Loan Crisis: A Nervous Week in Retrospect

Mikhail Khodorkovsky, the president of Menatep Bank, was enjoying lunch break at his elegant art deco offices in central Moscow's Kitai Gorod when his chief dealer rushed into the room to tell him that trading on Moscow's financial markets had ground to a halt.

"We immediately called the Central Bank," he said Friday. "But there was no one around who could take any emergency measures."

The entire banking industry was caught off guard as Moscow's $1 billion-a-day interbank lending and currency operations ground to a halt last week, turning a localized crisis of liquidity into a general crisis of confidence.

The failure of around 10 banks to make payments sent shock waves around the world with many Western banks freezing credit lines to Russian clients amid fears the crisis could spark panic among depositors.

Khodorkovsky and other senior bankers say the crisis is beginning to ease after injections by the Central Bank of some 2 trillion rubles ($452 million) and some recovery can be expected within the next few weeks. But they add that access to the markets will be significantly restricted to an number of participants will be sharply reduced."

Dealers said there was an upturn in interbank currency trading Friday, but most said banks were restricting deals to a few close partners.

One dissenting voice, however, came from Stolichny Bank president Alexander Smolensky, who said Friday that a major nonpayment crisis is likely next week. Smolensky told Reuters that most banks were delaying payments to clients and that demands worth 1.5 trillion rubles had already been forwarded to the Central Bank. Daily deposits were only 10 to 20 percent of their usual levels, he said.

But Smolensky's prediction was at odds with other accounts. Khodorkovsky said that while some smaller banks had been experiencing problems paying depositors, deposits at Menatep branches had actually grown since the start of the crisis.

Menatep, Russia's 10th largest bank with assets of around 7.6 trillion rubles, accounts for 5 percent to 10 percent of the Moscow interbank market, Khodorkovsky said. It is a member of a so-called "pool" of eight major banks that formed last week in a defensive move under which transactions entered into by each member of the group are guaranteed by the others.

The pool -- currently made up of Sberbank, Vneshtorgbank, Inkombank, Imperial Bank, MOST-Bank, Rossiisky Kredit, Stolichny Bank and Menatep -- is likely to expand to include a total of 12 to 15 leading financial institutions, Khodorkovsky said. The alliance is reinforced by an unprecedented degree of openness about traditionally secret financial data.

"We joined out of necessity," Khodorkovsky said. "We had to reduce the number of banks that had a credit line with us."

As a result of last week's liquidity crisis, Menatep has reduced the number of banks that have a credit line to a mere 12 to 15, down from around 40 earlier in the summer, Khodorkovsky said. Last year, by contrast, around 150 Russian banks had credit lines with Menatep.

The circling of wagons by the industry's leaders, however, is likely to take its toll on the smaller and weaker banks which will experience difficulty finding any new sources of credit. Fearing they would be left out in the cold, a group of medium-sized banks Thursday formed their own banking pool.

But analysts say Russia's banking industry -- riddled with bad and even criminal practices -- is long overdue for a shakeout.

In New York on Thursday, Inkombank president Vladimir Vinogradov told reporters that 10 percent of Russia's 2,800 banks are likely to go bankrupt within the next year as a result of the banking crisis. According to Khodorkovsky, last week's liquidity problems exposed systemic weaknesses in a number of large- and medium-sized banks.

While bankers say that a number of financial institutions may already be de facto insolvent, none has yet lost its banking license as a result of the crisis.

At a meeting in the Kremlin on Thursday, President Boris Yeltsin told the heads of 12 leading banks that the process by which larger banks have been taking over smaller ones has been progressing too slowly.

Rather than see smaller institutions go to the wall, Yeltsin said he wanted the industry's leaders to take responsibility for the problems of weaker players.

"The president told us he expects voluntary help from us for banks that are going bankrupt, with the aim of protecting the deposits of their customers," said Khodorkovsky, who was one of those invited. "The president wants a system where we help the banks before they die rather than after."

Inkombank says it is already providing a 15 billion ruble credit to aid a large Moscow bank. Itar-Tass reported Friday that Menatep is considering giving support to several minor banks.

According to Khodorkovsky, while some of the bankers at the meeting disagreed with Yeltsin's proposals, others were more sympathetic but asked for legislation detailing the responsibilities of the larger banks.

One Western banker, however, said that any such scheme is likely to be a non-starter.

"Why would you want to take over a failing bank?" asked Miljenko Horvat, president of Citibank-Russia. "It would simply mean that losses would be spread over a wider range of depositors."

Khodorkovsky said two factors had drained money from the markets in recent months: state treasury bills and Central Bank reserve requirements.

Banks bought around 23 trillion rubles worth of T-bills in the second quarter of this year, eating up much of the 50 trillion rubles the Central Bank released during this period.

In April, new Central Bank reserve requirements took effect. Khodorkovsky estimated that banks had to pay around 10 trillion rubles into central reserves.

"They sucked and sucked money away, step by step as the reserve requirements began to bite," he said.

Khodorkovsky and other bankers are calling for a decrease in the size of the Central Bank's compulsory reserves to increase liquidity. They would also like easier access to their reserves when the need arises.

Some say Russia's banks have emerged from last week's crisis with flying colors, considering the potential for a full-fledged banking crash.

"I think that overall they've come through rather well," said Thomas Reed, an economist with AIOC Capital. "This week has shown a rather quick recovery from a potentially serious problem."