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. Last Updated: 07/27/2016

Crisis Should Prompt Real Bank Reform

Russia's banking crisis is long overdue. No one wants to see this turn into a widespread banking crash, but being brought almost to the brink should provide the impetus for a serious rethink of how the industry is regulated.

Developed economies generally have no more than a few dozen banks. Russia, by contrast, boasts well over 2,500 of them, with an average of two branches each.

The vast majority of Russia's banks are shoebox-style operations with little capital. Worse, many have criminal ties, while others are little more than "pocket" banks, with their business closely linked to one company.

Ironically, Russia's banks profited from the economic chaos that swept Russia in the wake of liberalization in 1992. High inflation and a tumbling ruble spelled large profits on currency and loan operations, and many of Russia's larger banks have as much as 50 percent of their liquid assets tied up in the interbank currency and credit markets.

As the economy stabilizes, however, the ruble corridor and falling inflation rates are putting an end to that state of affairs. It is no accident that the more astute banks are already active in financing investment in industry, services and infrastructure.

It is tempting to say that a full-fledged banking crash would help sort the wheat from the chaff. The damage left in the wake of such a crash, however, would have devastating consequences for both Russia's economy and for its political stability. Literally millions of small depositors would stand to lose their savings. Businesses would see their funds vanish into thin air.

In this context, the Central Bank is right to offer banks the lifeline of short-term credits to tide them over until the liquidity crisis eases. On their own, however, credits will resolve nothing and will simply delay the inevitable. Other steps urgently need to be taken to regulate the banking world.

The key measure must be to raise substantially charter capital requirements for all banks. The current level of 6 billion rubles ($1.3 million) is way too low given that Russia's banks have assets in excess of $70 billion. Many banks have substantially less capital than even this meager amount because the requirement applies only to new banks.

Higher charter capital requirements would provide a serious obstacle to would-be banks. Existing banks, too, should be required to increase their capitalization, forcing them into a round of mergers and acquisitions that could eliminate many of the worst banks without the hardship of a banking crash.

Russia has already allowed its banks to get away with too much for too long. Reform of the banking system is inevitable and the Central Bank must start now.