Russian Banks in 2010: Turnaround Is Around the Corner

Dmitri Dmitriev
Head of Financial Institutions,
Consumer Goods and Services
VTB Capital

The Russian banking sector started the New Year having passed the tough tests of 2009, when banks’ very ability to survive was challenged. Russian banks and authorities clearly demonstrated that they could cope with turmoil on the global and Russian markets. Even though many problems have not yet been resolved — asset quality remaining the most important — there is now much more visibility concerning any potential difficulties. Furthermore, banks have gained considerable experience in dealing with them.

We believe that 2010 will see the negative trends from last year turning around, or at least slowing to a halt. Thus, the year will progress in two phases. In the first part, banks will continue to create loss provisions as a reaction to the deterioration in asset quality, with the focus on cost savings, margins and proactive work with troubled clients. In the second part, after all bad loans have been adequately provisioned, banks will substantially boost their profitability and look into possible ways to deploy their excessive capital (if any). The timing of the turnaround and the magnitude of change largely depend on the overall macroeconomic conditions and only to a lesser extent on the global markets situation.

The key challenge for Russian banks and monetary authorities will be lending revival. The current policy, which is aimed at reducing interest rates, should bear fruit in 2010 as long as banks’ risk appetite continues to increase. One of the key risks worth mentioning is the still-shaky macroeconomic environment, which is vulnerable to global shocks, and the substantial volume of hidden troubled loans that might surface if conditions deteriorate.

In terms of products, we expect corporate lending to be the engine of growth, with sizeable demand for retail lending returning in 3Q10. At first we expect more focus on short- and medium-term lending such as credit cards and cash loans, with demand for car loans and mortgages returning later on as rates fall and real disposable income recovers. The important issue last year was whether the system had adequate capitalization against the background of skyrocketing bad loans and provisions. It seems that this has been properly addressed by the authorities and, importantly, by the banks themselves. At the same time, expectations that we might see the sector consolidating, pushed by a lack of capitalization and funding sources, have not yet materialized.

On the funding side, banks can only rely on internal sources (deposits and state funds). The availability of such funding and the cost for each individual bank determine its competitive strength. Wholesale funding from abroad is all but unavailable: 2009 saw only sporadic deals. However, as the system has demonstrated its vitality and the authorities have proved that they are committed to supporting Russian banks, we believe that investor interest will return in 2010. At the same time, we think that the Central Bank will try to limit the inflow of such funds into the Russian banking system, most likely through reserve requirements. It should be noted, though, that competition is intensifying as (a) banks rush to lend the expensive retail deposits that they raised in 2009 and (b) companies have regained access to the international markets and can borrow more cheaply there. In a nutshell, we believe that these factors will continue to press lending rates down, squeezing banks’ margins and limiting revenue growth. In our view, this will be one of the major consequences of the crisis, and something that has to be dealt with, as well as bad debts.