the crisis, credit risks continue to be a potential risk factor. This is not exclusively a matter of evaluating borrowers' reliability, but should also incorporate evaluating more global risks: currency risk, liquidity risks, etc.

On the corporate-sector side, transparency and improvement of corporate governance, as well as the transition to IAS should be the major factors pushing credit risks down.