The Wet-Finger Approach

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There is a lot of commentary these days about Russian loan loss rates, but the data needs to be understood in terms of the Russian context. Take, for example, the panic and confusion caused by overdue payments. After listening to Western analysts, you might think that Russian banks are about to fail en masse before the end of the year. It is as wrong to be over-pessimistic and think the economy is about to melt down as it was to be over-optimistic a year and a half ago and say the ruble will be a reserve currency in the near future.

For example, the overdue payment ratio is a sensitive and rapid indicator of changes in the risk-profile of a bank's loan book. It is not a proxy for nonperforming loans. The two are related in the same way as the price of a barrel of oil affects the retail price of fuel at the gas station. So quoting the overdue payment ration figure and calling it a nonperforming loan ratio only generates the wrong impression. Sweeping inferences on bank losses with far-reaching implications should be based on more than partial data.

Take the situation with overdue payments on retail loans. Up until August 2008, these ran at about 3.6 percent. From October to February, they jumped to 4.6 percent because of the announcement of a government initiative to restructure mortgages that was never carried out. In the meantime, by March, overdue payments on retail loans actually declined to 4.1 percent. While there was a small upturn in April, certainly this does not constitute the meltdown that some analysts claim.

It is also important to understand the motivation for public pronouncements by some Russian banks. I strongly suspect that certain banks that made loans to government-supported firms need to "cry wolf" to try to get these loans paid back. Thus, public posturing in the media becomes part of the negotiating process in certain cases.

What we all really need to know is the answer to two questions: 1. In this period of recession, are banks generating sufficient cash from their loans -- even if restructured -- to cover current operations? 2. Has the recession cut the long-term value of the loan portfolio so much that the banks owe more than they can repay?

Western analysts have focussed on International Financial Reporting Standards accounting data and have not developed the methodology to interpret Russian accounts. At best, the data is available on a quarterly basis, but their statements are usually annual and delayed by over three months. Only Russian accounting data is available for the entire banking system. The result is research based on International Financial Reporting Standards concepts, such as nonperforming loans, but with numbers taken from Russian accounts. The conclusions are as accurate as sticking a wet finger in the air and declaring a value for the wind speed to 10 decimal places.

Although the Central Bank has been quite positive about its assessment of the Russian banking system and its ability to survive the crisis, there has been a gap between the data it makes available on its web site and its conclusions. Skeptical commentators who remember some overly optimistic pronouncements of a decade ago posit that the Central Bank does not know the real situation. My research tends to support the view that the system is far stronger than most in the West believe. Nevertheless, the Russian economy would benefit from more transparency. In particular, there is a need for publicly available data, taken from accounting figures, to provide a direct measure on the true solvency of banks. Some of this data is available, and we are in the process of reviewing it to determine a clearer picture of the country's bank loss situation.

How badly will the Russian banks as a system be affected? If the economy floats out of its troubles on the rising tide of oil prices, the second wave of nonrepayments will be little more than a manageable ripple. If, however, the recession continues, then one or two more banks, already wallowing as a result of overly risky lending practices but still managing their current situation, may be swamped. In either case, we would all benefit from clearer thinking based on better data rather than guesses in the dark.

Richard Hainsworth is CEO of RusRating.