Russian banking: up to its ears in arrears Reviewed by Momizat on . [caption id="attachment_5470" align="alignnone" width="615"] In early 2015, the volume of the Russian corporate loan market sharply contracted. For January-May [caption id="attachment_5470" align="alignnone" width="615"] In early 2015, the volume of the Russian corporate loan market sharply contracted. For January-May Rating: 0

Russian banking: up to its ears in arrears

In early 2015, the volume of the Russian corporate loan market sharply contracted. For January-May 2015, banks provided new loans to legal entities for the amount of RUB 11.9 trln down 17.5 percent against January-May 2014 (RUB 14.4 trln).

In early 2015, the volume of the Russian corporate loan market sharply contracted. For January-May 2015, banks provided new loans to legal entities for the amount of RUB 11.9 trln down 17.5 percent against January-May 2014 (RUB 14.4 trln).

By Chris Weston, CEE Consulting Group

The release of the Russian second quarter GDP figures showing a 4.4 percent decline were enough of a surprise to those who had not expected quite so dramatic a fall, but a closer look at Russia`s financial sector would tend to reinforce perceptions that the country might be headed for a far deeper recession than has so far been forecast.

In early 2015, the volume of the Russian corporate loan market sharply contracted. For January-May 2015, banks provided new loans to legal entities for the amount of RUB 11.9 trln down 17.5 percent against January-May 2014 (RUB 14.4 trln).

The overall quality of the banks` credit portfolio has also deteriorated: the amount of loan arrears went up by 30 percent from January 1 to June 1, 2015. The share of loan arrears as a percentage of corporate clients’ debt increased from 4.6 percent in January 2015 to 6.2 percent as of June 1, 2015.

This is on top of some marked increases in provisions made in the first quarter of 2015 which left Russia`s largest bank, Sberbank, with less than half the net profits of the prior year`s period – VTB Bank with a first quarter`s loss.

No comparative results are out for Russian Agricultural Bank but  2014 annual results paint a dismal financial picture of an institution focused too heavily on lending to the agricultural sector to take advantage of Russia`s embargo on EU food and is therefore a key instrument in the state`s food import substitution strategy.

Russian Agricultural Bank 2014 accounts reveal a total net comprehensive loss of RUB 59 bln (2013 – RUB 285 mln loss) and accumulated losses of RUB 40 bln. Russian Agricultural Bank appears to have functioned as less of a financial institution than as a conduit for huge loans to have been liberally sprayed over the agro sector with little chance of recovery.  As part of its recapitalisation, in February 2015 the bank issued RUB 10 bln in bonds (placed at par) maturing in January 2025 with quarterly payments of coupon at 15 percent p.a. for the first twenty quarterly interest periods; and a further 5 bln in bonds (placed at par) maturing in February 2025 with quarterly payments of coupon at 15.25 percent p.a. for the first four quarterly interest periods.  The Russian government has also stepped in with an injection of share capital for the amount of RUB 10 bln in June.

The latter – not to mention the question of who bought the bonds – would point to an ongoing Russian government effort to stabilise this bank and the banking sector in general to come.  This is a point we will return to in a moment. But the high rate of interest that the bonds command, together with the highly elevated interest rates of the Russian central bank at 11 percent – down from 17 percent at the peak of the crisis – raise important questions as to whether credits are affordable to borrowers.

Sberbank`s commentary on the Russian economy is worth reading in itself as it comes from a Russian and moreover state owned bank with presumably few axes to grind.

Here are the highlights:

  • The index of industrial output in the first quarter of 2015 fell by only 0.4 percent, year – on – year. The industrial sector is supported by the accelerated budget expenditure on national defense (the amount for the first quarter 2015 reached 46.9 percent of the total amount scheduled for the entire 2015) and by the start of the construction of the gas pipeline The Power of Siberia.
  • The  process  of  import  substitution  also played  the  role  in  the support of  industrial  output  level,  particularly  in  terms  of  growth  in  production  of  food products  (by  3.5 percent  in  the first quarter  of  2015,  year – on – year).
  • However, there was a reduction in productive capacity  utilization  (from  64 percent  to  61 percent  in the  processing  industry)  in  the first  quarter  of  2015  compared  to the same period in 2014 due to the entering into the recession phase; and there was a decline  in  sales  of  food  products  which reached  7.5 percent in February – March 2015, year on year.

Second quarter GDP figures suggest industrial output has sharply decreased:  there are “guns aplenty but no butter,” and that interest rates and credit rationing combined with deteriorating credit portfolio quality will feedback into the already poorly performing banking sector.  This will then affect the real economy in terms of little investment, output falls, higher unemployment and lower exports (as investment curbs expansion of energy sector).

A financial crisis in the banking sector has typically led to significant expansions in public debt. According to economists, Reinhart and Rogoff, for the five countries with systemic financial crises (Iceland, Ireland, Spain, the United Kingdom, and the United States), average debt levels increased by about 75 percent in the two years after each crisis.

In 2008, when the crisis hit the Russian economy, banks were not wholly turned away from foreign banks but remained significantly reliant on the Russian government to provide significant funds to ensure a banking crisis did not materialise until the western banks renewed lending. With western sanctions on the banking sector and the government`s reserves by no means as significant as was the case then, hard times may lie ahead.

Credit Suisse projects that GDP contraction and currency depreciation will push Russia’s external debt-to-GDP ratio from 32.5 percent in 2014 to 59.4 percent this year, which is already a dramatic increase, but if the RUB  does not stabilise, the ratio could reach 70 percent or even higher. The need to effect a recapitalisation of the banking sector – 500 out of just over 820 are projected by the head of VTB bank to close within five years, would further add to such pressures.

Photo courtesy of Alexandra Savicheva (Wikimedia Commons).

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