For Banks, Going Public Is a Very Private Affair

VedomostiCentral Bank Chairman Sergei Ignatyev
Scores of banks that were once little more than pocket institutions for the financial-industrial groups formed in the 1990s are now detaching themselves from their parents and searching out new sources of funding.

The groups themselves have been increasingly relying more on foreign loans for years, making their daughter banks a redundancy. Now that interest rates are cheaper abroad, they no longer need these banks for cheap loans, nor do they need them as a place to park money or rely on one particular bank for underwriting services.

This has left an increasing number of banks with adequate short-term capital, thanks to private deposits, but a lack of long-term capital. As a result, in order to have properly laddered short-, medium- and long-term resources, banks are gearing up to raise money on the market by going public.

To do that, however, a good reputation is required. In short, a bank looking to attract investors needs to look attractive.

The task of turning a Russian-style bank into a viable structure under these new conditions is daunting and calls for some hardheaded decision-making -- both by banks themselves and by the government.

As they move toward going public, banks simply must become more transparent if they are to convince the market that they are a good investment.

Doug Gardner, head of Ernst & Young's global financial services group in Russia and the CIS, breaks down potential investors into three major groups, each with specific misgivings investing in banks.

"Individual investors play a very small role in Russian markets, so there is no demand from them," he says. "Individuals' overall lack of confidence in the banking system would keep them from investing in banks. This mentality is pervasive and requires serious measures to reverse."

The second group, institutional investors, is sophisticated and understands the current challenges: lack of transparency, corporate governance issues, legal and regulatory infrastructure and risk concentration, Gardner says. "They have safer ways of investing their money for a higher return."

Finally there are international investors, who Gardner says are scared of the lack of transparency and risk concentration as well as the overall regulatory environment and the quality of financial information provided under Russian accounting standards.

The 15 Largest Banks
What they discloseNo. of banks
Owners with at least 30% stake9
Board member information7
State's stake5
Large private owners5
IAS accounting5
Credit portfolio structure5
Manager's professional biography4
Board, management pay0
Quality of Information Disclosure*
Alfa Bank41
Bank of Moscow37
Guta Bank33
BIN Bank17
*100 equals full disclosure
Source: Standard & Poor's, 2002

International Standards

One of the prerequisites of becoming transparent is adopting international accounting standards, or IAS. And with the Central Bank's October 2004 deadline looming for all banks to make the switch, a certain level of transparency is being imposed on the sector.

Banks that have already switched to IAS -- generally either those planning an initial public offering or those that have already placed shares on the market -- are increasingly anxious for a Big Four firm to audit their financial statements as an added measure of openness.

"The adoption of IAS certainly plays a role [in the move toward transparency]," says Sergei Lobanov, a spokesman for Uralsib, one of the top 15 banks in the country. Uralsib, which has declared its finances under IAS for several years, raised $100 million abroad last year.

Today, there are just a couple of banks publicly listed. But virtually no trading in bank shares occurs, apart from state-controlled retail monopoly Sberbank, but Uralsib and other banks say this situation will soon change.

"This year several more banks will list their shares on the exchange," Lobanov says.

Placing shares on the market "is more than an image-boosting move; this is a part of our development strategy," says Valentin Shapka, spokesman for Rosbank, which recently announced plans to place its stocks on the market or prepare the necessary conditions for placement by 2007. "[Going public] is a way for a bank to demonstrate that it is an open entity whose activities can be analyzed by any interested party."

"I can see banks putting their shares on the market in one or two years," says Richard Hainsworth, head of bank rating agency RusRating. "The need for your counterparty to understand why you are working in this particular way has increased. There has always been a need for transparency, but now it has gained a higher priority. More and more banks are finding it easy to disclose information about their ownership ... more banks share their financials with the counterparty in the market; it has become an exception when banks do not communicate with other banks; and they are willing to share information with rating agencies."

More important than reporting under IAS, in terms of increasing transparency, is disclosing a bank's beneficial owners, something many of the leading banks started doing only recently.

Mikhail Matovnikov, head of bank ratings at Interfax Rating Agency, says several leading banks in the past few years have made their accounts under IAS accessible to the general public and disclosed their ownership structure. Ownership through a tangle of offshore companies is being gradually replaced by a system whereby ownership can be traced to one particular company.

However, he says, along with the revelations came several enigmas -- names of some of the owners revealed nothing.

According to Matovnikov, "people were shocked" when they found out that the nation's largest private bank, Alfa Bank, was owned by a company called Monna; that Mikhail Khodorkovsky's Menatep St. Petersburg was owned by a firm called Laguna; that MDM Bank was owned by an unknown entity called Tekhnosfera; and that several big banks appeared to have just one shareholder with a stake larger than 5 percent.


No matter how willing banks may be to market their shares there is little they can do unless the government and the market regulator, the Central Bank, deliver on banking reform.

At a banking conference earlier this month, Central Bank Chairman Sergei Ignatyev urged banks to go public and says the government was working on a way to encourage banks to do so.

Bankers say the most important step in this direction would probably be for the government to help spur the consolidation of the sector.

At the moment, potential investors are kept at bay by the risks involved investing in one of the nation's 1,500 banks before it becomes clear which ones are going to survive consolidation.

"Without doubt, [putting a bank's shares on the market] will be tied with banking reform," Lobanov says. "The moment serious changes start ... when the process of mergers and acquisitions begins across the market, the process of going public will become more visible and will become a tendency."

The government and lawmakers also need to move faster in other areas to boost the confidence of investors, such as introducing a deposit insurance scheme, experts say.

"Until we get to the point when the Central Bank gets a little bit tougher on the banks from the regulatory point of view and forces the consolidation that must happen, I don't believe we will really see a significant move of the banks to the public markets," says Gardner of Ernst & Young.

Capital requirements for banks will need continued strengthening, especially for those that want to take large amounts of deposits from the general public. New tough measures are required from the Central Bank to ensure that capital put into banks by shareholders is real and not simply "round trip loans."

The Central Bank itself must upgrade the overall quality of its supervision skills in order to achieve this as well as shift its focus to the substance of transactions and not merely their legal form, bankers say.

Following, Not Leading

"From a macro perspective, the lack of publicly traded banks may be consistent with other industries, other than strategic sectors such as energy and telecommunications," says Gardner. "In other words, it is consistent with the general lack of access to capital markets in Russia. The energy and telecoms sectors will lead, as these are businesses that are highly capital-intensive. ... They have a continued appetite for capital that they must raise from the markets. Banking is not quite so capital market-driven, as you have the deposit funding element."

Also, a desire to stay opaque may in many cases outbalance the banks' appetite for investors' capital.

"Going public means more transparency and it thus is less desirable, especially given the number of schemes that Russian banks use to manipulate their compliance with prudential normative ratios and other regulations," Gardner says. "Given the hesitancy to disclose sensitive financial information, bank management and owners would not easily move to selling equity."

An alternative source of long-term capital has been bonds. Russian banks have so far issued hundreds of millions of dollars' worth of debt, which unlike shares allows a bank to attract capital without giving outsiders control of its operations, even though it lowers its transparency.

"A bond issue for three to five years of $100 million to $150 million would have a very positive impact on most banks in Russia for the simple reason that it would lengthen the maturities of their funding sources," Gardner says.