Russian Banks Are Under Damocles' Sword of Overdue Loans

As bad news from the banking sector about the performance in 2008 comes out, what does this mean for 2009?

Alexei Simanovsky, the Head of the CBR's Department for Banking Supervision, stated recently that by the end of December the percentage of loans overdue had risen dramatically to 3.8%, up from 2.4 the preceding month, and added that the projection of CBR experts were that it would hit 4.0% - 4.5% by 1Q09. He pointed out that the system provisions currently stand at slightly over 5% and were banks to take a more prudent approach would account for 5.5-5.6% of the gross loan book. German Gref, the CEO of Sberbank, has joined in with a warning that he expects the percentage of overdue loans to reach 10% by 2010.

It would seem therefore that despite the state's huge refinancing efforts, corporations are having considerable difficulty servicing their debts. The situation will probably worsen as the risk of high-scale loans becoming overdue is rising, and retail loans follow the trend of corporate ones as companies, trying to cope with the worsening economic environment, start laying off staff (and even those who manage to keep their jobs will suffer from the devaluation of the ruble). Nevertheless, things are not likely to get as bad as recent crises when bad loans reached 25 -30%, as the government has shown strong commitment to supporting important industries and companies. There is a special program for mortgage borrowers who are at risk of losing their jobs, which presupposes that their mortgages will be refinanced by a special state agency (borrowers are accorded a grace period during which they do not pay interest). This is likely to ease the social consequences of the crisis and remove some of the bad assets from banks' balances.

The large percentage of overdue loans calls for a sharp increase in provisions. This, in turn, will hit banks' earnings and capital hard. The main risk for banks in this situation is the possible need to be recapitalized in order to maintain the capital adequacy. Russian banks' recently published 4Q08 RAS results clearly show the trend of rising provisions, meaning a number of banks (such as Bank of Moscow and Bank Vozrozhdenie) were already loss-making in 4Q08 while Sberbank posted losses in November and December. The government is now discussing capital injections into the largest state banks. Bank of Moscow has announced plans to raise new tier 1 capital through a preferential share issue in favor of the City of Moscow, and it is likely that more banks will have to follow this path, hence creating the risk of dilution for minorities. Moreover, the CBR expects that the recapitalization of the banking sector will mainly be done using state funds, as is now occurring elsewhere in the world. Needless to say, that is positive for the state banks, which will be first in line to receive help, allowing them to cement their market positions.