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. Last Updated: 07/27/2016

GKO Conundrum for Dubinin

Sergei Dubinin, the current chairman of Russia's Central Bank, used to be a university lecturer in economics. In a recent academic seminar, he predicted Mother Russia would in 1996 see a round of bank collapses somewhat more serious than the mini-crisis of August 1995. A quick lesson in the history of contemporary Russian banking makes Dubinin's view plausible. But at the same time, it is a view which even he may need to qualify.

Banks in these parts developed rather differently than their Central and East European cousins. High Russian inflation wiped out the official loan portfolios of the Soviet monoliths, they lost their political clout and collapsed into a number of smaller operations. Meanwhile, a lack of regulation meant a rabble of private commercial banks sprung up from nowhere.

In most Central European countries, where inflation was lower, the financial landscape is still dominated by a handful of huge state banks. Russia, in contrast, has a large -- but diminishing -- number of de novo private banks, several of which have hit the big time, but most of which are tiny.

At the center of Dubinin's view is the observation that a fiscal squeeze has pushed many industrial firms to the brink of bankruptcy, rendering them unable to service their loans. This is true.

However, it is worth mentioning that a sizable proportion of Russia's 2,500 or so banks are "pocket" banks, being set up by state enterprises explicitly to channel state handouts. Because federal subsidies to enterprises have fallen from 32 percent of GDP in 1992 to almost nothing today, the pocket banks are a bit short of business. But that's a good thing. They aren't banks at all.

In addition to the pocket banks, most other Russian banks are also very weakly capitalized -- in fact, 51 percent of Russian banks have a share-capital less than 500 million rubles -- or $100,000. Such "tiddlers" have survived by panhandling for hard-currency interest pickings during delays between the presentation of funds and settlement.

Another reason why more bank failures are likely is that even these profits have disappeared.

The reason is not that the clearance system has become more efficient, but the real appreciation of the ruble. If the nominal value of the ruble is "fixed," continued inflation means the ruble appreciates in real terms. This foils the tiddlers' survival strategy.

In fact, the introduction of the ruble corridor in July was a major reason for the August crisis -- tiddlers went to the wall as the real value of the ruble rose. Continued ruble appreciation is squeezing those that remain.

It is reassuring that Central Bank chief Dubinin has his finger on the pulse of his own industry: In a recent survey of 1,300 bankers, 45 percent said a crisis is "very likely," 44 percent said "likely," and a mere 11 percent said "unlikely." Clearly, the bankers themselves agree with him.

What is not reassuring is the observation that Dubinin currently faces an unenviable conflict of interest.

Since he took the bank's helm, the monetary authorities have taken active steps to lower yields on GKOs, state treasury bills. Putting the recent foreigner "access" charade to one side, since the beginning of December, there has been considerable Central Bank intervention on the GKO secondary market in an earnest attempt to rein in the official cost of domestic borrowing.

While Dubinin may in fact be glad the pocket banks are squirming, and the tiddlers as well, it is all too clear that messing with GKO yields has unfortunate side effects. The Central Bank wants to bring an elite of private domestic banks to the edge of international respectability, allowing Russia to jump on the global superhighway of corporate finance.

Most of the candidates for elite status are currently capitalizing themselves on the strength of high GKO yields. Dubinin's secondary market intervention -- while thoroughly responsible from a fiscal point of view -- nevertheless undermines the stockpiling efforts of the emerging banking thoroughbreds.

In fact, while the de novo banking elite are using the GKO market to build capital, a lot of the non-tiddler, non-pocket bank residue are using it as an oxygen mask. Tiddlers and pocket banks can sink with no worries. But given the importance of GKO profits to Russia's banking "middle class," Dubinin's next lecture could well belie his economics background.

On the one hand we want lower GKO yields, but on the other ...