The State Is Going the Wrong Way in Banking

Op-ed in the Moscow Times

October 11, 2006

On September 13, Andrei Kozlov, whom I had known since the early 1990s, was killed in what looked like a contract hit. He excelled as one of Russia's brightest, most honest and most fearless civil servants. At the age of 30, he became deputy chairman of the Central Bank on sheer merit. Professionally and morally, he was a giant.

Throughout his many years at the Central Bank, he was the most principled fighter for a decent banking system. When Viktor Gerashchenko, once called history's worst central banker, returned to the Central Bank after the financial crash of 1998, Andrei quietly left. When Gerashchenko departed, he happily returned, because work made sense again.

The murder of a major official is always shocking, but more so when the victim is one of the few officials whom nobody accuses of corruption.

There are two main hypotheses as to the motive. One is that Kozlov, as the top bank regulator, had a list of banks that would lose their licenses. Anyone whose bank was on the list might have killed him, assuming that only Kozlov was brave enough to close a contentious bank. The other is that anyone from one of the 91 banks he had already closed down decided to take revenge.

Let's examine the banking system more broadly. Although it is experiencing a boom in consumer lending and borrowing, the banking system remains remarkably small. Russia's monetization-that is money and credits as a ratio to GDP-is persistently far lower than that of Ukraine. Structurally, the banking system is one of the most backward parts of the economy and acts as a bottleneck for the country's economic development.

The chief reason for this backwardness is the dominance of state banks. The two biggest, Sberbank and Vneshtorgbank, own almost half of the total banking assets. No private bank possesses more than 2 percent of total assets, and their share is not increasing. This state dominance is a result of Gerashchenko's discrimination against private banks after the 1998 financial crash. In most other CIS countries, bank crashes wiped out the worst, that is, the state banks.

In Ukraine, by contrast, there are only two state banks, which hold about 5 percent of total banking assets. The biggest private banks have about 10 percent each. Banking is the biggest boom industry in Ukraine, and 18 of the country's 30 richest men are bankers. With a strong banking sector, all of the country's regions and small enterprises have a much better chance to develop than in Russia. Hardly any of Russia's  richest men are primarily bankers. In Ukraine, foreign banks are paying high prices for Ukrainian banks, and foreign bank ownership accounts for about 30 percent of banking capital. Ukraine has accomplished this only as a result of the dominance of private banks.

In Russia, however, foreign ownership in the sector is almost stagnant at 13 percent of total capital. It is positive that the government has approved a bill to abolish so-called blessed shares, which can be purchased only by foreigners with state approval. That is a major reason why few commercial banks are traded on Russia's stock exchanges. Finance Minister Alexei Kudrin's advocacy of raising the cap on foreign capital in the banking sector to 50 percent is also welcome. But the problems with the sector are structural. Foreign investors are most interested in niche banks, regional banks or consumer banks, while few want to deal with the key enterprise sector. It is, naturally, much more difficult to get bank loans for enterprises in Russia than in Ukraine, even though Russia is so much richer. Again, the fundamental problem with Russia's banking sector is the dominance of state ownership.

You might suspect that the prevalence of state banks would lead to stability, but in the summer of 2004 there was a major run on banks. It was instigated by paid-for newspaper articles. We know this because one of the victims, Alfa Bank, Russia's biggest private bank, went to court for libel and won. The main victim was Guta Bank, which was swiftly picked up after bankruptcy by Vneshtorgbank, further extending state-bank dominance.

Nor does the dominance of state banks help transparency. Admittedly, Sberbank is quite transparent, but nobody would say that about Vneshtorgbank. With close links to the Kremlin and the security services, it is involved in all of the siloviki's business activities. It was Vneshtorgbank that bought 5 percent of Airbus parent company EADS for a so far unidentified agency. State banks also financed Rosneft's purchase of Yuganskneftegaz.

With their market position and political connections you would expect state banks to be highly profitable. Sberbank is quite impressive, with a 2005 return on equity of 34 percent, but Vneshtorgbank logged a miserable 8 percent in the boom year of 2004 and 15.6 percent in 2005. We don't even know whether these public accounts are dependable.

If Vneshtorgbank is performing so poorly, it ought to contract. Instead, it is the most aggressive promoter of renationalization in the bank sector. Besides Guta Bank, it has also gobbled up Promstroibank and St. Petersburg Promstroibank (two different entities) as well as Ukraine's Mriya bank, as part of its CIS-oriented strategy. There are rumors of other purchases. Vneshtorgbank is characteristic of the government's strategy since the confiscation of Yukos. The less profitable and the less transparent a state company is, the more aggressively it indulges in renationalization.

Kozlov's murder ought to make the government rethink the murky banking system it has bred. Two days after Kozlov's death, President Vladimir Putin held a meeting on fighting economic crime in Sochi. His words were rather revealing: "Unfortunately, we continue to see banks being used for criminal purposes and for procuring billions of rubles in cash every month. ...In order to make the fight against economic crime more effective, I think we need to act as quickly as possible." His suggestion was to create a ministerial-level group that would include representatives of the Prosecutor General's Office, the Tax Service, the Financial Intelligence Service, the Federal Security Service, and the Interior Ministry. Few Russians would see any of these bodies as honestly fighting crime, so why transfer the responsibility for fighting money laundering to them from the Central Bank?

Four days after Kozlov's murder, a new bank regulator, Gennady Melikyan, was appointed. Melikyan was labor minister from 1992 to 1997 and made a name for himself as someone who didn't want to upset anybody. This might be a plus in his social life, but it is hardly a desirable quality in a bank regulator. With this appointment, Putin actually underscored the emasculation of Central Bank regulation of the sector.

The banking system is riddled with problems. In a sense, it is both over- and under-regulated. Far too many rules exist, but bank inspection is focused more on bureaucratic detail than essence. Bank inspection should be handled by an independent bank inspectorate or the Central Bank, not by the Prosecutor General's Office. The real cure for Russia's banking problems lies in the privatization of the sector, but the opposite is happening. Murky as it is, Vneshtorgbank is supposed to be paraded for investors in an IPO to provide the siloviki with more private international funding, which will give it the resources to gobble up more private banks.